As policymakers consider ways to address the current mortgage crisis, it is important to evaluate new proposals with an eye toward their future effects on the economy. The unintended consequences of government programs can have far-reaching economic and social effects. It’s important to keep in mind that government intervention played a central role in creating and elevating the current crisis: Interest rate manipulation, tax code loopholes, and “smart growth” land-use policies all contributed to artificially inflating home prices and shifting nvestment counter to real demand.
A prime example of a public program gone awry—and one of the key causes of the current credit crisis—is the Community Reinvestment Act (CRA). CRA was designed to ensure that all homeowners were treated “equally” by avoiding “redlining,” the deliberate shifting of financing away from low-income or high-risk areas. While CRA was designed to serve a positive goal, the economic implications of the new regulation were far more complicated. CRA required mortgage lenders to provide loans to riskier clients, often in stark contrast to what market forces may have dictated. This was done by incentivizing mortgage lenders to make loans for homes in certain zip codes and also by penalizing perceived failures to do enough.
These new loans spawned the subprime mortgage market, a financial sector that is now embroiled in controversy, whose collapse triggered the current downward economic trend. CRA is in many ways socialized financing, forcing banks to lend counter to market trends, thus increasing the risk of failure. We are now caught in a financial downturn that has emerged as a direct result of these risky loans. Any expansion of CRA that limits market flexibility and unnecessarily increases risk is not good policy: A financial collapse benefits no one.
The Virginia Cost Cutting Caucus believes that a more transparent, accountable and competitive government will yield better services at a lower cost to the taxpayers. Started in 2001, we work to foster a meaningful dialogue within the legislature on spending practices and substantive reform.