Don't Blame the Community Reinvestment Act

The mortgage crisis is far from over. Foreclosure filings in the first quarter of 2009 increased 24 percent over the already-heady 2008 levels; April filings were up 1 percent over March and 32 percent over the prior April. During 2008, foreclosure notices were filed on over 2 million properties, and banks took back more than 850,000 properties. Delinquencies continue to climb: 7.88 percent of all mortgages on one- to four-unit buildings were delinquent at the end of 2008, the highest rate on record. For sub-prime loans, the rate was 21.88 percent and almost 14 percent of sub-prime loans were in foreclosure. With home prices still falling -- in March 2009 prices were down 32.2 percent from their 2006 peak -- and unemployment now at 9.4 percent and still rising, it is unlikely the situation will get better any time soon.

How did we get into this? There are a plethora of potential culprits. One was the unsustainable run-up in home prices fueled by a combination of low interest rates and often deceptive loan products that enabled homeowners to get deeper and deeper into debt with "low monthly payments" that quickly ballooned and ultimately proved unaffordable. An explosion in the international demand for high-yielding "safe" investments combined with financial engineering and overreliance on overly optimistic credit ratings created an insatiable appetite for mortgage-backed securities and the mortgages behind them, no matter how risky. Regulation was entirely missing in some cases -- mortgage brokers and credit-default swaps come to mind -- and lax in others. Finally, a public policy that regarded homeownership for all as the key to prosperity -- combined with stagnant incomes, exploding costs for necessities such as health care and education, and lack of support for affordable rental alternatives -- made it highly likely that when house prices stopped going up, millions of Americans would find themselves unable to afford their mortgage payments.

But in the face of all these factors, some have fixed their attention instead on a formerly obscure 32-year-old statute, the Community Reinvestment Act (CRA). Echoing much of the conservative blogosphere, The Wall Street Journal in September 2008 assigned CRA blame for the ongoing crisis, albeit behind "the Federal Reserve," "banking regulators," and "a credit-rating oligopoly." The election of President Barack Obama and subsequent revelations about the extent to which unregulated credit-default swaps and mortgage-backed securities backed by sub-prime loans played a pivotal role in the economic devastation, have tempered but not silenced the criticism.

This is ridiculous. The case against fingering CRA for the destruction of the mortgage market rests on both logic and fact. Recent work by economists at the Federal Reserve Board of Governors and the Federal Reserve Bank of San Francisco provides a strong factual rebuttal, but let's start by understanding what the Community Reinvestment Act is and isn't.

CRA was enacted in 1977 in response to concerns that banks were unwilling to lend in minority communities and in those in danger of "tipping." Note that we're talking about 1977. While one can argue about the precise timing of the start of what ultimately became the sub-prime bubble, as late as 2001, 24 years after CRA was enacted, only about 9.7 percent of mortgage originations (about $200 billion) were sub-prime or Alt-A loans (Alt-A loans have weak or no documentation of income or credit records); by 2006, sub-prime and Alt-A loans were 33.5 percent of loans made and had quintupled to $1 trillion.

CRA states, rather simply, that "regulated financial institutions have [a] continuing and affirmative obligation to help meet the credit needs of the local communities in which they are chartered." It requires the federal bank regulators to "assess the institution's record of meeting the credit needs of its entire community, including low- and moderate-income neighborhoods, consistent with safe and sound operation of such institution," (emphasis added) and to "take such record into account in its evaluation of an application for a deposit facility [including a merger or acquisition] by such institution."

Although CRA and its close cousin, the Home Mortgage Disclosure Act (passed in 1975 to gather data on bank lending patterns), had some effect during the 1980s, the statutes came into their own during the 1990s. In 1989, the Federal Reserve denied a proposed merger by the Continental Illinois Corporation because of poor CRA performance, the first time any agency had used this enforcement action. Amendments to CRA in 1989 and 1994 made data more public and more useable. With its reduction in direct federal support for housing, the Reagan Revolution of the 1980s rather ironically led to the growth of the community-development movement, which included both organizations that partnered with banks subject to CRA to meet community credit needs and entities that functioned as advocates to ensure that the statute was enforced (sometimes the same community groups played both roles).

The Clinton administration made enforcement of CRA a priority. A major stimulus to this effort was the 1994 Riegle-Neal Interstate Banking and Branching Act, which permitted, through merger and acquisition, the nationwide banks we have today. That brought the CRA's primary enforcement mechanism, consideration of a bank's record of serving its community in evaluating the merger application, into play.

