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Home Publications Blogs Beat the Press The Blame the Community Reinvestment Act Industry

The Blame the Community Reinvestment Act Industry

Sunday, 06 January 2013 04:46

One of the major occupations for economists these days is blaming efforts to help poor people for the housing bubble and bust. The main villains in this story are Fannie Mae, Freddie Mac, the Federal Housing Authority (FHA) and the Community Reinvestment Act (CRA). A reader recently sent me another work in this proud tradition.

I just did a quick reading of the paper, but it seems that the smoking gun in this one is that banks subject to the CRA appeared to do more lending in CRA tracts in the periods where their lending behavior was being scrutinized by regulators. Just to remind folks, the CRA requires banks to make loans in the areas from which they were taking deposits, in particular focusing on areas that are disproportionately African American or Hispanic. The authors take this timing result, which is especially pronounced in the peak bubble years of 2004-2006, as evidence that the CRA played a major role in the pushing of bad loans on moderate income people. As they note, the loans issued in these tracts in these periods had a much higher default rate than other loans.

It's not clear that this gun is smoking quite as much the paper implies. First, it is important to remember that the biggest peddlers of subprime loans were mortgage lenders like Ameriquest and Countrywide. These lenders were for the most part not subject to the CRA since they were not banks (they raised money through the capital markets, not by taking deposits). Therefore the CRA was not a gun to the head of these lenders forcing them to make bad loans.

However even for the banks to whom the CRA did apply the evidence in this paper is less compelling than it may seem. Let's assume that banks do care about their CRA ratings for the reasons mentioned in the paper. (The CRA rating would likely be a factor that would come up when a bank was interested in a buyout or merger.) Let's also imagine that banks time their loans to CRA tracts so that they can show more loans in the periods where their compliance is being reviewed. Let's also hypothesize that in total the CRA doesn't get banks to make any more loans to CRA tracts than they would otherwise.

In this case, we would get exactly the sort of pattern of lending found in this study. Banks that are subject to the CRA would refrain from focusing on CRA tracts when they know no one is looking. Then when the light is on, they would make a stronger effort to make loans in the neighborhoods covered by the CRA. If banks engaged in this sort of timing of loans to CRA tracts, we would find that loans during CRA review periods were higher than in other times, even if there was no net increase in loans as a result of the CRA.

 As a practical matter, I would be surprised if the CRA had no effect whatsoever on lending to the covered tracts. But it's not clear how this paper can distinguish a timing effect from a situation where banks actually increased lending to CRA tracts beyond what they would have done without the law.

In the process of prosecuting the case against the CRA, the paper produces some exonerating evidence for Fannie and Freddie. It finds that the CRA effect was strongly associated with private securitization because the investment banks had lower standards than Fannie and Freddie. It comments on this finding:

"We conjecture that banks are more likely to originate loans to risky borrowers around CRA examinations when they have an avenue to securitize and pass these loans to private investors
after the exam."

And, just to remind folks, the FHA became almost irrelevant in the peak bubble years, with its share of the market dwindling to almost nothing. At the time it was derided as an outmoded relic since the private sector was so much more efficient in providing loans to low and moderate income families.

Anyhow, I don't think there is any doubt that the efforts to push homeownership went seriously awry in the bubble years. Many of the organizations that encouraged moderate income families to buy homes at badly inflated prices as a wealth building strategy should be wearing bags over their heads for the next three decades. But there is no escaping the fact that the main motivation for issuing the bad mortgages was money: the banks were booking huge profits in these years. And no believer in the free market can think that bankers have to be told by government bureaucrats to go out and make money.

Comments (9)Add Comment
what share of market was sub prime?
written by David, January 06, 2013 11:20

What share of the real estate market during the bubble years went to sub prime and low income borrowers. I seem to recall a lot of activity all up and down the income ladder in real estate in the first half of the last decade, not to mention all the commercial building.

written by watermelonpunch, January 06, 2013 12:07
And, just to remind folks, the FHA became almost irrelevant in the peak bubble years, with its share of the market dwindling to almost nothing. At the time it was derided as an outmoded relic since the private sector was so much more efficient in providing loans to low and moderate income families.

Yes, people need to be reminded of this more often.
And by more often I mean, every time someone mentions the FHA in the present, this fact needs to be in a side bar in big print.

(Yes, I have a particular blog in mind that is completely sensible about most things, but every time posting on FHA in the present, there's always some clown in the comments who takes the opportunity to push this FHA caused the housing crapola to begin with.)

FHA may indeed be cause for concern now. But blaming it for the nonsense disaster loan making during the housing bubble is like blaming malaria for wiping out half of Europe in the mid 1300s.

