The Problem with the CRA

The Problem with the CRA
Dennis Schroader
BUS 311
Karen Bond
January 26, 2009

The Community Reinvestment Act of 1977 (CRA) has caused a great deal of trouble for the American economy. Originally passed to help end discriminatory lending practices, its effect has been to cause lending institutions to write mortgage loans for borrowers and properties which may not otherwise qualify. This paper asserts that the CRA is primarily responsible for the current mortgage crisis and resultant recession.

This paper will discuss the political factors which influenced the passage of the CRA in the first place and those which have arisen from it, the legal precedent upon which the act was founded, the legal effect it has had on lending institutions, and its role in leading to the American housing market collapse and the widespread economic recession to which it gave birth.

Political Factors
As with all legislation, political influence played a large role in getting the CRA passed. The political reality of the day – unequal lending practices and racial animosity from the ongoing Civil Rights movement – ensured passage. Over the last thirty years, lobbyists and politicians have continued to exert political pressure.

Thomas DiLorenzo, professor of economics at Loyola College in Maryland, wrote concerning the CRA, “…the Fed and other financial regulators have pressured/extorted banks into making more loans to less-than-creditworthy borrowers than they would normally be willing to risk” (The CRA Scam and its Defenders, 2008).

Legal Precedent
The Community Reinvestment Act (CRA) was enacted by Congress and signed into law by President Carter in 1977. This Act was a direct result of pressure from activist groups to address the conditions of lower-income and minority neighborhoods. It followed similar legislation passed to reduce discrimination in the credit and housing markets including the Fair Housing Act (1968), the Home Mortgage Disclosure Act of 1975 (HMDA) and the Equal Credit Opportunity Act (1974). The Equal Credit Opportunity Act and the Fair Housing Act prohibit discrimination on the basis of race, sex, or other personal characteristics. The Home Mortgage Disclosure Act requires that financial institutions publicly disclose mortgage lending and application data. In contrast with those acts, the CRA seeks to ensure the provision of credit to all parts of a community without regard to the relative wealth or poverty of a neighborhood.

Legal Effect
When considering the legal impact of this legislation, it is important to keep in mind not only the intended outcomes – ending redlining and making lending practices fairer – but also the unintended results. To better understand the whole of the law, it is best to consult a legal expert. In a 1994 memorandum to Eugene Ludwig, then Comptroller of the Currency, Walter Dellinger, then Assistant Attorney General, wrote:
“The purpose of the CRA is 'to require each appropriate Federal financial supervisory agency to use its authority when examining financial institutions, to encourage such institutions to help meet the credit needs of the local communities in which they are chartered consistent with the safe and sound operation of such institutions.' 12 U.S.C. § 2901(b). To further this end, the CRA requires the agencies to assess an 'institution's record of meeting the credit needs of its entire community,' 12 U.S.C. § 2903(1), and to 'take such record into account in its evaluation of an application for a deposit facility by such institution.' 12 U.S.C. § 2903(2). ;Application for a deposit facility' is defined to include applications for approval to open a branch, to relocate a main or branch office, or to merge with or acquire another institution. 12 U.S.C. § 2902(3)” (Dellinger, Authority of the Federal Financial Supervisory Agencies Under the Community Reinvestment Act, 1994).

From this legal opinion and from the text of the legislation itself, one concludes that this Act is intended to give federal regulatory agencies the authority to review lending practices. While they do not have the authority to impose fines or sanctions (that authority is granted under separate laws), these agencies get a say when a financial institution wants permission to grow. Financial institutions are businesses. Business wants to grow and expand.

An honest analysis of American government and political culture, however, reveals the perils for financial institutions which do not look impeccable on these reports. Although the law specifically mentions lending within “safe and sound operations”, if a bank or credit union is not lending enough within its geographical area, a bureaucrat may block further expansion or mergers with other institutions. Also, this may give cause for a special interest group to file a law suit. For example, in the case of Buycks-Robertson v Citibank Fed. Sav. Bank (1998), the plaintiffs filed a class action suit against Citibank under the CRA. According to Snopes.Com (2008), “The case was eventually settled out of court, with some class members receiving cash payments and Citibank agreeing to help ease the way for low- and moderate-income people to apply for mortgages.”

