The Housing Chronicles Blog: Blame the Community Reinvestment Act?

Tuesday, September 30, 2008

Blame the Community Reinvestment Act?

There's been a lot of noise lately on the culpability of the Community Reinvestment Act (CRA), which reportedly encouraged (some say forced) lenders to make subprime loans to those who couldn't afford it in the name of increasing homeownership.

So what is the CRA? First, from a Wikipedia entry:

The CRA was passed by the 95th United States Congress and signed into law by President Jimmy Carter in 1977 as a result of national grassroots pressure for affordable housing, and despite considerable opposition from the mainstream banking community.[1] Only one banker, Ron Grzywinski from ShoreBank in Chicago, testified in favor of the act.[2] The CRA mandates that each banking institution be evaluated to determine if it has met the credit needs of its entire community. That record is taken into account when the federal government considers an institution's application for deposit facilities, including mergers and acquisitions after the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 repealed restrictions on interstate banking.[3] However, until 1995 the Act was laxly enforced and banks only were required to advertise in local minority newspapers or sit on the boards of local community groups.[4] The CRA is enforced by the financial regulators (Federal Deposit Insurance Corporation ("FDIC"), Office of the Comptroller of the Currency ("OCC"), Office of Thrift Supervision ("OTS"), and the Federal Reserve System.[citation needed] It also charged the Federal Reserve System to implement the CRA through ensuring banks and savings and loans met their CRA obligations.

So what's the controversy? Again, from Wikipedia:

Some economists and financial experts have wondered if the CRA was - or at least had become - irrelevant, because it was not needed to force banks to make profitable loans to a variety of lenders.[11][12] Economist Howard Husock writes that a CRA-connected community group The Woodstock Institute found in a survey in the Chicago-area that even banks not subject to CRA tended to loan in a variety of neighborhoods. He also criticized as an "amateur delivery system" community groups' involvement in marketing loans.[4] Federal Reserve chairman Ben Bernanke has stated that an underlying assumption of the CRA – that more lending is always better for local communities – is questionable.[3]

Economist Stan Liebowitz notes that the Fannie Mae Foundation singled out Countrywide Financial as a "paragon" of a nondiscriminatory lender who works with community activists, following "the most flexible underwriting criteria permitted." The chief executive of Countrywide is said to have "bragged" that in order to approve minority applications, "lenders have had to stretch the rules a bit." Countrywide's commitment to low-income loans had grown to $600 billion by early 2003.[13] On the other hand, Professor of Law Michael S. Barr stated in congressional testimony that a Federal Reserve survey showed that affected institutions considered CRA loans profitable and not overly risky.[14]

Congressman Ron Paul has partially attributed the ongoing subprime mortgage crisis to legislation such as the Community Reinvestment Act.[15] A Wall Street Journal editorial argued that the law compelled banks to make loans to poor borrowers who often could not repay them and that this contributed in part to the subprime crisis.

So what's the story? Are these charges true? An blog post in BusinessWeek says no:

Fresh off the false and politicized attack on Fannie Mae and Freddie Mac, today we’re hearing the know-nothings blame the subprime crisis on the Community Reinvestment Act — a 30-year-old law that was actually weakened by the Bush administration just as the worst lending wave began. This is even more ridiculous than blaming Freddie and Fannie...

Not surprisingly given the higher degree of supervision, loans made under the CRA program were made in a more responsible way than other subprime loans. CRA loans carried lower rates than other subprime loans and were less likely to end up securitized into the mortgage-backed securities that have caused so many losses, according to a recent study by the law firm Traiger & Hinckley (PDF file here).

Finally, keep in mind that the Bush administration has been weakening CRA enforcement and the law’s reach since the day it took office. The CRA was at its strongest in the 1990s, under the Clinton administration, a period when subprime loans performed quite well. It was only after the Bush administration cut back on CRA enforcement that problems arose, a timing issue which should stop those blaming the law dead in their tracks. The Federal Reserve, too, did nothing but encourage the wild west of lending in recent years. It wasn’t until the middle of 2007 that the Fed decided it was time to crack down on abusive pratices in the subprime lending market. Oops.

Better targets for blame in government circles might be the 2000 law which ensured that credit default swaps would remain unregulated, the SEC’s puzzling 2004 decision to allow the largest brokerage firms to borrow upwards of 30 times their capital and that same agency’s failure to oversee those brokerage firms in subsequent years as many gorged on subprime debt. (Barry Ritholtz had an excellent and more comprehensive survey of how Washington contributed to the crisis in this week’s Barron’s.)

There’s plenty more good reading on the CRA and the subprime crisis out in the blogosphere. Ellen Seidman, who headed the Office of Thrift Supervision in the late 90s, has written several fact-filled posts about the CRA controversey, including one just last week. University of Oregon professor and economist Mark Thoma has also defended the CRA on his blog. I also learned something from a post back in April by Robert Gordon, a senior fellow at the Center for American Progress...

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