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 FINANCIAL CRISIS INQUIRY COMMISSION REPORT

In , President Bill Clinton asked regulators to improve banks’ CRA perform-
ance while responding to industry complaints that the regulatory review process for
compliance was too burdensome and too subjective. In , the Fed, Office of Thrift
Supervision (OTS), Office of the Comptroller of the Currency (OCC), and Federal
Deposit Insurance Corporation (FDIC) issued regulations that shifted the regulatory
focus from the efforts that banks made to comply with the CRA to their actual re-
sults. Regulators and community advocates could now point to objective, observable
numbers that measured banks’ compliance with the law.
Former comptroller John Dugan told FCIC staff that the impact of the CRA had
been lasting, because it encouraged banks to lend to people who in the past might not
have had access to credit. He said, “There is a tremendous amount of investment that
goes on in inner cities and other places to build things that are quite impressive. . . .
And the bankers conversely say, ‘This is proven to be a business where we can make
some money; not a lot, but when you factor that in plus the good will that we get
from it, it kind of works.’” 
Lawrence Lindsey, a former Fed governor who was responsible for the Fed’s Divi-
sion of Consumer and Community Affairs, which oversees CRA enforcement, told
the FCIC that improved enforcement had given the banks an incentive to invest in
technology that would make lending to lower-income borrowers profitable by such
means as creating credit scoring models customized to the market. Shadow banks
not covered by the CRA would use these same credit scoring models, which could
draw on now more substantial historical lending data for their estimates, to under-
write loans. “We basically got a cycle going which particularly the shadow banking
industry could, using recent historic data, show the default rates on this type of lend-

ing were very, very low,” he said. Indeed, default rates were low during the prosper-
ous s, and regulators, bankers, and lenders in the shadow banking system took
note of this success.

SUBPRIME LENDERS IN TURMOIL:
“ADVERSE MARKET CONDITIONS”

Among nonbank mortgage originators, the late s were a turning point. During
the market disruption caused by the Russian debt crisis and the Long-Term Capital
Management collapse, the markets saw a “flight to quality”—that is, a steep fall in de-
mand among investors for risky assets, including subprime securitizations. The rate
of subprime mortgage securitization dropped from . in  to . in .
Meanwhile, subprime originators saw the interest rate at which they could borrow in
credit markets skyrocket. They were caught in a squeeze: borrowing costs increased
at the very moment that their revenue stream dried up. And some were caught

holding tranches of subprime securities that turned out to be worth far less than the
value they had been assigned.
Mortgage lenders that depended on liquidity and short-term funding had imme-
diate problems. For example, Southern Pacific Funding (SFC), an Oregon-based sub-
prime lender that securitized its loans, reported relatively positive second-quarter