The Community Reinvestment Act (CRA) is a frequent target of the right wing. Congress passed the CRA in 1977 as a result of communities organizing against redlining, a practice where banks refused to lend to people of color and their communities. Aside from the obvious moral problems, it is hard to imagine how anyone would be able to pull themselves out of poverty without being able to get a loan to buy a home or start a business, which is why this is such an important issue.
The CRA requires banks to make credit available to the communities they serve, and to do so in a way that doesn’t endanger the financial institution or the community. The CRA establishes an examination process where financial regulators regularly assess how well a bank meets the needs of the communities it serves, and to make sure that they meet these needs in a safe and sound manner.
Many right wing commentators, such as Republican Congressmen Jeb Hensarling, say that the CRA is to blame for our recent recession. They claim that banks were forced into making subprime loans in order to accommodate financial regulators who wanted more mortgages for people of color and the low to moderate income. While the federal government did encourage and guarantee a good deal of mortgages with more flexible underwriting standards, the CRA was actually used to ensure that banks were making home loans in a safe manner.
The Federal Reserve and many other research organizations have found that loans originated by institutions regulated under the CRA were significantly less likely to be in foreclosure than loans originated by companies not regulated by the CRA, even after factoring in other explanations such as credit score and the applicant’s income. Even Forbes wrote, “of the top 25 subprime lenders in 2006 only one was subject to the usual mortgage laws and regulations.”
Rep. Hensarling himself acknowledges that companies not regulated by the CRA did the vast majority of subprime lending. However, he argues that the real damage done by the CRA was the precedent that “require[s] lending institutions to abandon their traditional underwriting standards.” Wrong. CRA-regulated institutions were actually warned by their regulators that “badly underwritten subprime products that ignored consumer protections were unacceptable.” Instead of being the cause of the subprime lending crisis, the CRA could have been an effective means of preventing it, if it had covered the firms making the most toxic loans.
The problem was that unregulated mortgage institutions started making a large amount of subprime loans with toxic provisions and shoddy underwriting. Then these companies started bundling these subprime loans into mortgage-backed securities and selling them to investors.
I know that when many people hear phrases like “mortgage-backed securities” they start to tune out, but these actually are pretty easy to understand. Mortgage-backed securities are when you take a group of mortgages that are supposed to have regular cash flows and bundle them together into a single product, which is then sold to investors. Mortgage- backed securities are just one type of an asset-backed security, or derivative; other examples could include rental payments or car loans. Financial institutions and investment firms were doing this at an alarming rate, so that, derivatives “in 2007 amounted to three times the size of the entire global economy.” When those booby-trapped subprime loans started to default at an astonishing rate, these financial institutions and investment firms faced serious trouble.
So many subprime loans failed because they weren’t designed with the interest of homeowners in mind. They typically involved adjustable interest rates where borrowers could make very small payments in the beginning, but then the payment would skyrocket after several years. CRA-regulated institutions were warned to stay away from exactly these kinds of features. These time-bomb mortgages ultimately brought down the whole house of cards and resulted in a global financial crisis.
That’s why it makes no sense to blame the CRA for the housing crisis. The most problematic lending was mainly done by institutions not regulated by CRA. Second, even if institutions not regulated by CRA were driven to subprime by the “precedent,” as Rep. Hensarling suggests, then what led them to start bundling subprime loans into mortgage-backed securities? I would argue that the massive size of the derivatives market indicates that these institutions pursued subprime lending to make some quick cash, and not to satisfy regulators that had no authority over them. Finally, the idea that CRA pushed the institutions it regulates to aggressively pursue anything to this degree seems a bit farfetched when you consider that practically every financial institution already passed their CRA exams every single time since the law was passed in the late 1970’s.
I bring this up because we need to understand the true origins of our recent economic calamity. Blaming CRA may lead political leaders to deregulate the financial sector, but as this experience has shown, doing that may invite another catastrophe. Instead, we should work to close the loopholes in the CRA that allowed irresponsible lenders and investors to tank our economy.
At Greenlining, we use the CRA as a tool to improve our communities. Importantly, the CRA applies not only to housing, but also to small business lending and community development services such as banks volunteering staff time to help people file their tax returns. We recently weighed in on a proposed merger between PacWest Bank and CapitalSource Bank, two similarly sized business banks primarily located in Southern California. The most noticeable difference between the two is their commitment to small business and community development, with CapitalSource demonstrating a high commitment and PacWest demonstrating a mediocre one. Without the CRA, community groups would have no venue to comment on these mergers, which would mean having less input over the level of services and resources in our communities.
The CRA is one of the most important mechanisms for ensuring that financial institutions serve our communities. It helps ensure that banks offer quality mortgages and small business loans to our communities and encourages them to promote community development services. The CRA has benefitted our country, and weakening it or repealing would mean fewer consumer protections and less community input on the important issues of homeownership, entrepreneurship and community development.