Defenders of the Community Reinvestment Act have tried to maintain that the law didn’t require lenders to adopt lax lending standards that characterised the boom years.
Unfortunately, that’s just not true. The CRA led directly to lending practices that included extremely low to nonexistent down payments, outrageous loan to value ratios and other “innovations” that later became some of the best predictors of defaults and foreclosures.
The primary way the CRA encouraged lax lending was by empowering bank regulators to block mergers if one side was found to have flunked the government’s test for discriminatory lending. To avoid flunking, banks would adopt these innovative lending schemes that helped them grow their minority borrower base.
You can see this process at work the very first time the Federal Reserve ever blocked a bank merger using the powers under the CRA. Back in 1993, the Shawmut National Corporation, based in Hartford, Connecticut, wanted to buy the New Dartmouth Bank of Manchester, N.H. The deal required the approval of the Fed, which was mandated by the CRA to examine whether the banks had complied with fair-lending laws. The Fed voted 3-3, with one abstention, on the acquisition. The tie meant the deal was not approved, and could not go forward.
How did Shawmut react? It immediately began touting its “flexible income criteria” for loans and establishing mortgages with down payments of as little as 2.5 per cent.
The Shawmut rejection was a shot across the bow of the banking industry. Here’s the NYT:
“The Fed is sending a strong signal to the banking industry that they’re going to be looking at banks’ lending practices,” said Joseph Duwan, a banking analyst with Keefe, Bruyette & Woods. “Clearly Shawmut is being made a little bit of scapegoat.”
In a move showing banking regulators’ increased emphasis on ending loan discrimination, the Federal Reserve Board has, for the first time, blocked a large bank merger because of concern over possible bias against minority groups in mortgage lending.
It wasn’t just the Fed. At the same time the Justice Department, the Department of Housing and Urban Development and banking regulators all promised to step up efforts against “discrimination” in lending. The Office of the Comptroller of the Currency said it would examine 200 of the nation’s largest mortgage lenders for lending practices that had a “disparate impact” on minority groups.
The easiest way out of this problem for banks was to offer loans that were flexible, innovative and, as we know now, riskier.
Five years later, at the “Community Reinvestment Act Conference of the Consumer Bankers Association” in Arlington, Virginia, Fed Governor Laurence H. Meyer addressed concerns about how bank consolidation would effect lending to minorities. He called on the conference to look at the consolidations as opportunities to increase the availability of financial services to “the community.” One of the ways it was already doing this, he said, was encouraing banks to develop No Money Down loans.
One quite interesting development is use of these technologies by banks to develop and market new credit programs that are specifically targeted toward low- and moderate-income consumers. New mortgage products, for example, that employ low or no down payments and up to 100 per cent loan-to-value ratios are made possible by credit scoring and automated underwriting. And many of the products have received secondary market acceptance. These new technologies also have significantly expanded consumer access to credit cards and are being used by many lenders to underwrite small business loans based on the creditworthiness of the business owner.
This doesn’t absolve the greedy and often corrupt lenders, the bubble-headed securitizers, the blundering ratings agencies or the careless MBS investors. But it does show that the government, through the CRA, had a strong hand in creating the kind of mortgage products we now regard as part of the problem. Back then, they were regarded as part of the solution.