Friday, December 26, 2008

Don’t Blame the Community Reinvestment Act

It has almost become conservative orthodoxy to blame the current housing crisis on the Community Reinvestment Act. The line of argument is that the housing crisis was caused by loaning money to undeserving borrowers and these loans would not have been made if not due to pressure from the government forcing lenders to make bad loans. Despite this argument having been repeated over and over, I am not buying it.

When I have read some of the columnist making this claim, I have often wondered what expertise they had to support their conclusion and what evidence they had to support their claim. I often wonder if commentators are not listening to the echo chamber and repeating each other without a firm basis for reaching their conclusion.

The CRA has been around since 1976; only in the past three years did we start seeing the massive mortgage defaults. Since 1976 we have had many years of Republican dominance of the House and Senate and we have had Presidents Ford, Reagan, Bush 41 and Bush 43. If the CRA was so bad, why have Republicans not repealed it?

I have a background in mortgage lending and have been the Director of Housing Services for a non-profit housing counseling agency since 1996. I have helped hundreds of low-income people become homeowners. The people I helped have usually gotten FHA loans and had to meet standard underwriting guidelines. The help I provided was getting them eligible for the loans. I taught them money management skills, helped them repair and improve their credit and educated them to be good consumers. They often did get down payment assistance, but otherwise met the same underwriting guidelines as everyone else who got good loans.

Below is a condensed version of a speech given by Federal Reserve Board Governor Randall S. Kroszner at the Confronting Concentrated Poverty Policy Forum of the Board of Governors of the Federal Reserve System in Washington, D.C. on December 3, 2008.

Before becoming a member of the Federal Reserve Board, Dr. Kroszner was Professor of Economics at the Graduate School of Business of the University of Chicago from 1999 to 2006. He was also Assistant Professor (1990-1994) and Associate Professor (1994-1999) at the University. Dr. Kroszner was Director of the George J. Stigler Center for the Study of the Economy and the State and editor of the Journal of Law & Economics. He was a visiting scholar at the American Enterprise Institute, a research associate at the National Bureau of Economic Research, and a director at the National Association for Business Economics. Dr. Kroszner also was a member of the Federal Economic Statistics Advisory Committee at the Bureau of Labor Statistics in the Department of Labor.

You will note that Dr. Kroszner is well credentialed including an association with AEI, a free market think tank. I think Dr. Kroszner’s evaluation is a more accurate portrayal of the roll of the CRA in the current crisis than what we are hearing from many conservative columnist.

The Community Reinvestment Act and the Recent Mortgage Crisis
By Randall S. Kroszner

Some critics of the CRA contend that by encouraging banking institutions to help meet the credit needs of lower-income borrowers and areas, the law pushed banking institutions to undertake high-risk mortgage lending. We have not yet seen empirical evidence to support these claims, nor has it been our experience in implementing the law over the past 30 years that the CRA has contributed to the erosion of safe and sound lending practices. The findings of a recent analysis of mortgage-related data by Federal Reserve staff runs counter to the charge that the CRA was at the root of, or otherwise contributed in any substantive way, to the current subprime crisis.

In the 1970s, when banking was still a local enterprise, the Congress enacted the CRA. The act required the banking regulators to encourage insured depository institutions--that is, commercial banks and thrifts--to help meet the credit needs of their entire community, including low- and moderate-income areas. The CRA does not stipulate minimum targets or goals for lending, investments, or services. Rather, the law provides incentives for financial institutions to help meet the credit needs of lower-income people and areas, consistent with safe and sound banking practices, and commensurately provides them favorable CRA consideration for those activities. By requiring regulators to make CRA performance ratings and evaluations public and to consider those ratings when reviewing applications for mergers, acquisitions, and branches, the Congress created an unusual set of incentives to promote interaction between lenders and community organizations.

Given the incentives of the CRA, bankers have pursued lines of business that had not been previously tapped by forming partnerships with community organizations and other stakeholders to identify and help meet the credit needs of underserved communities. This experimentation in lending, often combined with financial education and counseling and consideration of nontraditional measures of creditworthiness, expanded the markets for safe lending in underserved communities and demonstrated its viability; as a result, these actions attracted competition from other financial services providers, many of whom were not covered by the CRA.