Once again, I can't understand how anyone thinks they should get away with this kind of thing.
share of subprime & low income borrowers
written by watermelonpunch, January 06, 2013 12:45
@ David
Not criticizing your comment... but it just begs me mention that talking about subprime & low income borrowers, and leaving it at that... I don't like it. ha ha

Again, I think when mentioning subprime & low income borrowers, there should always be a big print bold sidebar mentioning the share of subprime that was in fact flippers with subprime mortgages on non-owner-occupied properties.

And indeed, a good percentage of subprime defaults has been flippers who, while trying to make quick & easy money, got caught with their pants down when margin phone started ringing.

But yeah, I agree with the point of your comment that the housing bubble was made up of insane activity up & down the economic strata of loans in the housing market.

How anyone can forget this is beyond me.
But then I had a friend (in a well paid profession), who was buying a house near work during the boom, and found it impossible to get a traditional loan that would cover the exaggerated prices of houses in the area.

To get a traditional mortgage in some areas during the boom meant a huge down-payment. (Luckily my frugal friend had adequate savings to cover that, and so got a traditional loan.)

But that's yet another reason that it wasn't even just "poor people" & flippers who got subprime, but even regular people buying houses to live in, who were forced into it if they didn't have significant savings beyond the standard down-payment, and wanted to buy a house.
And it's important to note the area this friend was buying in was quite affluent and probably didn't have many, IF ANY, low income borrowers anywhere near there.

But I imagine that a lot of people don't have anecdotes about this because many people don't talk to their friends about their trials & tribulations in buying a house.
At the risk of going off on a harping tangent... I honestly think our culture's taboo of talking about personal finances is part of the problem with our economy.
That and our stratified society where people who fall into unemployment &/or start struggling financially, quickly fall away from friendships with their previous peers because they can't afford to keep up the social relationships, and are often too embarrassed to explain why, because of the stigma attached.
pushing homeownership went VERY WELL INDEED politically
written by Blissex, January 06, 2013 3:11
«I don't think there is any doubt that the efforts to push homeownership went seriously awry in the bubble years.»

From a political point of view it went VERY WELL INDEED because it created a large class of rabid wannabe rentiers who voted relentlessly for lower wages and higher asset prices for two decades.

There are quite a few bits of research that show that home price speculation strongly correlates with right-wing voting, and indeed after decades of expansion of home speculation there have been two politicians to the right of Reagan like Clinton and Obama elected as Democratic Presidents.

As Norquist wrote (my usual quote):

«The growth of the investor class--those 70 per cent of voters who own stock and are more opposed to taxes and regulations on business as a result -- is strengthening the conservative movement. More gun owners, fewer labor union members, more homeschoolers, more property owners and a dwindling number of FDR-era Democrats all strengthen the conservative movement versus the Democrats.»
written by watermelonpunch, January 06, 2013 5:41
70%? When is that quote from? I thought it was closer to half.
evidence is clear....
written by pete, January 07, 2013 10:27
The money flowed from James Johnson to congress, so that Fannie and Freddie could avoid strict SEC rules and pad their balance sheets. Efforts in the early 2000s to stop this were stimied by the like of Frank and Dodd. Lots of Fannie lobby dollars went to poorer districts...get the point. Follow the money. Anyone who ignores this is setting themselves up for a repeat. Already we are hearing "housing rebound" when in fact we are still at high levels historically. Sounds like another bubble brewing.
written by Warren Stewart, January 07, 2013 3:44
Regardless of who took which loans to buy what house for what reason, we must never forget that Wall Street controls the throttle and brakes of the housing market through the availability of financing. Very few bubbles occur (if any) in the real world without a short-selling component in place to profit from the bust. When Clintom repealed the Glass-Steagle Act, and signed the Commodity/Furures Modernization Act of 2000, he opened the door for Wall Street to create $56 Trillion worth of credit-default insurance that made sabatoging the real estate market, and pushing it off a cliff very very profitable. That is, for the few institution allowed to participate.
written by James Rytting, January 07, 2013 10:21
Nice try at being fair and balanced by rapping unnamed community organizations, but The organizations that encouraged moderate income families to take out mortgages on inflated properties as a wealth building strategy would be ... the banks!
obvious question posed by this story
written by Joe Emersberger, January 08, 2013 11:46
" The authors take this timing result, which is especially pronounced in the peak bubble years of 2004-2006, as evidence that the CRA played a major role in the pushing of bad loans on moderate income people."

So how, according to this story, did the government cow the Financne industry into staying quiet about the housing bubble while it was inflating for several years? To put it another way, where is the evidence that the finance industry was using its considerable resouces to warn the public about a massive housing bubble those dastardly "moderate income" people were creating all on their own using their clout with the government?

Dean, did you realize through all those lonely years writing about the housing bubble while it inflated that you had the finance industry secretly at your side?

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.