Are CRA, Clinton and Carter Really to Blame?

by Harold Black

I am fed up with the conservative talk show hosts putting the blame of the current economic crisis on the Community Reinvestment Act. I’ve heard them say that the CRA was signed into law by Jimmy Carter and aggressively expanded under Bill Clinton forcing banks to make loans to people who could not afford them. Fannie Mae and Freddie Mac were also forced to buy these loans. Since people could not afford them, they defaulted causing the failure of Fannnie and Freddie and precipitating the crisis.

As my father used to tell me, “Harold, that sounds good if you are interested in sounds”. But what is the truth? The truth is that republican presidents rather than democrats were ultimately responsible. When I was Deputy Director of Economic Research at the Comptroller of the Currency, the Congress passed the Equal Credit Opportunity Act in 1974 and the Home Mortgage Disclosure Act in 1975. I was charged with determining if national banks (those who received their charter from the federal government) were guilty of discrimination and of redlining. Discrimination is the act of denying a person a loan based on a prohibited basis such as race. Redlining is the denying a loan to anyone regardless of race who is applying for a loan in a specific geographical area.

My study (published in the American Economic Review, "Discrimination in Mortgage Lending," (with R. L. Schweitzer and L. Mandell), May 1978, v. 68, n. 2, pp. 186-192) showed weak statistical evidence of racial discrimination in the accept/reject decision but no evidence of redlining. These acts and our research at the OCC laid the foundation for other research on discrimination and to the passage of the CRA in 1977.

Although the CRA was signed into law by Jimmy Carter, two other important acts the Equal Credit Opportunity Act (ECOA) and the Home Mortgage Disclosure Act (HMDA) were signed by a republican, Gerald Ford. The talk show hosts also state that Bill Clinton was responsive for the expansion of CRA and forcing the banks to make bad loans. However, the two major changes in the CRA occurred in 1989 with the passage of the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) and the Federal Housing Enterprises Financial Safety and Soundness Act of 1992. Both were signed into law by George H. W. Bush. Under FIRREA, the reporting requirements of CRA compliance were expanded. The latter act required Fannie Mae and Freddie Mac to support affordable housing by purchasing CRA-qualifying loans. Even though the talk show hosts have said that up to one half of Fannie and Freddie loans were CRA loans, the act suggests that by the year 2010, that one-third of their purchases be affordable housing loans.

If there were pressures to expand CRA lending, it came in part from the banks themselves. As a result of the Riegel-Neal Interstate Banking and Branching Act of 1994, signed into law by George W. Bush, CRA ratings became an important factor in determining if banks could merge or acquire across state lines. Because advocacy groups would use CRA ratings as a protest against the banks in order to get additional CRA lending, the banks greatly expanded these types of loans. I recall going to a Fed Atlanta conference on CRA lending, compliance and enforcement. A banker told me that the Feds never pressured him into making a bad loan. However, because they wanted to expand into other states, they had instituted a more liberal CRA lending policy. So the truth is that if there is blame to be handed out for a misguided CRA policy, it has to be laid at the feet of the republicans and the banks. Jimmy Carter and Bill Clinton are convenient whipping boys and are well deserving of other blame but CRA lending is not one of them.

As to the banks making loans to people who could not pay them back? We in Finance have a technical term for such lenders – it is a fool. This makes no sense at all. Some people will say that the bankers could make bad loans because they would be sold to Fannie Mae and Freddie Mac. Well most CRA mortgages and subprime mortgages were sold to private investors. If these loans defaulted within 90 days, then the purchasers would put them back to the originator, If they defaulted later and more bad loans were made by the originator, then the investors would either not buy them or would offer low prices on mortgage pools of the originator. Either way, the originator would lose and would quit making bad loans.

Lastly, there are too few subprime mortgage to have caused the financial crisis. At year end 2008, there were $1.3 trillion in subprime mortgages. The default rate on subprimes had increased from 8 percent to around 20 percent. If you assume 100 percent loss on the defaulted mortgages, then this totals $260 billion. Well in 2008 the total loss in mortgage backed securities was $435 billion. If subprime defaults were at fault, then there would have been no need for the $800 TARP package. So like Carter and Clinton, subprime is just a convenient whipping boy. As my readers know, I am a laissez-faire free market conservative. But that does not blind me to the truth.

Harold A. Black is the James F. Smith, Jr. Professor of Finance, University of Tennessee, Knoxville. He has served on the faculties of American University, Howard University, the University of North Carolina - Chapel Hill and the University of Florida. His government service includes the Office of the Comptroller of the Currency and as a Board Member of the National Credit Union Administration. Dr. Black blogs at Caveat Emptor where he originally published this article. It is reprinted on this blog with his permission.

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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: http://www.federalreserve.gov/newsevents/speech/kroszner20081203a.htm

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