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The Phony Time-Gap Alibi For The Community Reinvestment Act
Perhaps one of the most misleading points made by those who wish to completely exonerate the Community Reinvestment Act’s role in encouraging lenders to adopt loose standards for mortgages is to insist that a statute originally put in place in 1977 could not have played a role in a housing bubble 25 years later. This point ignores the profound changes in the CRA and related fair housing that occurred in the subsequent years.

In the first place, it should be noted that the attempt to exonerate the CRA seems to turn on the idea that the act didn’t encourage much lending at all. This, of course, runs completely contrary to the advocates of the CRA during the housing boom. Back then, they were bragging about how effective the CRA had been in spurring lending....

...In 1989, President George H.W. Bush signed into law the Financial Institutions Reform Recovery and Enforcement Act that included provisions to increase public oversight of the way the CRA was enforced. Regulators were required to issue public, written performance evaluations of banks, including a system that rated bank compliance as Outstanding, Satisfactory, Needs To Improve or Substantial Non-Compliance. This public scrutiny began to push banks to make more loans to low-income borrowers, a process that often involved putting in place relaxed lending standards.

Shortly afterward, Fannie Mae and Freddie Mac addressed bank fears that the low-income lending with relaxed standards would unduly increase risk by beginning to securitize “affordable” mortgages. This was the beginning of subprime lending. It was the “pull” factor that complimented the “push” factor of the CRA.

The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, which opened the door for interstate banking and encouraged a new wave of banking M&A, made the ratings under the CRA a test for determining whether acquisitions would be allowed. That same year, the Fed refused to allow a Hartford, Connecticut bank to acquire a New Hampshire bank on fair housing and CRA grounds.

This was the first time the Fed had ever taken this kind of action, and it had profound effects through the banking sector. It sent a strong signal to the banks that the Fed would closely scrutinize lending practice, limiting the ability of banks to grow or make acquisitions if they were found to have insufficient low income or minority lending. Banks immediately responded by lowering down payment requirements and using more flexible income criteria.

The CRA defenders like to claim that the statute did not require these things, but the enforcement of the act did. Banks knew what kind of lending would increase their CRA compliance and meet with the approval of the regulators. CRA defenders often like to say that banks didn’t need to adopt standards that involve high loan-to-value ratios, low down payments, and loosey-goosey income tests. But this counter-factual claim is without basis in reality: the defenders cannot point to banks that did pass scrutiny of regulators and received top ratings from regulators without adopting these standards. The fact is that banks loosened standards because that is what regulators required. Any proposals that other strategies could have been employed is simply conjecture and second-guessing.

And there can be no doubt that the regulators were pushing for “no down payment” loans and 100 percent loan-to-value ratios. They also urged automated under-writing and reliance on credit scoring, two more factors that have since been viewed as contributing to overly-risky lending...

...After all, one of the tests for whether banks were engaged in discriminatory lending was whether they had adopted standards that were stricter than those approved of by regulators. Stricter standards were assumed to be evidence of discrimination, and if they had a disparate impact the matter was even worse. So when a Fed governor tells banks that they should be making no down-payment, 100% LTV loans based on credit scores and automated underwriting, we shouldn't be surprised that they started making these kind of loans.

In 1995, regulators began to enforce the CRA in a very different way than they had in the past. Instead of focusing on the process of bank lending, the new regulations were focused on objective performance evaluations. At the same time, regulators began disclosing more information about particular banks. As one commenter put it at the time, “We have learned from 30 years of CRA policy that what is measured gets done.” In short, publicly measuring low-income loans encouraged more of it. And the way regulators advised making low income loans involved features we now regard as toxic....

...In early 2005, largely at the behest of the banking sector, the Office of Thrift Supervision implemented new rules that were widely perceived as weakening the CRA. Supervision of banks with under $1 billion in assets was loosened, and larger banks were allowed to voluntarily reduce the amount of regulator scrutiny of their “investment” and “service”–two long-standing categories of assessment under the CRA.

This had two unintended consequences that would later prove to be very costly. In the first place, it increased CRA scrutiny of larger banks, who were now the main focus of regulators. This put even more pressure on the banks to make CRA loans. Secondly, by allowing banks to de-emphasize “investment” and “service,” the new regulations created an even greater incentive for banks to meet CRA obligations by making home loans.

As we’ve shown elsewhere, the CRA had a clear and strong role in loosening lending standards. Those who claim the long time gap between its original passage are probably ignorant of the profound changes in the law and the way it was enforced...