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The core of the financial crisis of 2008 consisted of unsound practices in mortgage underwriting and mortgage finance. A number of regulatory developments helped to stimulate the boom in mortgage lending and securitization.

… Based on my research and the findings of this paper, perhaps the most useful steps that policy makers could take to prevent a recurrence of the financial markets crisis would be to tilt policies away from debt finance. One way to encourage a more stable housing market would be to provide less encouragement to mortgage indebtedness. With larger down payments and smaller mortgages, there would be less of a self-reinforcing effect of house price appreciation, speculative demand, and mortgage credit availability.

Policy makers should also rethink the mortgage interest deduction and reconsider the role played by Freddie Mac and Fannie Mae. If, without the GSEs, mortgage financing reverted to a traditional lending undertaking by banks, that might prove to be more sound, particularly if monetary policy keeps inflation under control.

A number of experts believe that aggressive enforcement of the 1970s-era Community Reinvestment Act contributed to the mortgage meltdown, and thus to the greater financial crisis, by requiring financial institutions to lend to unqualified borrowers. Now, the Democratic majority in the House of Representatives is responding to that situation by proposing to expand the scope and power of the Community Reinvestment Act.

This morning House Financial Services Committee chairman Rep. Barney Frank held a hearing on H.R. 1479, the "Community Reinvestment Modernization Act of 2009." The bill's purpose is "to close the wealth gap in the United States" by increasing "home ownership and small business ownership for low- and moderate-income borrowers and persons of color." It would extend [the] CRA … to non-bank institutions like credit unions, insurance companies, and mortgage lenders. It would also make CRA more explicitly race-based by requiring CRA standards to be applied to minorities, regardless of income, going beyond earlier requirements that applied solely to low- and moderate-income areas.

Republicans on the committee strongly oppose the plan. "Instead of looking to expand the number of institutions that must abide by Community Investment Act regulations," California Rep. Ed Royce said in prepared opening remarks at today's hearing, "I think we should reassess the role this and other government mandates played in the financial collapse and consider scaling it back."

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