CRA, Fannie/Freddie Theory

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The idea of the CRA->Fannie/Freddie theory (CRAFFT) is as follows:

Inflating the bubble

  • (1) Fannie/Freddie (F/F) was created to help the poor get better loans (sell sub-prime loans, using MBS’s).
  • (2) The CRA (Community Reinvestment Act) started under Carter, magnified under Clinton (and Bush), and was a way for communities to use Community Organizers (ACORN, Obama, etc), to punish banks/bankers who didn’t loan enough to sub-prime customers. (They could harass them in their homes using transparency rules, or businesses, block mergers, and new offices and so on). So it was created to encourage/force banks to take more risk in these high risk (sub-prime) loans in inner-city and under-developed areas. (They’re higher risk because poorer people don’t have the up-front capital, worse credit histories and don’t have the resources/judgement if things go bad).
  • (3) Think of F/F as the carrot (they buy/bundle/resell these loans into MBS’s), and CRA was the stick (community organizers punish banks that aren’t giving out enough liar loans in their community) .
  • (4) Fannie/Freddie had quotas (forced on them by congress) on who they had to loan to (ratios), and this was continuously getting pushed down by politicians (Democrats especially, since this was more of their base). In 1992 30% had to be loans to those below the median income, and by 2008 that hit 56% of all loans. To get that many loans out there, F/F had to keep dropping the standards on who would qualify for a loan. And banks got to comply as that’s what F/F was buying, and the CRA would punish them.
  • (5) Banks didn't know how much risk was in the system (F/F doesn't report well on total types of loans, etc), banks only knew what F/F was buying from them (individually). And these unsecured sub-prime mortgages were being snapped up by the government (F/F), so Banks were happy to keep selling them. ( It's a Banks job to sell the loans that others are buying). Banks did hold some of these loans themselves: 24% of all these loans were held by banks directly (it looked like good returns), but 76% were held by Government agencies. So if you weigh who was more culpable banks or government there's your weighting right there. Government blamed banks, because they weren't going to own their own mistake.
  • (6) Banks started following Fannie/Freddie and bundling their own MBS's as well (they had always bought/sold/bundled loans too). Still, remember Fannie/Freddie is bigger than all the banks combined, and they set most of the standards. If banks didn't lower their risk profile to match Fannie/Freddie then they won’t be selling enough loans to keep on CRA’s good graces. When Franklin Raines took over Fannie (Clinton appointee), he said he wanted to use the influence of Fannie and Freddie to induce the private sector to lower credit standards. The banks FOLLOWED Fannie/Freddie.
  • (7) Politicians/Congress also incentivized the population to take on this debt through tax policies like home interest deduction, and inflationary spending will drive up the costs of everything (meaning you HAVE to put you money in investments like housing, or it will lose it's value).

This is why politicians didn't attack commercial bankers: getting them on the stand would mean they would explain to the public what happened, and it would all point back to the politicians/government (democrats especially, as they controlled congress/senate). So they would demagogue that it was all their fault, but they wouldn’t give them the microphone of any high publicity trials to defend themselves. And the left-leaning media wasn’t going to let them explain how the business works.

❝ There are many flavors of the same explanation for how the bubble got inflated, but they all cover this same material. Peter has a great synopsis: Book: Hidden in Plain Sight

Bursting the Bubble

❝ Now whether you think Glass-Steagall or CRA/Fannie/Freddie caused the bubble,
the following happened after the bubble popped. ❞

When things go bad, they go really bad:

  • The problem is with all these sub-prime loans, too many folks had nothing down, poor government oversight to get in, as soon as the market goes down at all, lots of the people can walk away with no risk or accountability. They have no skin in the game. So we had our first down-blip in 20 years, and many people in sub-primed started defaulting on the loans (like many had warned).
  • That put way too much real-estate on the market at the same time, which caused crashing housing values.
  • And that loss of paper equity (for many Americans), convinced people to invest less, or take money out of their stock accounts (causing stock market to go down). Wall St. didn't cause this, they were a victim of it.