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What happened during the 1990s? The homeownership rate, which had been stagnant since the 1960s, climbed from 64 percent in 1994 to 67.8 percent in 2001, with larger increases for minorities, women, and lower-income families. Between 1993 and 1998, CRA-covered lenders increased their home-mortgage lending in low- and moderate-income areas by 39 percent, compared to a 17 percent increase in other areas. In 2002, the Joint Center for Housing Studies at Harvard found that "CRA has expanded access to mortgage credit; CRA-regulated lenders originate more home purchase loans to lower-income people and communities than they would if CRA did not exist." And CRA did not just expand home-mortgage lending. Testifying in 1999, Federal Reserve Chair Alan Greenspan reported that in 1997 alone, CRA loans included "525,000 small business loans worth $34 billion; 213,000 small farm loans worth $11 billion; and 25,000 community-development loans totaling $19 billion."

What didn't happen? An explosion of sub-prime lending. That came later. So for starters, the timing is entirely wrong for the contention that CRA caused the crisis. Nevertheless, by the end of the 1990s, bank regulators became concerned that poor lending practices were beginning to develop in the home-lending market and that some might ignore CRA's admonition that CRA lending needed to be done "consistent with safe and sound operation." In 1999, banking regulators issued guidance concerning sub-prime lending and made the point that CRA lending needed to be responsible -- well underwritten, well priced, and understandable by the borrower.

Even efforts after 2001 to press Fannie Mae and Freddie Mac to buy sub-prime loans, as part of the Bush administration's "Ownership Society," do not implicate CRA. Those who scapegoat CRA often contend that it was a reckless push for homeownership -- by both the Clinton and Bush administrations -- that led to the sub-prime crisis. But while homeownership increased significantly during the Clinton years, sub-prime (and also Alt-A) lending was still under 10 percent of mortgage originations when President Bill Clinton left office. President George W. Bush's further pressure for homeownership, which included substantial pressure on Fannie Mae and Freddie Mac to purchase loans, in particular low-documentation loans, was dubious policy, but cannot be blamed on CRA. In 2006, the height of the sub-prime boom, almost two-thirds of the high-cost loans made were for purposes other than the purchase of a home by an owner-occupant -- they were mostly refinancings to extract equity. But even this overstates the case against homeownership. As the Center for Responsible Lending has demonstrated, between 1998 and 2006, only about 9 percent of sub-prime loans went to first-time homebuyers.

Note also that CRA applies only to banks and savings institutions ("thrifts"). It does not apply to credit unions, independent mortgage companies, or investment banks. And banks and thrifts get credit under CRA only for lending to low- and moderate-income borrowers or in low- and moderate-income census tracts in their assessment areas, broadly the area near their branches which, for large institutions, generally includes entire metropolitan areas. This is critically important to understanding the role of CRA in the current debacle. When CRA was enacted, there were approximately 18,000 banks and thrifts, which made about 70 percent of all home-mortgage loans, and almost all loans were originated by branches and thus were covered by CRA. By 2006, there were 8,700 banks and thrifts, with a market share of about 43 percent. Even adding the share of their CRA-covered subsidiaries (15 percent), this was a marked decline.

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This leads to three critical questions: What kind of lending were CRA-covered institutions doing that "counted" under CRA? How did those loans perform? And who was doing the sub-prime lending, especially in the low- and moderate-income census tracts and to low- and moderate-income borrowers, that is, sub-prime loans that would "count" under CRA? Three recent studies provide strong evidence that even during the boom years that led to the crisis, CRA lending that "counted" was relatively small in the context of a multitrillion-dollar mortgage market, the CRA loans were of relatively high quality, and CRA-covered loans have performed well compared to those that were not covered by CRA.

