28 October 2008

Don't Blame The CRA For The Crisis

Did a federal government mandate on banks to lend in a non-discriminatory way in low income neighborhoods make a significant contribution to the subprime mortgage crisis or the financial crisis that followed? No.

The current financial crisis is not the result of the extension of credit to low- to moderate-income and highly concentrated minority communities as urged by the [Community Reinvestment Act] CRA. The CRA was established in 1977 and “is intended to encourage depository institutions to help meet the credit needs of the communities in which they operate.” . . . the current financial distress is a recent phenomenon created largely by institutions that are not subject to CRA requirements. Over the last several years lending by mortgage bankers and other non-depository intermediaries has eclipsed the production of depository lenders, accounting for more than half of the mortgage loans originated over the past five years. Additionally, a review of data provided by mortgage lenders pursuant to the Home Mortgage Disclosure Act reveals that lenders that are not subject to oversight by a federal banking agency (i.e. not subject to CRA) originated over half of the higher-priced conventional mortgage loans reported in 2005.

CRA did not push banks and other institutions to make loans to unqualified borrowers nor did it encourage them to relax underwriting criteria to the point where they failed to consider a borrower’s capacity to repay the loan. . . .

New data from state housing finance agency-originated loans shows that these loans made primarily to low- and middle-income households, with average to below-average credit scores, have foreclosure rates significantly better than subprime.

According to the Mortgage Bankers Association, 4.26 percent of subprime loans began the foreclosure process in the second quarter this year. In contrast, foreclosure rates among community land trust (CLT) homeowners (who are workforce families) is approximately 30 times lower than the national foreclosure rate[.]

In fact 90.8% of subprime loans were made by financial companies not covered by the CRA (see also this addendum to the linked report). "CRA Banks were 58 percent less likely than other lenders to originate high cost loans to" low and middle income borrowers.

Equally important:

It is unlikely that a rush to qualify new home owners in previous years, CRA-related or otherwise, resulted in the credit crunch we are facing today. Whereas over half of subprime mortgages were refinances between 1998 and 2006, less than 10 percent of subprime mortgage originations went to first-time home buyers.

Neither the timing, nor the incentives were right:

CRA was passed in 1977. The explosive growth in subprime lending occurred more than two decades later, nearly doubling from 2001-2006 alone. No major changes to CRA were enacted during this time. . . . CRA penalizes banks for reckless, irresponsible and otherwise predatory lending.

The underwriting practices favored by the CRA were hardly radical. For example, when a potential homebuyer had no credit history, as opposed to a negative credit history, regulators suggested that "Willingness to pay debt promptly can be determined through alternative sources of information including timely rent, utility bills, and other scheduled payments," which do not show up on credit reports, but do show creditworthiness.

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