The Phony Time-Gap Alibi For The Community Reinvestment Act

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Perhaps one of the most misleading points made by those who wish to completely exonerate the Community Reinvestment Act’s role in encouraging lenders to adopt loose standards for mortgages is to insist that a statute originally put in place in 1977 could not have played a role in a housing bubble 25 years later. This point ignores the profound changes in the CRA and related fair housing that occurred in the subsequent years.

In the first place, it should be noted that the attempt to exonerate the CRA seems to turn on the idea that the act didn’t encourage much lending at all. This, of course, runs completely contrary to the advocates of the CRA during the housing boom. Back then, they were bragging about how effective the CRA had been in spurring lending. “Over the last decade, Treasury studies have shown that CRA helped to spur $1 trillion in home mortgage, small business, and community development lending to low- and moderate-income communities,” the pro-CRA Brookings Institute wrote in 2004.

For the first decade or so of its existence, the CRA probably didn’t have much of an effect. In fact, fair housing advocates and others were severely critical of the way it was enforced. The process was standard-based and described as “hands-off.”

In 1989, President George H.W. Bush signed into law the Financial Institutions Reform Recovery and Enforcement Act that included provisions to increase public oversight of the way the CRA was enforced. Regulators were required to issue public, written performance evaluations of banks, including a system that rated bank compliance as Outstanding, Satisfactory, Needs To Improve or Substantial Non-Compliance. This public scrutiny began to push banks to make more loans to low-income borrowers, a process that often involved putting in place relaxed lending standards.

Shortly afterward, Fannie Mae and Freddie Mac addressed bank fears that the low-income lending with relaxed standards would unduly increase risk by beginning to securitize “affordable” mortgages. This was the beginning of subprime lending. It was the “pull” factor that complimented the “push” factor of the CRA. 

The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, which opened the door for interstate banking and encouraged a new wave of banking M&A, made the ratings under the CRA a test for determining whether acquisitions would be allowed. That same year, the Fed refused to allow a Hartford, Connecticut bank to acquire a New Hampshire bank on fair housing and CRA grounds.

This was the first time the Fed had ever taken this kind of action, and it had profound effects through the banking sector. It sent a strong signal to the banks that the Fed would closely scrutinize lending practice, limiting the ability of banks to grow or make acquisitions if they were found to have insufficient low income or minority lending. Banks immediately responded by lowering down payment requirements and using more flexible income criteria. 

The CRA defenders like to claim that the statute did not require these things, but the enforcement of the act did. Banks knew what kind of lending would increase their CRA compliance and meet with the approval of the regulators. CRA defenders often like to say that banks  didn’t need to adopt standards that involve high loan-to-value ratios, low down payments, and loosey-goosey income tests.  But this counter-factual claim is without basis in reality: the defenders cannot point to banks that did pass scrutiny of regulators and received top ratings from regulators without adopting these standards. The fact is that banks loosened standards because that is what regulators required. Any proposals that other strategies could have been employed is simply conjecture and second-guessing.

And there can be no doubt that the regulators were pushing for “no down payment” loans and 100 per cent loan-to-value ratios. They also urged automated under-writing and reliance on credit scoring, two more factors that have since been viewed as contributing to overly-risky lending. In 1998, Fed Governor Laurence H. Meyer delivered a speech on the CRA to a conference of bankers praising exactly these features. To quote:

“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.”

When your primary regulator speaks to you in these terms, you had better listen or you will quickly find yourself in hot water. After all, one of the tests for whether banks were engaged in discriminatory lending was whether they had adopted standards that were stricter than those approved of by regulators. Stricter standards were assumed to be evidence of discrimination, and if they had a disparate impact the matter was even worse. So when a Fed governor tells banks that they should be making no down-payment, 100% LTV loans based on credit scores and automated underwriting, we shouldn’t be surprised that they started making these kind of loans.

In 1995, regulators began to enforce the CRA in a very different way than they had in the past. Instead of focusing on the process of bank lending, the new regulations were focused on objective performance evaluations. At the same time, regulators began disclosing more information about particular banks. As one commenter put it at the time, “We have learned from 30 years of CRA policy that what is measured gets done.” In short, publicly measuring low-income loans encouraged more of it. And the way regulators advised making low income loans involved features we now regard as toxic.

In November 2000, then-HUD Secretary Andrew Cuomo announced that Fannie Mae and Freddie Mac were committed to purchasing $2 trillion of “affordable housing” mortgages. This greatly increased the willingness of banks to make the kind of mortgages being promoted by the regulators.  As the push factor of the CRA was increasing, the pull factor of Fannie-driven securitization was also increasing.

But don’t mistake this as something that only occurred during the Clinton administration. The Bush administration was also active in pushing expanded home-ownership. That history has been well-explored elsewhere. Instead, I’d like to focus attention on one seemingly unintended way a Bush administration CRA reform helped contribute to lax lending standards.

In early 2005, largely at the behest of the banking sector, the Office of Thrift Supervision implemented new rules that were widely perceived as weakening the CRA. Supervision of banks with under $1 billion in assets was loosened, and larger banks were allowed to voluntarily reduce the amount of regulator scrutiny of their “investment” and “service”–two long-standing categories of assessment under the CRA.

This had two unintended consequences that would later prove to be very costly. In the first place, it increased CRA scrutiny of larger banks, who were now the main focus of regulators. This put even more pressure on the banks to make CRA loans. Secondly, by allowing banks to de-emphasise “investment” and “service,” the new regulations created an even greater incentive for banks to meet CRA obligations by making home loans. 

As we’ve shown elsewhere, the CRA had a clear and strong role in loosening lending standards. Those who claim the long time gap between its original passage are probably ignorant of the profound changes in the law and the way it was enforced. There was a long process of CRA evolution that led to banks responding by adopting loose lending standards. In light of this, we expect a widespread re-assessment the CRA and its role in contributing to lax lending standards. But perhaps we’re being too optimistic about the open-mindedness of the CRA defenders.

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