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It's Still Not CRA

September 22, 2008 - 9:36pm

When the Wall Street Journal lists the Community Reinvestment Act as only the 6th Washington policy responsible for the current mess-behind such items as "The Federal Reserve," "Banking regulators" (the Fed gets dinged in this category too), and "a credit-rating oligopoly," I suppose those of us who think CRA did (and continues to do) some good should be pleased.  After all, it was not so long ago that CRA was being fingered by conservative commentators as "the" cause of the crisis.  But just to remind folks why CRA shouldn't even be on the Journal's list at all (their major compliant is that CRA "compels" banks to make loans to "poor borrowers who often cannot repay them," which describes one hell of a lot of not poor borrowers who banks made loans to without any prodding), I thought it would be useful to republish this blog's first posting.  Here it is:

It has lately become fashionable for conservative pundits (Larry Kudlow, George Will) and disgruntled ex-bankers (Vernon Hill, for example, in his March 7 American Banker editorial) to blame the current credit crisis on the Community Reinvestment Act. This is patent nonsense. The sub-prime debacle has many causes, including greed, lack of and ineffective regulation, failures of risk assessment and management, and misplaced optimism. But CRA is not to blame.

First, the timing is all wrong. CRA was enacted in 1977, its companion disclosure statute, the Home Mortgage Disclosure Act (HMDA) in 1975. While many of us warned against bad subprime lending before the turn of the millennium, the massive breakdown of underwriting and extension of risky products far down the income scale-without bothering to even check on income-was primarily a post-2003 phenomenon. To blame a statute enacted in 1977 for something that happened 25 years later takes a fair amount of chutzpah.

It's even more outrageous because of the good CRA clearly did in between. The 1990s were the heyday of CRA enforcement-for a variety of reasons including the raft of mergers and acquisitions that followed the 1994 Riegle-Neal Interstate Banking and Branching Act, increased scrutiny of lending practices by the media and activism by housing advocacy groups and tougher enforcement by the Clinton Administration.That period saw increased home mortgage lending to lower income households and in lower income communities by the banks and thrifts covered by CRA, and a steady increase in the homeownership rate, especially for lower income and minority families. (See The Joint Center for Housing Studies). In addition, there was significant investment in affordable rental housing, community facilities and broader community economic development, directly by banks and thrifts earning investment credit under CRA or indirectly through bank investment in Community Development Financial Institutions and other community-based organizations.

New research by Ingrid Gould Ellen and Katherine O'Regan of NYUWagner, presented at a conference sponsored by the Philadelphia Federal Reserve Bank, convincingly demonstrates that property values went up dramatically in low and very low income urban census tracts during the 1990s, reversing severe declines during the prior two decades. While Ellen and O'Regan point out that this does not necessarily mean that everyone in those communities benefited, relating the improvement in home values in distressed communities to the effects of a statute designed to increase access to mortgage credit in those communities, during a period when the statute was vigorously enforced, is a reasonable connection.

Second, CRA does not either encourage or condone bad lending. Bank regulators were decrying bad subprime lending before the turn of the millennium (see Interagency Guidance on Subprime Lending), and warning the CRA-covered institutions we regulated that badly underwritten subprime products that ignored consumer protections were not acceptable. Lenders not subject to CRA did not receive similar warnings.And we also explained to those we regulated how to serve lower income communities and borrowers in a manner that was good for the borrower, good for the bank, and earned CRA credit.

For example, in October 2000, when I spoke to the National Association of Affordable Housing Lenders, a group of CRA-covered lenders, I said, "key to successful community reinvestment activity is being a responsible lender. Being responsible means making loans on responsible terms to people who can afford to pay them back, and making certain borrowers both understand the terms of the loan and have the opportunity to get the best terms available given their credit and financial position. But it also means expanding both the market for and affordability of loan products. It means working with customers to make them more bankable, helping families find the loan that is right for them, and investing in their success and yours by supporting organizations that assist you by counseling these individuals on the front and the back end of a loan."

CRA enforcement became a lower priority for bank regulators after 2001. My successor at the Office of Thrift Supervision, in fact, led an effort-eventually thwarted-to unilaterally loosen CRA regulations for institutions with more than $1 billion in assets. See 70 Fed. Reg. 10023. Nevertheless, CRA regulations were eased more generally in 2005. See 70 Fed. Reg. 44256.

The years that coincided with reduced CRA enforcement are also the years when CRA-covered entities wandered deeper into "higher priced loans," a category that includes, but is not limited to, "exploding ARMs" and other particularly pernicious kinds of loans. Thanks to the valiant efforts of late Fed Governor Ned Gramlich, starting in 2004 we have data about "higher priced loans." In that year, bank, thrifts and their subsidiaries-the entities covered by CRA-made about 37% of high cost loans. By 2006, the bank, thrift and subsidiary percentage was up to 40.9%. That a lack of interest in CRA enforcement coincided with CRA-covered entities getting into higher priced lending does not seem to me an argument for less CRA enforcement. Rather, it's an argument for better enforcement of a statute that, when well enforced, had proven its worth in helping both borrowers and communities.

