- The American Conservative - https://www.theamericanconservative.com -

About That Community Reinvestment Act

I recently came across an astonishing assertion about the Community Reinvestment Act, the legislation tagged by many on the Right as to blame for the financial meltdown. According to what I was reading, the CRA was really a good thing since banks covered by CRA were only one-third as likely as other financial institutions to originate subprime mortgage loans, even though the former were denying loan applications at the significantly lower rate.

This might pose a problem for people who want to blame the crisis entirely on CRA, but other than weakening that argument, this claim actually says very little since CRA only applies to (some) banks and savings institutions, not to non-bank financial services companies like the late Countrywide Financial, which were the biggest speculators in the mortgage market. Now, were CRA banks less likely to roll dice on bad mortgages because of CRA, or were they less apt to do so because banks are generally more conservative than entities like Countrywide? Similarly, you can see the self-selection bias involved in the percentages of loan applicants denied. If you’re not very creditworthy, are you going to seek a loan from a stingy bank or from some riskier outfit? What CRA did was to worsen the financial crisis — not create it — by involving the banks more deeply in questionable mortgages. If it had not been for CRA, presumably banks would have originated even fewer than one-third of subprime mortgages (which is still many billions of dollars)  and would have been turning away more uncreditworthy applicants. That was definitionally and intentionally what CRA did — it instructed banks to give more loans to riskier customers. If that didn’t produce more defaults, it would be a miracle almost fit to get the U.S. Congress canonized.

Here, by the way, is the report [1] that makes the original claims about CRA’s benign effects. In a few places it separates data on non-CRA bank and CRA bank loans, but the aggregate data about originating the subprime loans notably does not make the differentiation: non-CRA banks are lumped in with “other lenders.” This report dates from January 2008 and uses data from 2006. Interestingly, CRA banks assumed a much larger share of the subprime-origination market beginning in 2007, as a later report states [2]:

CRA-subject banks increased their market share of home mortgage originations to LMI [subprime] borrowers by 30 percent in 2007. We suspect that the void created by non-bank lenders who ceased or curtailed their mortgage operations in 2007—and obviously not underwriting standards—was the primary reason for CRA-subject banks’ increased market share of LMI loans.

In other words, CRA  banks stayed in the subprime market at a time when even the riskier lenders were getting out. It’s hard to read that as a good thing. Remarkably, the attorneys responsible for these reports state as their 2008 hypothesis, “If critics were correct about banks having lowered underwriting standards for LMI borrowers, lending data from 2007, a time of constricting credit and significantly tightened underwriting standards, should show greatly diminished service to LMI borrowers by CRA-subject banks.” But the whole point of criticism of CRA is that it forces banks to lend to unworthy borrowers, and for that reason a critic would expect the very thing that the report shows: CRA banks did not get out of the subprime market because they were subject to a law that hampered them from doing so.