Facilitating dialogue to promote open and multi-faceted discussion and awareness

The world was thrown into a financial storm at the end of 2007 due to the housing market collapse from its lofty, inflated position it held during the previous years of that decade. Terms like “mortgage-backed securities,” “credit default swaps,” and “subprime mortgages” have become the catchphrases since, as analysts, economists, politicians, and laymen all attempt to find the origin of this mess. Talking heads try to explain the crisis almost hourly through the media networks, pointing to the government, to banks, to consumers, and even to environmentalists as root causes of the collapse. One specific point many conservative-leaning thinkers believe was a mainspring of the economic crisis was government over-regulation of the housing market. The idea that government intervention distorts the way the market works and innovates is not a new idea and is almost instinctively pounced upon in the wake of crisis, sometimes too generously to the chagrin of researchers endeavoring to explain market phenomena such as recessions and expansions. More specifically, the Community Reinvestment Act of 1977 (or the CRA) has been a target for many conservatives. From Thomas Sowell (Sowell) to even Glenn Beck (Beck p. 4), many have cited the Community Reinvestment Act as a main contributor to the housing boom and bust. Even Forbes columnist, Yaron Brook, accuses the CRA of forcing “banks to make loans in poor communities, loans that banks may otherwise reject as financially unsound (Brook).” This act has been highly controversial, even from the time of its passing, and must be fully analyzed to come to a conclusion on it’s effect on the housing market boom and bust. In order to scrutinize this act, the context of which the CRA was passed must be acknowledged, the revisions in the decades leading up to the 2000’s must be understood, and it’s effect on the housing market during the housing market expansion in the middle part of the decade must be reviewed before coming close to some sort of conclusion.

The Context and Results of the Community Reinvestment Act

The CRA was passed during a time of tremendous urban turmoil. The problem of urban blight worried leaders and communities, as city structures and systems were deteriorating and many fled for the suburbs. Advocates pointed toward the lack of credit availability in these communities as a reason for this urban decay. Specifically, redlining was singled out as a practice by banks that discriminated against low-to-moderate (LMI) communities, denying them credit availability. Redlining was literally a policy used by many banks whereby they would map out the area in which they are charted and encircle certain communities with a red line, indicating the poor or no credit found in these communities which were typically LMI communities. Many considered this discrimination because these areas are predominantly home to minorities and African-Americans.

The question: “Did banks really practice discriminatory lending?” continues to be a heated debate. Many studies have been done analyzing redlining and default rates to come to some sort of understanding about credit availability to minorities in the 1970’s. Credit discrimination was an issue confronting many minorities and women, leading to the passage of several laws banning discriminatory lending practices. The Equal Credit Opportunity Act (ECOA) of 1974 states in part: “It shall be unlawful for an creditor to discriminate against any applicant, with respect to any aspect of a credit transaction… on the basis of race, color, religion, national origin, sex or marital status, or age, provided the applicant has the capacity to contract.” This ECOA had a considerable effect on the credit availability to women; lenders often discounted women’s income by 50 percent or more if they were of childbearing age or had pre-school children, which the ECOA prohibited (Ardalan). The issue of redlining was a main contributor to the passing of the Community Reinvestment Act. Critics of banks practicing redlining accuse banks of being more than willing to accept deposits from LMI communities, but do not reinvest that money back into the communities they are charted in, but rather provide that credit to other more affluent communities. One study done in Atlanta in 1988 found that mortgage loans were made “in predominantly white middle-income census tracts at approximately five times the rate in predominantly black middle-income neighborhoods (Bernanke).” Critics of reports such as these declare that these analyses leave out some of the most important factors in banks providing credit: loan risk, mortgage demand, and external risks that may have threatened property values.

Regardless, the case for credit discrimination was made, and the Community Reinvestment Act was introduced by Senator William Proxmire on February 13, 1977 and passed that year. This act created a system by which banks are encouraged to “help meet the credit needs of the local communities in which they are chartered consistent with the safe and sound operation of such institutions.” The controversy over this act made the enforcement of it quite ambiguous. Federally insured banks were simply rated by how they met the credit needs in their communities through marketing, branches available in those areas, participation in community development projects, and the geographic distribution of loans.

These ratings were kept confidential until the passing of the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) in 1989. This act mandated that banks provide their CRA ratings and performance reports publicly, thereby further providing incentive for banks to open up credit availability and innovate to meet the needs of these communities. This act also created a 4-tiered system by which banks would be rated from Outstanding, Satisfactory, Needs to Improve, or Substantial Noncompliance (Bernanke). In 1993, President Clinton issued an executive order that directed banking agencies to make regulations more performance-oriented (Duke). These reforms allowed analysts and advocates access to bank ratings and helped quantify and clarify results of rating. This also assisted in being able to quantify the effectiveness of the CRA with its main goal, to offer more credit availability to LMI and local communities according to “safe and sound” practices.

Has the CRA been effective in its goal? Research seems to indicate so. Conventional home-purchase lending to blacks has grown from 3.8% in 1993 to 6.6% in 2000 compared to all loans. In Hispanics, the rate has grown from 19% to 29% (Friedman and Squires). As a matter of fact, home mortgage lending to LMI households and neighborhoods increase faster than home mortgage purchasing over all. Studies have also shown that banks and institutions that are CRA regulated tend to loan to LMI households and communities significantly more then those non-CRA regulated institutions. In comparison between regulated lenders and non-regulated lenders in home purchase lending, analysis indicates that CRA-regulated institutions “continue to lead the market in the provision of prime, conventional residential mortgage loans to low-and-moderate income borrowers and neighborhoods particularly in terms of their greater outreach to minority (Ardalan).” Former Federal Reserve governor Randall Kroszner contends that this proliferation of credit availability to LMI neighborhoods has actually benefited banks as well:

“[CRA loans have] 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.” Governor Randall S. Kroszner 2008

Several studies seem to confirm what Kroszner said, in that there is no significant fluctuation in profits stemming from CRA-regulated loans compared to non-regulated loans.

