Yes, the Community Reinvestment Act encouraged banks to make risky loans
The Kansas City Star
One of the big points of debate in the aftermath of the housing debacle is whether the Community Reinvestment Act — an anti-redlining law — contributed to the disaster. Defenders of the CRA turned themselves into pretzels to defend it, but all along it was obvious that the answer was yes.
It’s even harder for CRA supporters to deny it now, after the release of a study by the National Bureau of Economic Research. Where many academic studies hem and haw, this one doesn’t beat around the bush.
“Did the Community Reinvestment Act (CRA) Lead to Risky Lending?” the authors ask. “Yes, it did. … We find that adherence to the act led to riskier lending by banks.”
The CRA required banks to serve depositors in all neighborhoods in their areas, including those of low and moderate income. The NBER economists found that lending to borrowers in low and moderate-income census tracts increased around the the time of a bank’s regulatory exam and more of those loans went bad.
Quoting from the study (summarized in an Investor’s Business Daily editorial: “There is a clear pattern of increased defaults for loans made by these banks in quarters around the (CRA) exam. Moreover, the effects are larger for loans made within CRA tracts.”
Bascially, the process was as follows. Banks had to make affordable-housing loans under the CRA. Congress then forced Fannie Mae and Freddie Mac to buy up an increasing proportion of those loans, effectively imposing quotas. Many of the loans were subprime or otherwise dubious. To accept the loans, Fan and Fred had to drastically lower their credit standards, which debased credit quality in the mortgage market generally.
Yes, Wall Street got into the game in a big way, but it was Fan and Fred that provided much of the purchasing power for these lousy loans, encouraging subprime factories like Countrywide to crank out even more. Countrywide made the loans, sold them to Fan or Fred, which, by the way, then attached a taxpayer guarantee. Between 2001-2007, Fannie and Freddie scooped up roughly half of the home loans made under the CRA. Most of them had subprime features.
By the end of 2007, the bubble was enormous but by then the crash was already beginning. Wall Street had leveraged itself to the hilt to inflate the bubble, financing much of this effort with short-term money.
When the lousy mortgages started defaulting and the complex bond packages — backed by the mortgages — failed to perform as expected, the shakier firms couldn’t renew their short-term loans and the unraveling began, first with Bear Stearns and then spectacularly with Lehman — which set off the panic.
Two years ago, I had an exchange in an Editorial Board meeting with Rep. Emanual Cleaver, who at one point burst out, “There’s no evidence that anyone told Fannie and Freddie to make bad loans.”
He then sent me a five-page memo defending the CRA and its role in the debacle. In the meeting, Cleaver had said he wanted to change the law to make it even more “impactful,” which sounded as if he wanted more of that contributed to the problem in the first place.
The NBER study ought to end the debate over whether the CRA was one of the factors culpable in the housing bubble. It was. It encouraged lending of taxpayer-backed deposits to people with bad or dubious credit, and when those loans were scooped up by Fan or Fred, taxpayers ended up on the hook.
When I wrote about this two years ago, I noted that one result of the crash was that many of the people Cleaver says he wanted to help ended up financially ruined. One hopes that Rep. Cleaver can find the time to take a glance at the NBER study.