Community Reinvestment Act Induced Banks To Take Bad Risks, Economic Study Finds

by Hans Bader on December 26, 2012 · 4 comments

in Economy, Regulation

The Community Reinvestment Act, which “prods banks to make loans in low-income communities,” 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  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  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.

One  rationale for creating the Consumer Financial Protection Bureau in 2010 was to make enforcement of the Community Reinvestment Act even more rigid and onerous, by discarding any consideration of how its enforcement could undermine the health of banks and the financial system. In explaining why there was supposedly a need for this new agency, when other agencies already enforced the Community Reinvestment Act, the Obama administration’s regulatory blueprint complained that “State and federal bank supervisory agencies’ primary mission is to ensure that financial institutions act prudently, a mission that, in appearance if not always in practice, often conflicts with their consumer protection responsibilities” (p. 54). In other words, the Obama administration thought the power to force banks to make low-income loans should be given to an agency that has no interest in prudent lending and gives no thought to whether such imprudent loans could harm banks and America’s financial stability. The CFPB, which is extremely powerful and largely unaccountable to anyone (Congress has no control over its budget, it has a sweeping grant of authority over the financial sector, and its director, once appointed, can’t be replaced by a succeeding president who disagrees with his policies) is being challenged in court.

Government pressure on banks to make low-income loans was a key reason for the mortgage meltdown and the financial crisis. Yet, the Dodd-Frank Act reinforced the status quo by mandating more risky, low-income loans in several ways, not just through the CRA.  The Obama administration pushed for more onerous CRA enforcement even though many already had argued the Community Reinvestment Act was a key contributor to the financial crisis — along, of course, with government-sponsored mortgage giants Fannie Mae and Freddie Mac, and by federal affordable-housing mandates.

The liberal Village Voice previously chronicled how Clinton administration housing secretary Andrew Cuomo helped spawn the mortgage crisis through his pressure on lenders to promote affordable housing and diversity:

Andrew Cuomo, the youngest Housing and Urban Development secretary in history, made a series of decisions between 1997 and 2001 that gave birth to the country’s current crisis. He took actions that—in combination with many other factors—helped plunge Fannie and Freddie into the subprime markets without putting in place the means to monitor their increasingly risky investments. He turned the Federal Housing Administration mortgage program into a sweetheart lender with sky-high loan ceilings and no money down . . . Three to four million families are now facing foreclosure, and Cuomo is one of the reasons why. (See Wayne Barrett, “Andrew Cuomo and Fannie and Freddie: How the Youngest Housing and Urban Development Secretary in History Gave Birth to the Mortgage Crisis,” Village Voice, August 5, 2008.)

Banks and mortgage companies have long been under pressure from lawmakers and regulators to give loans to people with bad credit, in order to provide “affordable housing” and promote “diversity.” That played a key role in triggering the mortgage crisis, judging from a 2008 story in The New York Times. For example, “a high-ranking Democrat telephoned executives and screamed at them to purchase more loans from low-income borrowers.” The executives of government-backed mortgage giants Fannie Mae and Freddie Mac “eventually yielded to those pressures, effectively wagering that if things got too bad, the government would bail them out.” But they realized the risk: “In 2004, Freddie Mac warned regulators that affordable housing goals could force the company to buy riskier loans.” Ultimately, though, Freddie Mac’s CEO, Richard F. Syron, told colleagues that “we couldn’t afford to say no to anyone.”

As a Washington Post story shows, the high-risk loans that led to the mortgage crisis were the product of regulatory pressure, not a lack of regulation. In 2004, even after banking officials “warned that subprime lenders were saddling borrowers with mortgages they could not afford, the U.S. Department of Housing and Urban Development helped fuel more of that risky lending. Eager to put more low-income and minority families into their own homes, the agency required the two government-chartered mortgage finance firms purchase far more ‘affordable’ loans made to these borrowers. HUD stuck with an outdated policy that allowed Freddie Mac and Fannie Mae to count billions of dollars they invested in subprime loans as a public good that would foster affordable housing.”