Finally, it is nevertheless the case that CRA-covered lenders are not the source of the problem. One of CRA's major failings, in fact, is that it only applies to banks and thrifts. Remember all the investment banks who demanded product and then sliced and diced loans until it was impossible to understand their quality?They're not covered. Neither are the independent mortgage banks, the kinds of firms that have gone bankrupt or nearly so because of their abysmal lending practices, who regularly made about 50% of the high cost loans. Bank affiliates, another uncovered group, made about 12% of the high cost loans.

Janet Yellin, President and CEO of the Federal Reserve Bank of San Francisco recently made this point, saying "Most of the loans made by depository institutions examined under the CRA have not been higher-priced loans, and studies have shown that the CRA has increased the volume of responsible lending to low- and moderate-income households." And a recent study by Traiger & Hinckley LLP (See also the addendum).

CRA is not perfect. It doesn't cover a substantial portion of the financial services landscape. It has become complex, and the primary focus is on numbers of loans, with less attention to the quality of those loans. Asset-building depository and other services are given short shrift. And banks and thrifts have been allowed to "count" loans made by affiliates that are not subject to effective regulatory scrutiny. Governor Gramlich was right when he said that these entities-like the independent mortgage bankers-should be subject to far greater regulatory scrutiny, for many reasons. Certainly banks should not be allowed to count loans made by these affiliates for CRA purposes without such scrutiny.

But these are not reasons to repeal CRA or blame it for a mess caused primarily by those not subject to its reach during a period when even those under its umbrella were not encouraged to take it seriously. Rather, our challenge is to respond to the ongoing credit crisis in part by modernizing CRA, expanding its reach and making it even more effective than it was in the 1990s.


Something fishy here

The question is: if you set up a system where entities are given incentives to make subprime mortgage loans (or are punished for failure to do so), then those entities will have a tendency to seek out and make subprime mortgage loans. When you set up a system where entities are able to deliver subprime mortgages with no risk whatsoever to them, because a government-backed entity buys up these loans, allowing the issuer to quickly make money and get rid of the underlying debt, this creates incentives for entities to identify situations where they can issue such subprime mortgages, so that they can be in turn purchased by the government-backed entity. If the government backed entity gets into the business of issuing securities based upon these subprime loans, advertising them as being very good risks when in fact they really weren't, you end up with what we have now - a recipe for disaster. This article smells because its written by someone from the Office of Thrift Supervision, an agency that clearly failed to do anything to avert the disaster - it also smells because the facts that it cites don't seem to add up to anything that undermines the basic logic of events and incentives that led us to this disaster. I'm working on understanding "what went wrong," - but the efforts of people to claim that "it's not the CRA" and/or "it's not due to a government social program designed to help poor people obtain mortgages in order to buy houses" don't ring true to me. Sounds like these people know more about "CYA" than "CRA."

CRA and problem mortgages

I was on a local Chicago Bank board from 1992 to 2006 and I can vouch for the fact that we received a lot of pressure from the federal examiners to make loans to low and moderate income people. We were able to keep such loans to a minimum, but many banks simply through in the towel and loaded up on such loans. I don't know how many bad loans were made under CRA pressure, but I am sure there were alot of them.

The Wingnuts and the CRA

After all, it was not so long ago that CRA was being fingered by conservative commentators as "the" cause of the crisis.

Sean Hannity is still trying to blame the CRA and so are other wingnut gasbags:

Great Quotes for History

"If Fannie and Freddie "continue to grow, continue to have the low capital that they have, continue to engage in the dynamic hedging of their portfolios, which they need to do for interest rate risk aversion, they potentially create ever-growing potential systemic risk down the road" "We are placing the total financial system of the future at substantial risk" - Alan Greenspan "It's a classic case of socializing the risk while privatizing the profit. The Democrats and few Republicans who oppose portfolio limitations could not possibly do so if their constituents understood what they were doing." - Wallison "Without their (Frannie and Freddie) checkbooks keeping the market liquid and buying up excess supply, the market would likely have not existed" - Kevin Hassett PAC contributions from Freddie and Fannie to senators: Christopher Dodd - $165,000+ (Senate Banking Committee Chairman) Hillary Clinton - $75,000+ Barack Obama - $125,000+ Senator John McCain co-sponsored S. 190, a bill that would have fixed this mess back in 2005. Take a look at Inflation Data dot com, notice the charts where the inflation rate neared dangerous deflation a couple of times, the Fed acted and lowered the prime rate, triggering the real estate bubble to get the economy back on a inflationary trend. Obviously all the "goodwill" socialized housing risky attempts (CRI & GSE's) only work when real estate prices continue to climb, not during a price drop, especially a dramatic drop that's occurring now. The problem clearly lays in the huge mess that Congress and all it's many lawmakers create. They can't act together well at all. Too many chiefs and no indians. This is why corporations run so much better. A board elects a CEO, if he/she doesn't return a profit to shareholders, they are replaced with someone else that will. It's time to disband Congress. It can't act in time, it can't act well for the best interests of our country. We can still have three parts of the government, just one person to run each branch instead of many.

