Friday, December 17, 2010

No, Virginia, the CRA Didn't Cause the Financial Meltdown

Once again, we're seeing the great lie that the Community Reinvestment Act was a cause of the financial meltdown in 2008. This is being promoted by the dissent to the report issued by the Congressional Committee that is looking into the crisis. First, I love the idea that a law -- passed in the late 1970s -- was the cause of a crisis 30 years later. However, the Minneapolis Federal Reserve looked into the issue and here is their conclusion:

Before we turn to our analysis of CRA lending data, we have two important points to note regarding the CRA and its possible connection to the current mortgage crisis.

The first point is a matter of timing. The current crisis is rooted in the poor performance of mortgage loans made between 2005 and 2007. If the CRA did indeed spur the recent expansion of the subprime mortgage market and subsequent turmoil, it would be reasonable to assume that some change in the enforcement regime in 2004 or 2005 triggered a relaxation of underwriting standards by CRA-covered lenders for loans originated in the past few years. However, the CRA rules and enforcement process have not changed substantively since 1995.2/ This fact weakens the potential link between the CRA and the current mortgage crisis.

Our second point is a matter of the originating entity. When considering the potential role of the CRA in the current mortgage crisis, it is important to account for the originating party. In particular, independent nonbank lenders, such as mortgage and finance companies and credit unions, originate a substantial share of subprime mortgages, but they are not subject to CRA regulation and, hence, are not directly influenced by CRA obligations. (We explore subprime mortgage originations in further detail below.)


Using loan origination data obtained pursuant to the Home Mortgage Disclosure Act (HMDA), we find that in 2005 and 2006, independent nonbank institutions—institutions not covered by the CRA—accounted for about half of all subprime originations. (See Table 1.) Also, about 60 percent of higher-priced loan originations went to middle- or higher-income borrowers or neighborhoods, populations not targeted by the CRA. (See Table 2.) In addition, independent nonbank institutions originated nearly half of the higher-priced loans extended to lower-income borrowers or borrowers in lower-income areas (share derived from Table 2).

In total, of all the higher-priced loans, only 6 percent were extended by CRA-regulated lenders (and their affiliates) to either lower-income borrowers or neighborhoods in the lenders' CRA assessment areas, which are the local geographies that are the primary focus for CRA evaluation purposes. The small share of subprime lending in 2005 and 2006 that can be linked to the CRA suggests it is very unlikely the CRA could have played a substantial role in the subprime crisis.


It is also possible that the remaining share of higher-priced, lower-income lending may be indirectly attributable to the CRA due to the incentives under the CRA investment test. Specifically, examiners may have given banks "CRA credit" for their purchases of lower-income loans or mortgage-backed securities containing loans to lower-income populations, which could subsequently affect the supply of mortgage credit.

Although we lack definitive information on banks' CRA-induced secondary market activity, the HMDA data provide information on the types of institutions to which mortgages are sold. The data suggest that the link between independent mortgage companies and banks through direct secondary market transactions is weak, especially for lower-income loans. (See Table 3.) In 2006, only about 9 percent of independent mortgage company loan sales were to banking institutions. (Figure not shown in table.) And among these transactions, only 15 percent involved higher-priced loans to lower-income borrowers or neighborhoods. In other words, less than 2 percent of the mortgage originations sold by independent mortgage companies in 2006 were higher-priced, CRA-credit-eligible, and purchased by CRA-covered banking institutions.


Two basic points emerge from our analysis of the available data. First, only a small portion of subprime mortgage originations is related to the CRA. Second, CRA-related loans appear to perform comparably to other types of subprime loans. Taken together, the available evidence seems to run counter to the contention that the CRA contributed in any substantive way to the current mortgage crisis.

So, who are you going to believe. A group of economic wonks who have done a ton of research looking at the data, or a bunch of Congressional/political hacks who have been lobotomized by the Washington political process?