Lenders also face the risk of being sued for discrimination if they fail to make loans to people with bad credit, which often has a racially-disparate impact. The Justice Department is now extorting multimillion dollar settlements from banks, by accusing them of racial discrimination because they use traditional, non-racist lending criteria that minority borrowers are, on average, less likely to satisfy, such as having a high credit score, or being able to afford a substantial downpayment. Its Civil Rights Division chief, Tom Perez, “has compared bankers to Klansmen.” The “only difference, he says, is  bankers discriminate ‘with a smile’ and ‘fine print,’” calling their lending criteria “every bit as destructive as the  cross burned in a neighborhood.” Investor’s Business Daily chronicles this attack on small banks in “DOJ Begins Bank Witch Hunt,”

Such lower lending standards can have disastrous results. A recent book co-authored by The New York Times’ Gretchen Morgenson chronicles how federally promoted lower lending standards spawned the financial crisis and put minority borrowers into homes they could not afford:

“This is a story, the authors say, ‘of what happens when Washington  decides, in its infinite wisdom, that every living, breathing citizen  should own a home.’  Encouraged by politicians to expand home  lending—not least to minorities and to households with few  assets—[government-sponsored mortgage giant Fannie Mae] ignored reasonable standards of underwriting and piled  up fugitive profits almost as fast as it increased risk to taxpayers.   The disaster is now measured in the hundreds of billions of dollars. As  for the borrowers who were supposedly to benefit from Fannie’s  mortgage-industrial complex, Ms. Morgenson and Mr. Rosner write that  home ownership ‘put them squarely on the road to personal and financial  ruin.’”

A recent study by Peter Wallison, who had prophetically warned about Fannie and Freddie, found  two-thirds of all bad mortgages either were  “bought by government agencies or required to be bought by private companies under government pressure,” a finding echoed by other recent studies.


Hans Bader December 28, 2012 at 11:52 am

As I note above, the federal government promoted “risky, low-income loans in several ways, not just through the CRA.”

For example, HUD imposed affordable-housing mandates on the government-sponsored mortgage giants Fannie Mae and Freddie Mac. These mandates were imposed NOT by the Community Reinvestment Act (CRA), but by the federal Department of Housing and Urban Development (HUD), under Clinton’s HUD Secretary, Andrew Cuomo.

The discrimination lawsuits brought by the Justice Department under Civil Rights Division Chief Tom Perez also are NOT brought under the Community Reinvestment Act, but rather under various other laws regulating banks. These laws, not just the CRA, are being used to goad banks into risky lending.

The CRA is just one of several significant ways in which the federal government pressured lenders and mortgage giants to engage in risky lending or other risky financial practices. It was NOT the only way in which the federal government encouraged risky lending.

David Vine December 28, 2012 at 1:12 pm

This confirms my long-held suspicion that Bill Clinton engaged in a conspiracy to transfer wealth to “disadvantaged” persons by forcing down credit card financial standards requirements and using the FRB to go after banks for “redlining.”

On the other hand, did GWB engineer a massive transfer of wealth to the wealthy?

SISSY LAPPIN December 29, 2012 at 11:32 pm

But no one talks about the unnamed villain of the housing crisis that tipped the whole system intobankruptcy. This villain is the NAR.

The NAR stands for the National Association of Realtors, the lobbying group listed at #4 on’s list of political heavy hitters: an organization about which the New York Times once flatly stated, “You have to wonder sometimes what they’re smoking over there at the National Association of Realtors.”

Over the last decade, the NAR has stayed under the radar while doing a monstrous amount of damage. As the Bloodhound Realty blog says, “It was the NAR that lobbied for each law and rule change that resulted in the housing boomthat then led to the current housing crisis.” Yet chief economist for the NAR Lawrence Yun just stated that it was Wall Street. Yun, who has publicly state he never saw the housing crash coming said “Wall Street lenders went wild and Fannie Mae, along with it’s rival Freddie Mac, chased the market bubble profits.”

The question is who got these loosey goosey lending laws passed. The NAR pushed for each and everyone. They lobbied (spending hundreds of thousands of dollars) for sub-prime lending-catastrophe, the bundling of the bad loans so even more could be made, a large percentage of these bundled loans were sold to European Banks, which is a huge part of the Euro crisis. The unquestioning subsidization of the secondary mortgage market which led to the Fannie and Freddie bailout and then there is AIG. All of these practices have one common denominator the NAR lobbied for them-why because they sell more homes and yield real estate commissions. Who funds the NAR-real estate agents!! These practices that have led to their continued profits off of the exploitation of the American consumer. Every law that caused the current real estate collapse was heavily lobbied for by the NAR.

And make no mistake, they pushed hard. The NAR is the largest trade association in the United States. Of all political action groups, they are the third-largest contributors to political campaigns; since 1990, they have pumped over $30 million into the candidates that promise to fight for regulations that will hurt the public while keeping bad business afloat. Money is abundant as they spent $379,000 on a Rose Bowl float.