McCain's bill

I just want to point out the falsehood that McCain co-sponsored that bill in 2005. The speech by McCain that is frequently referenced occurred over a year after the bill had already died in committee and if you look up the bill, it doesn't list McCain as a sponsor.
That said, it looks like he sponsored the bill in 2006, although it doesn't look like it even made it to committee.

Seems to me...

I find this post quite balanced and rational.

That the problem we are having with those playing the CRA blame game, such as the last commentator, is that they are entirely partisan and have no knowledge basis for cherry picking their arguments.

For instance, "Mort Tennyson" above, who cites Kevin Hassett, McCain's economic advisor and author of "Dow 36,000: The New Strategy for Profiting From the Coming Rise in the Stock Market". If that's not the bubble mentality in a nutshell, I'm not sure what is...

Really, this anti-CRA behavior is like something that 9/11 conspiracy theorists would indulge in, an attempt to affix the blame to poorer Americans and minorities, while excusing the behavior of the irresponsible speculators primarily responsible for this mess.

Let's look at the motives of those who blame CRA

I used CRA in 1978 to get my community banks to participate in helping an inner-city community with some development projects. There was a spirit of "doing the right thing" that produced results. Now, fast forward to 1999; CRA was being vigorously "enforced" by the Fed; banks and thrifts were required to lend to communities in their market areas--not just loan their money anywhere in the world to maximize profit. This has been a disagreeable point to bankers since CRA was announced in the 70's as a policy. CRA enforcement typically involved banks developing a loan pool for loans to low and moderate income families through a community development corporation. Nothing about the enforcement of CRA required banks to make sub-prime and predatory loans, however, and that seems to be the spin that conservatives are putting on the program. Community Development Corporations that work to provide low and moderate housing opportunities do not promote sub-prime or other risky loans for low and moderate income buyers. They want successful, community-building projects and programs. Why would they want to "maximize" production and push people into homes that they could not afford?

On the other hand, banks and thrifts had to be on the sidelines when mortgage brokers were coming into low and moderate income communities with all kinds of short-term, easy-entry variable-rate loans. They had regulations that kept them from openly doing this kind of business (HMDA and CRA). But once the Federal Government changed its leadership in 2001, these regulations also began to fall in line with lower and lower controls, fewer standards that had to be met and CRA basically was reduced to a less enforceable regulation.

Who benefitted and who lost in this change in regulation? The Bush Administration clearly was pushing the idea of affordable housing, but in a way that fostered little regulation of the types of financing being offered to low and moderate income families. The wreckage left behind from the lack of responsible regulation includes many mortgage company workers who got wealthy and many low income families who lost everything they had saved, including their credit.

It is a mystery to me how anyone could believe that the people who failed to enforce the regulations and the ones who took advantage of it to pile up great profits are just completely innocent. Or, better yet, it is amazing that one would even consider blaming a regulation for "forcing banks to issue sub-prime loans" when that is a complete lie.

And so it goes...

In response to Seems to me . . .

"For instance, "Mort Tennyson" above, who cites Kevin Hassett, McCain's economic advisor and author of "Dow 36,000: The New Strategy for Profiting From the Coming Rise in the Stock Market". If that's not the bubble mentality in a nutshell, I'm not sure what is.."

Just because someone from a certain party made a statement does not make it untrue. Each statement should be judged on what it is saying and the validity of the statement, not on the background or books of the speaker. The background of the speaker does not affect the truth or untruth of the statement.

non-CRA facilities originated loans sold to CRA compliant banks

In it: "Most mortgages are now packaged by brokers, and nearly two in three mortgages are originated by nondepositories not covered by the CRA."

"nondepositories" and "originate" are key words here.

Banks, if they wanted FDIC insurance, discount rates, and an easier time with mergers, had to comply with CRA. Banks, and Freddie and Fannie bought mortgages. All were responsible for their pools of mortgages before, if not long after, being securitized. Mortgage brokers WERE NOT. They held onto stuff like mortgage servicing rights. The homeowner dealt with them.

You tell me: who other than Freddie or Fannie held most of the mortgages before being securitized? Banks. Big time, FDIC banks. Don't recall hearing about investment banks taking calls from brokers, either.

Undeserving Scapegoat

The CRA was not the cause of this financial mess - this sounds like the beginning of an effort to get the Act repealed - so the mega banks don't have to service areas that don't fit their target market.