In addition to providing financial services to lower-income people, banks also provide critical community development loans and investments to address affordable housing and economic development needs. These activities are particularly effective because they leverage the resources available to communities from public subsidies and tax credit programs that are targeted to lower-income people. In just the past two years, banks have reported making over $120 billion in community development loans nationwide. This figure does not capture the full extent of such lending, because smaller institutions are not required to report community development loans to their regulators.

Over the years, the Federal Reserve has prepared two reports for the Congress that provide information on the performance of lending to lower-income borrowers or neighborhoods--populations that are the focus of the CRA. These studies found that lending to lower-income individuals and communities has been nearly as profitable and performed similarly to other types of lending done by CRA-covered institutions. Thus, the long-term evidence shows that the CRA has not pushed banks into extending loans that perform out of line with their traditional businesses. Rather, the law has encouraged banks to be aware of lending opportunities in all segments of their local communities as well as to learn how to undertake such lending in a safe and sound manner.

Recently, Federal Reserve staff has undertaken more specific analysis focusing on the potential relationship between the CRA and the current subprime crisis. This analysis was performed for the purpose of assessing claims that the CRA was a principal cause of the current mortgage market difficulties. For this analysis, the staff examined lending activity covering the period that corresponds to the height of the subprime boom.

The research focused on two basic questions. First, we asked what share of originations for subprime loans is related to the CRA. The potential role of the CRA in the subprime crisis could either be large or small, depending on the answer to this question. We found that the loans that are the focus of the CRA represent a very small portion of the subprime lending market, casting considerable doubt on the potential contribution that the law could have made to the subprime mortgage crisis.

Second, we asked how CRA-related subprime loans performed relative to other loans. Once again, the potential role of the CRA could be large or small, depending on the answer to this question. We found that delinquency rates were high in all neighborhood income groups, and that CRA-related subprime loans performed in a comparable manner to other subprime loans; as such, differences in performance between CRA-related subprime lending and other subprime lending cannot lie at the root of recent market turmoil.

In analyzing the available data, we focused on two distinct metrics: loan origination activity and loan performance. With respect to the first question concerning loan originations, we wanted to know which types of lending institutions made higher-priced loans, to whom those loans were made, and in what types of neighborhoods the loans were extended. This analysis allowed us to determine what fraction of subprime lending could be related to the CRA.

Our analysis of the loan data found that about 60 percent of higher-priced loan originations went to middle- or higher-income borrowers or neighborhoods. Such borrowers are not the populations targeted by the CRA. In addition, more than 20 percent of the higher-priced loans were extended to lower-income borrowers or borrowers in lower-income areas by independent nonbank institutions--that is, institutions not covered by the CRA.

Putting together these facts provides a striking result: Only 6 percent of all the higher-priced loans were extended by CRA-covered lenders to lower-income borrowers or neighborhoods in their CRA assessment areas, the local geographies that are the primary focus for CRA evaluation purposes. This result undermines the assertion by critics of the potential for a substantial role for the CRA in the subprime crisis. In other words, the very small share of all higher-priced loan originations that can reasonably be attributed to the CRA makes it hard to imagine how this law could have contributed in any meaningful way to the current subprime crisis.

Of course, loan originations are only one path that banking institutions can follow to meet their CRA obligations. They can also purchase loans from lenders not covered by the CRA, and in this way encourage more of this type of lending. The data also suggest that these types of transactions have not been a significant factor in the current crisis. Specifically, less than 2 percent of the higher-priced and CRA-credit-eligible mortgage originations sold by independent mortgage companies were purchased by CRA-covered institutions.

I now want to turn to the second question concerning how CRA-related subprime lending performed relative to other types of lending. To address this issue, we looked at data on subprime and alt-A mortgage delinquencies in lower-income neighborhoods and compared them with those in middle- and higher-income neighborhoods to see how CRA-related loans performed. An overall comparison revealed that the rates for all subprime and alt-A loans delinquent 90 days or more is high regardless of neighborhood income. This result casts further doubt on the view that the CRA could have contributed in any meaningful way to the current subprime crisis.