How do they have so much money and influence? Well, membership in the NAR is mandatory in most markets if agents want access to Multiple Listing Services. So one million people pay a yearly $155 to continue to play in the real estate pool.
Last month, the NAR decided to raise the dues another $40 per member: a move they openly acknowledge is to add another $40 million annually to their political-contribution war chest that is 100% earmarked for political contributions-“soft money.”

The NAR’s mission statement states, “Working for America’s property owners, the National Association provides a facility for professional development, research and exchange of information among its members and to the public and government for the purpose of preserving the free enterprise system and the right to own real property.”

The NAR lobbied to make it illegal for banks to handle foreclosures in-house; now they have to use a real estate agent. The NAR has kept a stranglehold on the real estate industry; as housing prices quadrupled, so did broker’s commissions, even as the Internet made the business simpler than ever. The NAR dug homeowners into a state of crisis, and yet they continue to claim that they exist for the public and for the protection of homeownership.

We can no longer afford this protection!

Real estate agents, at this point, have no choice. Remember, they have to pay to play the game. Yet I wonder why, in right-to-work states like Texas, the NAR isn’t seen as a union breaking the rules.

The answer, as always, is money: money spent wining and dining our representatives.

Next year, the NAR needs to hire a couple of good economists with that Rose Bowl money. They state that they “never saw the housing crisis coming.” That’s either dishonesty or shameful ignorance, considering that most of the housing information in the media comes from this political group. Perhaps they should also hire an ethicist, as independent groups continue to find the NAR’s home sale statements inflated by up to 20%. They were called on the carpet by Core Logic and had to readjust their numbers.

The NAR ultimately exists for the broker’s commission, the direct way of taking enormous amounts from the public and putting it back in the huge purse of the real estate industry. With the Internet, the commission system is slowly breaking down. With this added $40 million it is frightening what new laws we might have passed.

Despite all of this spending the number of real estate agents is plummeting and only 22% of all homes are now sold with the full commission.

Real Estate agents are becoming a thing of the past at a very rapid.

According to statistics from the National Association of Realtors, they might be. The number of real estate agents has dropped over 26% in less than 5 years. And, the NAR has spent over $90 million in political contributions trying to save real estate commissions. Let’s just say they’re certainly invested in their own industry.

It’s common sense that the number of agents would have dropped. After all, a lot of professions have cut jobs since the recession. But across all sectors, you’d have to dig pretty deep to find a loss of 26%. In fact, only construction workers—a notorious casualty of the housing bust—can keep real estate agents company in terms of percentage of jobs lost.

Still, if I had to choose between being a construction worker and a real estate agent right now, I might choose to get out my hardhat. Once the economy turns around, people will begin building and buying homes again, if on a more modest scale. The age of the easily mortgaged McMansion is over, but construction workers will certainly be needed again, and their industry will recover. It has to—we haven’t yet found a way to outsource home building or build supercomputers that can do it for us. And thank goodness for that.

Real estate agents, on the other hand, are facing an entirely different dilemma. The business model that has employed them for so long is expiring.
I will be the first to admit that 10 years ago or even 5 years ago it would not have been in a homeowners best interest to sell their own home. There was only one web site that homes could be posted for sale and that was your local multiple listing services. To obtain a purchase contract, they were only available at the state association for realtors and only realtors had access to them. There were no templates to make flyers, and no sign companies that would make just one custom sign. Then there was distribution, how did you let people know your home was for sale. Those were the old days.

We now have web sites like Zillow, which is ranked #1 most searched web sites not the Multiple Listing Service. Purchase contracts are available at your local Office Max or online. There is a Kinkos/Fed Ex on every corner. And a custom sign is just a few clicks away. As a real estate agent, everyday my email is flooded wanting me to buy another program on how to use social media to sell my listings. A year ago a week would not go by that I do not get anemail from a “soccer mom” selling her own home and the flyer is better than what most real estate firms send out. With email and social media, anyone can advertise their home to the masses in a matter of seconds.

There’s a quiet revolution going on in real estate. Buyers and sellers are seeing that they can deal directly with each other, and most importantly, save money. Who would you rather go to Hawaii when you sell your house—you or your real estate agent? I don’t like to make assumptions, but I think I know the answer to that one.

The only surprise is that the real estate agent has lasted this long. At this point, the agent is the dinosaur in the deal. A few willsurvive, inevitably. But real estate agents can expect that their industry will have to change or die within the next decade, because it’s only getting easier to buy and sell a home yourself and save the commission. And commissions mean thousands, if not tens of thousands of dollars of cash in your pocket.

Innovation doesn’t care about the real estate commission. Innovation has never cared about its own consequences. And we embrace innovation every day.

The American public is embracing this huge opportunities to save money and take the real estate transaction into their own hands.

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