My similar experiences with HUD can read about here:

Housing and Urban Development

HUD (Housing and urban development) has various programs that are meant to help low income and first time buyers into their own homes. Sounds great, right? Too many people can’t afford a house, so a little wealth redistribution ought to help them out? Yet, in many cases the opposite has happened. Here's my story about some of the negative and unintended consequences of HUD.

Freezing the Credit Market

  • Once the housing costs started dropping, people started defaulting on those bad loans. And that caused the crisis.
  • Republicans had fought for more transparency and regulation of Fannie/Freddie (from 2001-2006), but Democrats in congress (Barney Frank especially, Chair of the House Finance Committee) was able to block all those efforts. Bush spoke on this a few times during that time, but he was burning his political capital on Iraq, so his pull was limited. Democrats obstructed this because these community organizers and special interests were a powerful lobby that paid handsomely, and their voters were the recipients of all these sub-prime loans, so as long as housing costs were going up, it looked like everything was great. (And if it went down, they could point fingers, and their constituents were gullible enough to buy-in. Win-win!)
  • MBS's were complex and opaque (as F/F had been designed: to hide the poison and get everyone to drink a little), but that meant that when the market was correcting, no one was sure how much poison they had (how many of these bad loans and what areas) were going to be impacted and how much exposure you had in your securities. And that was going to take 12-24 months to unravel and figure out.
  • Banks were regulated by law to keep a certain debt-to-asset ratios -- so if their assets (MBS's) were dropping, they couldn't loan to people, or to other banks. Thus government regulations required that they seize up the cashflow, and sell some assets (MBS's) to get their debt-to-equity (cash) balances right.
  • Democrats (in 2007) had passed something called FAS 157 which said that banks had to use Financial Terms#Mark-to-Market accounting. Before this banks could value their assets based on things like a 3 or 5 year rolling average of asset sales (to slow up/down trends). Mark-to-market said they had to peg all their like assets value, to the last market sale: immediately!
  • Since Bank-A had to sell MBS's (because of their debt-to-equity ratio), and no one was buying them (since the bank couldn't explain how much poison/exposure F/F had stuffed in them), then they were required to sell for whatever the market would bear. Let's say that bank was stressed and had to take $.10 on the dollar (10% of prior value, immediately). Boom, every other bank had to mark all their assets to the last market sale, and all their like assets dropped 90% in value immediately. Which meant they too had to sell more assets (to get their asset ratios up), and certainly couldn't loan money. And the markets froze! No one would loan (to keep their debt-to-equity rates up), and thus companies suddenly couldn't buy the inventory (which they buy on credit) to keep operating/growing/etc. It was going to be ruin that made the 1929 crash look like cakewalk.


Unlike the Glass-Steagall Theory, which only explains the parts of the problems the Democrats want to look at (with their usual scapegoating the evil banks and bankers for selling sub-prime loans), and allowing them to vilify the Republicans and lack of Regulations. This CRAFFT theory explains why the Bankers would do this (if it ultimately almost destroyed them), and also covers why the credit markets froze and how TARP (just loaning money to the banks) would help cure the problem. It fixed their debt-equity ratios, and that let them loan again.

You could have un-froze the market by just removing mark-to-market accounting regulations: but that would have required Democrats to admit they were wrong in passing them, and they would have rather let the economy burn to the ground that admit that or grow as humans. So instead of Bush behaving as poorly as Democrats and screaming and finger pointing, he took the high road, and created a "blameless" solution (and gave Democrats some cover), in order to save the economy.

The GST theory is great at pointing fingers at who (if you don't know how anything actually works, and aren't curious enough to ask). But it sure doesn't tell you the what, why, how like the CRAFFT theory does.


Financial crisis of 2007-2008 : CRA, Fannie/Freddie TheoryBig Fraud TheoryGlass-SteagallFinancial Terms