Our analysis of the data on loan performance and the roll of the CRA revealed the following:
  • Some lower-income lending by institutions subject to the CRA law was outside their local communities and was unlikely to have been motivated by the CRA..
    Delinquency rates for subprime and alt-A loans in neighborhoods just below the CRA-eligibility threshold are very similar to delinquency rates on loans just above the threshold, hence not the subject of CRA lending.
  • Most foreclosure filings have taken place in middle- or higher-income neighborhoods; in fact, foreclosure filings have increased at a faster pace in middle- or higher-income areas than in lower-income areas that are the focus of the CRA.
  • In conclusion, I believe the CRA is an important model for designing incentives that motivate private-sector involvement to help meet community needs. Contrary to the assertions of critics, the evidence does not support the view that the CRA contributed in any substantial way to the crisis in the subprime mortgage market.

    To read the uncondensed version and see the supporting research, visit this link:

    Stumble Upon Toolbar
    My Zimbio
    Top Stories

    Tuesday, December 23, 2008

    Merry Christmas

    To all my Democratic family and friends:

    Please accept my best wishes for an environmentally sensitive, politically correct, socially responsible, health-conscious, gender-neutral, Merry Christmas or Happy Kwanza, or Happy Holiday or celebration of the winter solstice, practiced within the most enjoyable traditions of the religious persuasion of your choice, or secular practices of your choice. These wishes or sent to you, of course, with the utmost respect and sensitivity for the religious/secular persuasion and/or traditions of others, or their choice not to practice religious or secular traditions at all, as the case may be.

    I also wish you financial success, personal fulfillment and good health in this the onset of the generally accepted calendar year 2009, but not without due respect for your sensitivities of the calendars of choice of other cultures whose contributions to society have helped make America great. Not to imply that America is necessarily greater than any other country, of course. Also in wishing you a financial success that is not to imply that you seek to acquire more that your fair share of earth’s bounty or that your financial success would be acquired at the expense of others or that you would use that financial success to engage in vulgar consumerism; I just hope you have all you need to be happy. Also, this wish is made without regard to the race, creed, color, age, physical ability, religious faith or sexual preference of the recipient of these good wishes. Gee, I hope I haven’t offended you.

    To my very religious conservative friends and family:

    Merry Christmas! I apologize if I sent you a secular Christmas card instead of religious card or if I inadvertently said "Happy Holidays"; and yes, I know Christ is the reason for the Christ-mas season!

    To everyone else:

    Merry Christmas and Happy New Year!

    Stumble Upon Toolbar
    My Zimbio
    Top Stories

    Monday, December 22, 2008

    An Elephant Tale

    It seems that I get lots of heartwarming stories forwarded to me this time of the year. I normally do not post them or forward them, but I wanted to share this one. I hope you enjoy it as much as I did. This story has no political message and I will let you draw your own conclusion as to the moral of the story. Rod

    An Elephant Tale

    In 1986, Peter Davies was on holiday in Kenya after graduating from Northwestern University...
    On a hike through the bush, he came across a young bull elephant standing with one leg raised in the air. The elephant seemed distressed, so Peter approached it very carefully.
    He got down on one knee, inspected the elephants foot, and found a large piece of wood deeply embedded in it. As carefully and as gently as he could, Peter worked the wood out with his knife, after which the elephant gingerly put down its foot.

    The elephant turned to face the man, and with a rather curious look on its face, stared at him for several tense moments. Peter stood frozen, thinking of nothing else but being trampled. Eventually the elephant trumpeted loudly, turned, and walked away. Peter never forgot that elephant or the events of that day.

    Twenty years later, Peter was walking through the Chicago Zoo with his teenage son. As they approached the elephant enclosure, one of the creatures turned and walked over to near where Peter and his son Cameron were standing. The large bull elephant stared at Peter, lifted its front foot off the ground, then put it down. The elephant did that several times then trumpeted loudly, all the while staring at the man.

    Remembering the encounter in 1986, Peter could not help wondering if this was the same elephant. Peter summoned up his courage, climbed over the railing, and made his way into the enclosure. He walked right up to the elephant and stared back in wonder.

