The Spectacle Blog

CRA is Back

By on 6.18.09 | 1:29PM

From the white paper on new regulations for the financial sector: 

Rigorous application of the Community Reinvestment Act (CRA) should be a core function of the CFPA. Some have attempted to blame the subprime meltdown and financial crisis on the CRA and have argued that the CRA must be weakened in order to restore financial stability. These claims and arguments are without any logical or evidentiary basis. It is not tenable that the CRA could suddenly have caused an explosion in bad subprime loans more than 25 years after its enactment. In fact, enforcement of CRA was weakened during the boom and the worst abuses were made by firms not covered by CRA. Moreover, the Federal Reserve has reported that only six percent of all the higher-priced loans were extended by the CRA-covered lenders to lower income borrowers or neighborhoods in the local areas that are the focus of CRA evaluations.

The appropriate response to the crisis is not to weaken the CRA; it is rather to promote robust application of the CRA so that low-income households and communities have access to responsible financial services that truly meet their needs.

One of the most vocal proponents of the argument blaming CRA for distorting the housing market was Peter Wallison of AEI. Wallison summarized his arguments in a feature in our February issue entitled "The True Origins of This Financial Crisis." I can't help but feeling that Wallison was one of only a handful of people the administration had in mind when they wrote this section. 

With that in mind, I have a few questions. 

Is this accusatory language appropriate? Although I personally don't agree with Wallison's narrative about the CRA because of the evidence provided in this Fed study, I think it's a bit ridiculous to assert that the argument that the CRA was a problem was "without any logical basis." If the CRA had in fact operated on a larger scale, there is no doubt it would have introduced important distortions into the market. Also, if you read his essay, Wallison considered the CRA's effects in conjunction with Fannie Mae and Freddie Mac's, which were much more damaging. By the way, this regulations proposal doesn't do much to address the enormous failures caused by Fannie and Freddie. 

Furthermore, the argument that the CRA wasn't forcing banks to take on risky sub-prime loans hinges on the fact that sub-prime loans issued by CRA-regulated firms and private actors have defaulted at similar rates. There are two possibilities here: 1) the CRA helped some low-income folks who otherwise wouldn't have been able to buy houses to procure mortgages during the boom. Now some unknown percentage of those same folks are likely facing underwater mortgages, have already defaulted, or are otherwise in a tough spot. 2) The CRA got some mortgages to folks who would have got them without the CRA anyways. 

So the CRA was either potentially harmful or useless. Does it make sense to include provisions for expanding a harmful or useless measure in a regulatory overhaul? 

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