This example illustrates how the CRA can and has been used to bully banks and other lending institutions into altering lending policy so as to avoid even the appearance of impropriety. That is no bad thing in and of itself, however, when that policy change induces an institution to make riskier loans, the results can be catastrophic when taken in aggregate.

The Housing Bubble, 2002-2007
Among other reasons, the housing bubble resulted from a culture of importance placed upon home ownership, belief that housing is always a good investment, promotion in the media, historically low interest rates, and risky mortgage products and lax lending standards (Wikipedia, Causes of the United States Housing Bubble, 2009).  While the CRA does not specifically require lax lending, it does set up an environment conducive to such, as previously discussed. One of the new practices regarding mortgages was called “securitization”. Among complex economic topics, this one is extremely complex and far beyond the scope of this paper. Suffice it to say that turning mortgages (not real estate) into traded securities has been controversial, to put it mildly.

According to Wikipedia, the Online Encyclopedia, “Bubbles can be definitively identified only in hindsight after a market correction, which in the U.S. housing market began in 2005–2006. Former U.S. Federal Reserve Board Chairman Alan Greenspan said ‘We had a bubble in housing’, and also said in the wake of the subprime mortgage and credit crisis in 2007, ‘I really didn't get it until very late in 2005 and 2006’” (United States Housing Bubble, 2009). Alan Greenspan is widely regarded as the single greatest economic mind of the last two decades. His assertion that he didn’t get it both strains credulity and lends credence to those who protest that they in no way foresaw what was coming next.

The Housing Crash, 2007-2008 The Great Debate
There are plenty of very smart people who completely disagree with each other on the CRA’s role in the housing crash. Paul Weyrich, former Chairman and CEO of the Free Congress Research and Education Foundation, wrote concerning the CRA. “It is among the factors responsible for the worst housing crisis in America since 1932” (The Subprime Causation Fiasco Continues, 2008). Aaron Pressman writes, “CRA loans carried lower rates than other subprime loans and were less likely to end up securitized into the mortgage-backed securities that have caused so many losses, according to a recent study by the law firm Traiger & Hinckley”

Lahle Wolfe of About.Com, a part of the New York Times Company, wrote, “There was no mortgage crisis prior to [2005] when CRA regulations were substantially weakened by Bush, but in the years following we saw a sharp increase and beginnings of a wide spread problem with subprime mortgages. It is also extremely important to note that the bulk of unfair and high-risk loans were offered by lenders who were not even subject to CRA regulations” (Is the Community Reinvestment Act (CRA) to Blame for the Mortgage Crisis? 2009). This is only included to illustrate that there are also plenty of smart people who are also completely unqualified to comment on certain topics. Ms. Wolfe should have consulted with Mr. Greenspan.

The Recession, 2008 - ?
It is difficult to discuss a recession and its likely causes without entering into a complex economic analysis. Since the only purpose of discussing this recession and its causes is to analyze the affect of bad law, the parameters of this discussion will be extremely limited. That being said, this brief investigation into the cause of economic recession will focus on how a housing market crash can cause widespread problems.

J.W. Elphinstone of the Associated Press reported, “Unlike downturns in some sectors, a slowdown in housing can affect jobs across many industries from financial services to construction to home furnishing retailers, said John Challenger, chief executive of Challenger, Gray and Christmas Inc.” (Housing Woes a Recession Catalyst? 2007). This is because so many industries are tied to housing. According to Wikipedia, “Any collapse of the U.S. Housing Bubble has a direct impact not only on home valuations, but the nation's mortgage markets, home builders, real estate, home supply retail outlets, Wall Street hedge funds held by large institutional investors, and foreign banks, increasing the risk of a nationwide recession” (2009).

Real estate agents and brokers and mortgage loan officers make their living based solely on the number of sales they close. The same is true of home inspectors and title and escrow companies. Construction companies get fewer contracts. Insurance agents sell fewer homeowners insurance policies. These are typically higher paying career fields.

All of these people have mortgages, credit cards and car payments of their own. When their income is affected, they have to start making decisions about whether to take the annual family vacation or send the kid to college. Tourism drops. Service industry businesses lose business and cut back on their hourly employees’ hours. These, the lowest paid of the American workforce, now have to cut out the daily Starbucks, switch to generic peanut butter, and cancel HBO and Showtime. Even governments begin to report lesser tax receipts.

