Whim and Fear

Many pundits have laid much of the blame for the housing bubble and the subsequent economic turmoil on the Community Reinvestment Act (CRA). The Act was first enacted in 1977. It was revised in 1995 and amended in 2005. According to the Federal Reserve web site:

CRA requires that each depository institution's record in helping meet the credit needs of its entire community be evaluated periodically. That record is taken into account in considering an institution's application for deposit facilities.

Neither the CRA nor its implementing regulation gives specific criteria for rating the performance of depository institutions. Rather, the law indicates that the evaluation process should accommodate an institution's individual circumstances. Nor does the law require institutions to make high-risk loans that jeopardize their safety. To the contrary, the law makes it clear that an institution's CRA activities should be undertaken in a safe and sound manner. [emphasis added]

In other words, lending institutions are supposed to "meet the credit needs of its entire community" but the standards that will be used to make this evaluation are left to the discretion of regulators--after the fact. A lending institution can only guess as to what criteria will be used, and if it guesses wrong, it could be subject to the wrath of regulators. Such non-objective laws place businesses at the complete whim of bureaucrats.

As Ayn Rand wrote in "The Nature of Government":

All laws must be objective (and objectively justifiable): men must know clearly, and in advance of taking an action, what the law forbids them to do (and why), what constitutes a crime and what penalty they will incur if they commit it.

The result of the CRA is that lenders had little choice but to lower their standards. If they didn't, they could be accused of breaking the law. And when they lowered their standards, they subjected themselves to defaults. The government however, covered its backside: "the law makes it clear that an institution's CRA activities should be undertaken in a safe and sound manner."

In short, the CRA forced lenders to extend loans that they previously thought imprudent--otherwise the lenders would have extended such loans--while simultaneously telling the lenders to be prudent. Thus, lawmakers were able to wash their hands of the entire affair and blame it on greedy bankers. "We told them to be careful," we can imagine legislators saying.

I cannot say to what extent the CRA contributed to the housing bubble and the subsequent economic turmoil. But it is clear that the CRA created an atmosphere of fear within the financial industry--the unknown edicts, standards, and whims of regulators were a constant threat hanging over the heads of lending institutions.

Non-objective law is precisely what the statists in Washington need to advance their cause. To quote Ayn Rand again:

An objective law protects a country’s freedom; only a non-objective law can give a statist the chance he seeks: a chance to impose his arbitrary will-his policies, his decisions, his interpretations, his enforcement, his punishment or favor-on disarmed, defenseless victims.

The financial industry was caught between the unknowable and the impossible. They were caught between the whims of regulators and the principles of sound lending. They could not appease the caprice of bureaucrats and also make a profit. They sacrificed their own judgment and integrity in an attempt to evade the realities of the market. In the end, reality won. It always does.