Researchers at the Center for Community Capital at the University of North Carolina tackled the performance question by comparing 50,000 loans made to lower-income borrowers and sold to Self-Help Credit Union under the Community Advantage Program (CAP) to sub-prime loans made to borrowers with similar risk characteristics. The CAP loans, which were CRA-eligible, had low down payments and flexibility with respect to credit and debt-to-income ratios, all usually regarded as high risk factors that could result in a borrower being consigned to a sub-prime loan. However, they were fixed-rate loans, with no prepayment penalties, and were made through normal retail channels, that is, at a bank. The sub-prime loans, by contrast, were adjustable-rate loans, many with prepayment penalties, and usually made through brokers. The result: The 2004 cohort of CAP loans had a default rate one-sixth the rate for broker-originated adjustable-rate loans with prepayment penalties; the 2006 cohort had one-third the defaults. The researchers concluded: "For comparable borrowers, the estimated default risk is much lower with a CRA loan than with a sub-prime mortgage. ... Borrowers and responsible CRA lending should not be blamed for the current housing crisis."

Economists at the Federal Reserve Bank of San Francisco looked at all three questions for home-purchase loans made in California between January 2004 and December 2006, the height of the California sub-prime lending boom: What kinds of loans did CRA-covered lenders make, how did they perform, and who made sub-prime loans in CRA-eligible census tracts? They found that about 16 percent of the loans made by CRA lenders were made in CRA-eligible neighborhoods, compared to 20.5 percent of the loans made by independent mortgage companies (IMCs). However, more than half the independent mortgage company loans in low-income communities were higher priced, compared with 29 percent of the loans made by CRA lenders; in moderate-income communities, 46.1 percent of the mortgage company loans were higher priced, compared to 27.3 percent of the loans of CRA lenders.

The study also looked at loan performance, controlling for a wide range of borrower, neighborhood, and loan characteristics. The researchers found that "loans made by lenders regulated under the CRA were significantly less likely to go into foreclosure than those made by IMCs." Even more important, "loans made by CRA lenders within their assessment areas, which receive the greatest regulatory scrutiny under the CRA, are significantly less likely to be in foreclosure than those made by independent mortgage companies that do not receive the same regulatory oversight."

Finally, in late 2008, Federal Reserve Board economists Glenn Canner and Neil Bhutta analyzed the 2005 and 2006 Home Mortgage Disclosure Act data to understand the relationship between CRA and the sub-prime crisis. After observing that "the [sub-prime] crisis is rooted in the poor performance of mortgage loans made between 2004 and 2007," Canner and Bhutta found that in 2006 "only 10 percent of all loans [were] 'CRA-related' -- that is, lower income loans made by banks and their affiliates in their CRA assessment areas." Looking at the higher-priced loans that are a proxy for the poor-performing sub-prime loans, they observed that "only 6 percent of all higher-priced loans in 2006 were made by CRA-covered institutions or their affiliates to lower-income borrowers or neighborhoods in their assessment areas."

With respect to performance, Canner and Bhutta did three types of analysis. First, looking at mortgages originated between January 2006 and April 2008, they found that sub-prime and Alt-A loans originated in zip codes with incomes just below the level that "counts" for CRA purposes performed slightly better than those originated in zip codes with incomes just above the CRA level. They also looked at the performance of first mortgages originated under the affordable-lending programs of NeighborWorks America, most of which counted for CRA purposes, and found that these loans had delinquency rates lower than sub-prime or Federal Housing Administration loans, and foreclosure rates lower even than prime loans. Finally, they noted that only about 30 percent of foreclosure filings in 2006 took place in CRA-eligible zip codes.

Based on the Canner and Bhutta study, former Federal Reserve Governor Randall Kroszner concluded, "we believe that the available evidence runs counter to the contention that the CRA contributed in any substantive way to the current mortgage crisis." In reaching this conclusion, Kroszner and the Federal Reserve Board joined other bank regulators in affirming that CRA did not cause the mortgage-market meltdown. Federal Deposit Insurance Corporation Chair Sheila Bair has stated, "I want to give you my verdict on CRA: Not guilty." Comptroller of the Currency John Dugan agrees: "CRA is not the culprit behind the sub-prime mortgage lending abuses, or the broader credit quality issues in the marketplace. Indeed, the lenders most prominently associated with sub-prime mortgage lending abuses and high rates of foreclosure are lenders not subject to CRA." All of these regulators were appointed by President George W. Bush.

CRA is not perfect. In fact, the lack of coverage of independent mortgage companies and mortgage companies that are part of bank holding companies but not banks is a major failing that should be corrected. Moreover, the concept of CRA assessment area is outdated, especially for large, national institutions; it is essential that a greater proportion of the lending done by CRA?covered institutions be actually evaluated under CRA. But these are reasons to fix CRA, not to blame it for a crisis it did not cause.

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