Slowly but surely, everyone starts to feel the pressure. Those who own homes try to maintain their standard of living with a home equity line of credit, only to find out that their home is not worth what it used to be and the banks are more stringent with their lending guidelines. At this point, financial institutions – which have financed the whole show, up to this point – are frantically trying to off-load the bad debt and shore up their portfolios. This is a recession which, if unarrested, may degenerate into a depression.

The Ethical Argument Against the CRA
Wolfe (2009) also wrote in the same piece previous cited, “I am not an economist, nor a politician, I am a business women but it is hard to see how a 30-year-old law that has been substantially watered-down (revised in May 1995 by Bill Clinton to strengthen the CRA and amended in August 2005 by George Bush to weaken CRA law) is now to blame for the mortgage crisis.” She is right. She is neither a politician nor an economist. As such, it is understandable that she fails to see how the CRA is to blame for our current troubles. Economics is a difficult field of study to fully understand. American politics is absolutely impossible!

The CRA created a climate – albeit unintentionally – where financial institutions needed to look as good as possible to federal regulators and diversity groups for good PR and to avoid costly litigation. It doesn’t even matter if the institution wins or settles the lawsuit. The cost to fight it can be extraordinary and the PR damage nearly impossible to undo. While certainly well intentioned, the actual effect of this law has been to influence lending institutions to make risky loans and confuse otherwise intelligent people who nevertheless lack either the capacity or inclination to fully research the topic.

It is unfortunate, but true, that politics plays a role in nearly every aspect of American life. It is reasonable to assume that the same is true of other nations, but that goes beyond the scope of this discussion. Political influences cause legislation to be passed, usually with good intentions, but without full consideration of the potential unintended consequences.

In the case of the Community Reinvestment Act of 1977, the Congress and President Carter surely only intended to eliminate redlining and other discriminatory lending practices. What resulted was a law by which activist groups can (and have) threaten financial institutions with costly lawsuits in order to further their own agendas. Home mortgage lenders have revised their lending criteria to ensure that they look good in the eyes of these special interest groups. It is a general truism that when special interests are being served, the common interest is neglected. The CRA is a prime example of this, as can be readily seen by the economic carnage of the last two years.



References:
Buycks-Roberson v. Citibank Fed. Sav. Bank, 94 C 4094 (N.D. Ill.). (1998)

Dellinger, W. (1994, December 15). Authority of the Federal Financial Supervisory Agencies Under the Community Reinvestment Act. Retrieved January 24, 2009, from U.S. Department of Justice website: http://www.usdoj.gov/olc/cra.htm

DiLorenzo, T. (2008). The CRA Scam and its Defenders. Ludwig von Mises Institute. Retrieved January 20, 2009 from http://mises.org/story/2963

Elphinstone, J. (2007). Housing Woes a Recession Catalyst? CBS News Online.  Retrieved on January 23, 2009 from http://www.cbsnews.com/stories/2007/12/19/2007/main3632153.shtml?source=related_story

Loan Arranger, The. (2008). Retrieved January 25, 2009 from http://www.snopes.com/politics/obama/loans.asp

Pressman, A. (2008). Community Reinvestment Act had nothing to do with subprime crisis. Business Week.  Retrieved January 20, 2009 from http://www.businessweek.com/investing/insights/blog/archives/2008/09/community_reinv.html

Weyrich, P. (2008). The Subprime Causation Fiasco Continues. Townhall.Com. Retrieved January 20, 2009, from http://townhall.com/columnists/PaulWeyrich/2008/12/09/the_subprime_causation_fiasco_continues

Wikipedia. (2008). Causes of the United States Housing Bubble. Wikipedia, the Online Encyclopedia. Retrieved January 25, 2009 from http://en.wikipedia.org/wiki/Causes_of_the_United_States_housing_bubble

Wikipedia. (2009). United States Housing Bubble. Wikipedia, the Online Encyclopedia. Retrieved January 25, 2009 from http://en.wikipedia.org/wiki/United_States_housing_bubble

Wolfe, L. (2009). Is The Community Reinvestment Act (CRA) to Blame for the Mortgage Crisis? About.Com. Retrieved January 22, 2009 from http://womeninbusiness.about.com/od/womenspolitics/a/cra-lie-truths.htm