Our guest blogger is Tim Westrich, a Research Associate at the Center for American Progress Action Fund.

In a front page article in today’s American Banker (subscription required), Peter Wallison, a Fellow at the conservative American Enterprise Institute and a promoter of deregulation, shows that he has a backward understanding of the financial mess.

The root cause of the financial mess is the hands-off approach towards mortgage and finance markets by the Bush administration, and its lack of action when a disaster was imminent. But desperate to point the finger elsewhere, conservatives are blaming the Community Reinvestment Act, a 1977 law that covers banks and thrifts and was intended to reverse the discriminatory lending process known as redlining.

CRA-covered institutions succeed at bringing conventional, prime loans to lower-income communities, while non-covered institutions are the ones that drove bad practices. However, Wallison would have us believe it’s the other way around:

“[CRA] caused standards for mortgages to deteriorate very substantially because it forced banks to find new ways to offer mortgages to people who couldn’t meet the normal standards,” said Peter Wallison, a fellow at the American Enterprise Institute and a member of the Shadow Financial Regulatory Committee. “Then those lower standards spread to the rest of the mortgage markets, so people who could have qualified for prime loans were able to get interest-only or negative amortization loans, and all of those things became more or less the standard for mortgage loans.”

Wallison is not alone among conservatives who are blaming the mess on the poor and advocates for the poor. However, studies show that CRA works at what it was intended to do. And moreover, federal regulators — including Federal Reserve Board Governor Randall S. Kroszner and Comptroller of the Currency John C. Dugan — have said there’s no link between CRA and the mortgage crisis

The real culprits in the mortgage mess are non-bank mortgage companies — not covered by CRA — that originated the lion’s share of bad mortgages at the heart of the crisis. They made an estimated 50 percent of subprime loans in 2005. Another 30 percent of loans were made by non-bank subsidiaries of banks or thrifts, which are allowed — at their option — to use their subsidiaries’ loans to count toward their CRA rating.

Today, Treasury Secretary Henry Paulson added to his growing list of ill-aimed responses to the financial crisis. Treasury is reportedly “considering a plan to intervene directly in the mortgage industry,” under which it would “buy securities that finance newly issued loans for home purchases.” The justification is that “subsidizing lower mortgage rates with taxpayer dollars would help revive the housing market.”

Now, Paulson is finally headed in the right direction, offering a plan to purchase mortgage securities. However, buying securities for newly issued loans does nothing to stem foreclosures, and thus misses the point of purchasing securities entirely. The problem in the financial system was not caused by recently issued mortgages, but by toxic mortgages that are already on the books.

Chairman of the Federal Reserve Board Ben Bernanke last week took an important step by directing the Fed to purchase mortgage backed securities from Fannie Mae and Freddie Mac. In a speech today, Bernanke explained the “public policy case for reducing preventable foreclosures”:

Foreclosures create substantial social costs. Communities suffer when foreclosures are clustered, adding further to the downward pressure on property values. Lower property values in turn translate to lower tax revenues for local governments, and increases in the number of vacant homes can foster vandalism and crime. At the national level, the declines in house prices that result from the addition of foreclosed properties to the supply of homes for sale create broader economic and financial stress.

Bernanke endorsed a “promising proposal” — similar to one crafted by the Center for American Progress — which “would have the government purchase delinquent or at-risk mortgages in bulk and then refinance them,” and thus “take advantage of the depressed market values of such mortgages.”

Already at the forefront of the push to stem foreclosures is Sheila Bair, Chairman of the Federal Deposit Insurance Corp. However, Bloomberg reported today that Timothy Geithner, the incoming Treasury Secretary, is looking to push Bair “out of office.” The Obama economic team has allegedly decided that “she won’t play a central role in policy,” even though Obama said yesterday that “We’ve got to start helping homeowners, in a serious way, prevent foreclosures.”

If Obama is serious about helping homeowners, it would be a mistake to freeze Bair out. At Bloggingstocks, Jim Cramer explained why Bair is “the franchise player to build around“:

When Indymac was seized (something I wish she had done earlier, but she waited as long as she could), she and her organization became the laboratory, the great central testing zone for what will work and what won’t work to stem foreclosures, the root cause of all of our financial problems. She was ignored, systematically ignored, even though she had the knowledge base.

Paulson has insisted on doing everything except addressing foreclosures. Bair, meanwhile, has found a formula that works. To purge her makes no sense at all.