The Community Reinvestment Act and the Economic Crisis

As mentioned above, many have accused the government of forcing banks to make unreliable loans to low-to-moderate income consumers at high risk, thereby fueling the flames that caused the housing crisis. Many presume that simply the idea of government rating a federally insured bank by how it meets its community’s needs is interference in the market. Regardless, there are several reports and studies that beg to differ and several key leaders who have responded critically against this charge.

The first assumption made about the CRA’s effect on the housing market is that banks were forced to make bad loans to people who could not afford them. This assumption goes against the very edict of the CRA to banks to find ways to offer credit to LMI neighborhoods according “safe and sound” practices. Analysis indicates that CRA-regulated institutions actually surpassed non-regulated institutions in providing prime, conventional residential mortgage loans to LMI income borrowers and continued to through the 2000’s (Apgar and Duda). Federal Reserve analysis also indicates that about 60% of higher-priced, or subprime, loans went to middle-or-higher income borrowers whom are not the focus of the CRA. As a matter of fact, Thomas Sowell agrees that the housing crisis was not necessarily a national problem, but house value inflation was concentrated in specific areas such as Miami, coastal California, Phoenix, and other areas of prime real estate with values of nearly $1 million and up, which were definitely not the focus of CRA. On top of that, independent institutions not regulated by the CRA granted more than 20% of higher-priced loans offered to low-to-moderate income borrowers (Kroszner). In fact, CRA-regulated institutions granted only 6% of all higher-priced loans (Duke).

Another assumption that has been proposed is that CRA-regulated loans have higher default rates then non CRA-regulated loans. Studies again beg to differ. Firstly, the default rates on subprime and Alt-A loans are nearly the same across all income levels (Kroszner). But to attempt to single out CRA regulated loans, the Fed conducted a study by comparing the default rates in neighborhoods just above and just below the CRA income eligibility threshold and found that there is no significant difference between the two. According to that same study, examinations on foreclosure activity across neighborhoods grouped by income exhibit that most foreclosure filings have occurred in middle-to-higher income neighborhoods, and have actually increased at a faster pace then lower income areas, which are the focus of the CRA.

According to the history and the findings on the CRA and its effect on the housing crisis, the CRA has been effective in its goal and there seems to be no trend indicating that the CRA was a substantial producer in the housing boom or bust. As a matter of fact, the CRA has become less useful as financial innovations in the mortgage lending industry over the past several decades have penetrated the housing market (Apgar). Many propose that now is the time to reform the Community Reinvestment Act in order to adapt to changes in the housing market, so that LMI communities and families may not be left behind, and that they may have access to credit especially in these economic times, and offer more opportunities to institutions to connect with these borrowers and benefit as well. Some contend that all institutions should be CRA regulated, thereby compelled to offer loans according to “safe and sound” practices. Whatever seems to be in the future of the CRA, credit availability seems to be more important then ever for all, and the CRA may just be the avenue for that. AS Governor Duke assured those who attended the CRA Policy Discussion in Washington D.C. in 2009: “together, we can determine the most effective way to improve upon a regulation that has had demonstrated success in making credit available to low-and moderate-income communities, and we can further determine the most effective way to strengthen its role as we meet the challenges ahead.”

Works Cited

Ardalan, Kavous. “Community Reinvestment Act: Review of Empirical Evidence.” Academy of Banking Studies Journal (2006): 1-22. Web. 5 Apr 2010. ent;col1>.

Apgar, William, and Mark Duda. “The Twenty-Fifth Anniversary of the Community Reinvestment Act: Past Accomplishments and Future Regulatory Challenges.” FRBNY Economic Policy Review. (2003): 1-23. Print.

Beck, Glenn, and Kevin Balfe. Arguing With Idiots. 1st. New York City, NY: Threshold Editions, 2009. 4. Print.

Bernanke, Ben S. “The Community Reinvestment Act: Its Evolution and New Challenges.” the Community Affairs Research Conference. Washington D.C., 30 Mar. 2007.

Braunstein, Sandra F. “The Community Reinvestment Act.” Before the Committee on Financial Services, U.S. House of Representatives. Washington D.C., 13 Feb. 2008.

Brook, Yaron. “The Government Did It.” Forbes 18 July 2008: n. pag. Web. 20 Apr 2010. cx_yb_0718brook.html>.

Duke, Elizabeth A. “CRA: A Framework for the Future.” At the Revisiting the CRA Policy Discussion. Washington D.C., 24 Feb. 2009.

Friedman, Samantha, and Gregory Squires. “Does the Community Reinvestment Act Help Minorities Access Traditionally Inaccessible Neighborhoods?.” University of California Press on behalf of the Society for the Study of Social Problems. 52.2 (2005): 209-231. Print.

Hussain, Reaul. “The Past, Present and Future of Community Reinvestment Act (CRA): A Historical Perspective.” University of Connecticut-Department of Economics Working Paper Series. 2004.30 (2004): 1-88. Print.

Kroszner, Randall S. “The Community Reinvestment Act and the Recent Mortgage Crisis.” At the Confronting Concentrated Poverty Policy Forum, Board of Governors of the Federal Reserve System. Washington D.C., 3 Dec. 2008.

Schwartz, Alex. “From Confrontation to Collaboration? Banks, Community Groups, and the Implementation of Community Reinvestment Agreements.” Housing Policy Debate. 9.3 (1998): 1-32. Print.

Sowell, Thomas. The Housing Boom and Bust. 1st. Philadelphia, PA: Basic Books, 2009. 1-184. Print.