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CRA Gets a Second Look

John on June 27, 2009 at 2:34 pm

Controversialist John Carney has been reassessing the role of the Community Reinvestment Act in the mortgage meltdown. As he notes in one of the first parts of this ongoing series:

For a long time I regarded the shouting about the the CRA as a distraction. I understood that the 1970s-era law pushed banks to lend to low-income households, but the attempts to link it to the current crisis seemed far-fetched. Much of the “blame the CRA” talk sounded to me like a partisan attempt by Republicans to cover up their party’s role in creating the housing mess.

But after taking a hard look, he decided that — like it or not — the CRA played a “significant role” in the crisis. It’s an argument based on evidence. For instance, he notes this significant statistic coming out of Bank of America:

CFO Joe Price said the CRA book accounts for 7% of the total in residential mortgages, but 24% of the losses.

He also notes the significant contribution that Clinton-era enforcement of the Act had on lending practices:

Back in 1993, the Shawmut National Corporation, based in Hartford, Connecticut, wanted to buy the New Dartmouth Bank of Manchester, N.H. The deal required the approval of the Fed, which was mandated by the CRA to examine whether the banks had complied with fair-lending laws. The Fed voted 3-3, with one abstention, on the acquisition. The tie meant the deal was not approved, and could not go forward.

How did Shawmut react? It immediately began touting its “flexible income criteria” for loans and establishing mortgages with down payments of as little as 2.5 percent…

It wasn’t just the Fed. At the same time the Justice Department, the Department of Housing and Urban Development and banking regulators all promised to step up efforts against “discrimination” in lending. The Office of the Comptroller of the Currency said it would examine 200 of the nation’s largest mortgage lenders for lending practices that had a “disparate impact” on minority groups.

The easiest way out of this problem for banks was to offer loans that were flexible, innovative and, as we know now, riskier.

The response to all this from critics has been to say (among other things) that the CRA did not require any such risk taking activity. But as Carney explains, this is just wishful thinking:

CRA defenders often like to say that banks  didn’t need to adopt standards that involve high loan-to-value ratios, low down payments, and loosey-goosey income tests.  But this counter-factual claim is without basis in reality: the defenders cannot point to banks that did pass scrutiny of regulators and received top ratings from regulators without adopting these standards. The fact is that banks loosened standards because that is what regulators required. Any proposals that other strategies could have been employed is simply conjecture and second-guessing.

And there can be no doubt that the regulators were pushing for “no down payment” loans and 100 percent loan-to-value ratios. They also urged automated under-writing and reliance on credit scoring, two more factors that have since been viewed as contributing to overly-risky lending.

And for those on the left looking for some solace, Carney does lay a share of the blame of President Bush:

In early 2005, largely at the behest of the banking sector, the Office of Thrift Supervision implemented new rules that were widely perceived as weakening the CRA. Supervision of banks with under $1 billion in assets was loosened, and larger banks were allowed to voluntarily reduce the amount of regulator scrutiny of their “investment” and “service”–two long-standing categories of assessment under the CRA.

This had two unintended consequences that would later prove to be very costly. In the first place, it increased CRA scrutiny of larger banks, who were now the main focus of regulators. This put even more pressure on the banks to make CRA loans. Secondly, by allowing banks to de-emphasize “investment” and “service,” the new regulations created an even greater incentive for banks to meet CRA obligations by making home loans.

We heard a lot after the crisis began in earnest about a lack of regulation. But whether it was under Clinton or Bush, the significant contribution of the CRA to the problem was in the form of too much regulation that resulted in a distortion of the market in the form of high risk loans to people least equipped to afford them.

[HT: Megan McArdle]

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