Hans Bader @ Openmarkets.org:
The Community Reinvestment Act, which “prods banks to make loans in low-incomecommunities,” encouraged banks to make riskier loans, concludes a recent study from the National Bureau of Economic Research.
As J.D. Tuccille at Reason notes, the federal government played
a role in inducing, even strong-arming, banks to take risks they otherwise would have avoided. Specifically, the Community Reinvestment Act and related policy pressures are pointed to as culprits, part of a government effort to extend home-ownership in lower-income neighborhoods. Now comes a new study from the National Bureau of Economic Research that says, quite bluntly. that the CRA played a major role.
In the academic world, mealy-mouthed delivery of even powerful conclusions is the norm, so it’s refreshing to see authors Sumit Agarwal, Efraim Benmelech, Nittai Bergman, Amit Seru answer the title’s question, “Did the Community Reinvestment Act (CRA) Lead to Risky Lending?,” with the clear, “Yes, it did. … We find that adherence to the act led to riskier lending by banks.” The full abstract reads:
Yes, it did. We use exogenous variation in banks’ incentives to conform to the standards of the Community Reinvestment Act (CRA) around regulatory exam dates to trace out the effect of the CRA on lending activity. Our empirical strategy compares lending behavior of banks undergoing CRA exams within a given census tract in a given month to the behavior of banks operating in the same census tract-month that do not face these exams. We find that adherence to the act led to riskier lending by banks: in the six quarters surrounding the CRA exams lending is elevated on average by about 5 percent every quarter and loans in these quarters default by about 15 percent more often. These patterns are accentuated in CRA-eligible census tracts and are concentrated among large banks. The effects are strongest during the time period when the market for private securitization was booming.
Investor’s Business Daily does a very nice job of summarizing the nature of the pressure brought on lenders . . .“‘We want your CRA loans because they help us meet our housing goals,’ Fannie Vice Chair Jamie Gorelick beseeched lenders gathered at a banking conference in 2000, just after HUD hiked the mortgage giant’s affordable housing quotas to 50% and pressed it to buy more CRA-eligible loans to help meet those new targets. ‘We will buy them from your portfolios or package them into securities.’ She described ‘CRA-friendly products’ as mortgages with less than “3% down” and “flexible underwriting. “From 2001-2007, Fannie and Freddie bought roughly half of all CRA home loans, most carrying subprime features.”
Tuccille is correct that beginning the article abstract with the certainty of “Yes, it did” is unusual for generally cautious academics. The conclusion is also worth highlighting, as the authors note their estimated impact of the CRA on lending risk “provide[s] a lower bound to the actual impact of the Community Reinvestment Act. If adjustment costs in lending behavior are large and banks can’t easily tilt their loan portfolio toward greater CRA compliance, the full impact of the CRA is potentially much greater than that estimated” in their study.
The 2010 Dodd-Frank Act makes enforcement of the Community Reinvestment Act even more onerous and rigid by taking its enforcement away from non-ideological bank regulators who had an interest in safeguarding banks’ financial health, and giving it to the Consumer Financial Protection Bureau, which gives little thought to the effect of its actions on the stability of the financial system. The Community Reinvestment Act was enacted in 1977, but it was not enforced very stringently until regulations dramatically expanded its reach in the 1990s. It then became one of the factors that contributed to the financial crisis. The Obama administration and Congress responded to the financial crisis by making the financial system even worse, and encouraging more of the risky lending that helped spawn the crisis.