    The elephant trumpeted again, wrapped its trunk around one of Peter legs and slammed him against the railing, killing him instantly.

    Apparently it wasn't the same elephant.

    (If you would like to suggest a moral to the story or an analogy please feel free to post a reply. Rod)

    Stumble Upon Toolbar
    My Zimbio
    Top Stories

    Sunday, December 21, 2008

    Christmas Party Memo

    GCF: Christmas Party Memo
    FROM: Pat Lewis, Human Resources Director
    TO: Everyone
    RE: Christmas Party
    DATE: December 1

    I'm happy to inform you that the company Christmas Party will take place on December 23, starting at noon in the banquet room at Luigi's Open Pit Barbecue. No-host bar, but plenty of eggnog! We'll have a small band playing traditional carols... feel free to sing along. And don't be surprised if our CEO shows up dressed as Santa Claus!

    FROM: Pat Lewis, Human Resources Director
    DATE: December 2
    RE: Christmas Party
    In no way was yesterday's memo intended to exclude our Jewish employees. We recognize that Chanukah is an important holiday which often coincides with Christmas, though unfortunately not this year. However, from now on we're calling it our "Holiday Party." The same policy applies to employees who are celebrating Kwanzaa at this time.

    FROM: Pat Lewis, Human Resources Director
    DATE: December 3
    RE: Holiday Party
    Regarding the note I received from a member of Alcoholics Anonymous requesting a non-drinking table ... you didn't sign your name. I'm happy to accommodate this request, but if I put a sign on a table that reads, "AA Only"; you wouldn't be anonymous anymore. We're not trying to exclude anyone, honest! How am I supposed to handle this? Somebody?

    FROM: Pat Lewis, Human Resources Director
    DATE: December 7
    RE: Holiday Party
    What a diverse company we are! I had no idea that the party occurs during the Muslim holy month of Ramadan, which forbids eating and drinking during daylight hours. There goes the party! Seriously, we can appreciate how a luncheon this time of year does not accommodate our Muslim employees' beliefs. Perhaps Luigi's can hold off on serving your meal until the end of the party -- the days are so short this time of year or else package everything for take-home in little foil swans. Will that work?
    Meanwhile, I've arranged for members of Overeaters Anonymous to sit farthest from the dessert buffet and pregnant women will get the table closest to the restrooms. Did I miss anything?

    FROM: Pat Lewis, Human Resources Director
    DATE: December 8
    RE: Holiday Party
    So December 22 marks the Winter Solstice... what do you expect me to do, a tap-dance on your heads? Fire regulations at Luigi's prohibit the burning of sage by our "earth-based Goddess-worshipping" employees, but we'll try to accommodate your drumming circle during the band's breaks. Okay???

    FROM: Pat Lewis, Human Resources Director
    DATE: December 9
    RE: Holiday Party
    People, people, nothing sinister was intended by having our CEO dress up like Santa Claus! Even if the anagram of "Santa" does happen to be "Satan," there is no evil connotation to our own "little man in a red suit." It's a tradition, folks, like sugar shock at Halloween or family feuds over the Thanksgiving turkey or broken hearts on Valentine's Day. Could we lighten up for a minute

    FROM: Pat Lewis, Human Resources Director
    DATE: December 10
    RE: Holiday Party
    Vegetarians! ?!?!? I've had it with you people!!! We're going to keep this party at Luigi's Open Pit Barbecue whether you like it or not, so you can sit quietly at the table furthest from the "grill of death," as you so quaintly put it, and you'll get your salad bar, including hydroponic tomatoes. But you know, they have feelings, too. Tomatoes scream when you slice them. I've heard them scream, I'm hearing them scream right now!

    FROM: Teri Bishops, Acting Human Resources Director
    DATE: December 14
    RE: Pat Lewis and Holiday Party
    I'm sure I speak for all of us in wishing Pat Lewis a speedy recovery from her stress-related illness and I'll continue to forward your cards to her at the sanitarium. In the meantime, management has decided to cancel our Holiday Party and give everyone the afternoon of the 23rd off with full pay.
    (Author unknown)

    Stumble Upon Toolbar
    My Zimbio
    Top Stories