Sep072013

The continuing Community Reinvestment Act debate

This a debate that is still being argued from the beginning of the bubble and I wanted to revisit on this blog.  I really wonder if this debate would be ever settled.  Other subjects such inflation or even the gold are continually debated between blog commentators.  Readers have strong opinion on these subjects, so I doubt the CRA debate, a similarly controversial subject will be settled any time soon.  Of course unless some sort of evidence the pops up and ends the debate.

The theory is that Community Reinvestment Act that was passed in 1970’s under Carter evolved over time into a  force that allowed mortgage standards to be relaxed to all segments of the mortgage market.  This one act along with other policies from the  Federal Reserve and Government Sponsored Enterprises lowered the interest rates and lowered the lending standards.  These policies lead to an explosion of easy credit.   This theory has been study and analyzed from all different angles by a diverse group of people.  I have posted a summary of the pro and the con arguments.

Below is position from Federal Reserve Governor Randall S. Kroszner that states the CRA did not play an important in the easing credit standards before the bubble started.  I have included key points, since this is a very long article.

The Community Reinvestment Act and the Recent Mortgage Crisis

…In analyzing the available data, we focused on two distinct metrics: loan origination activity and loan performance. With respect to the first question concerning loan originations, we wanted to know which types of lending institutions made higher-priced loans, to whom those loans were made, and in what types of neighborhoods the loans were extended. This analysis allowed us to determine what fraction of subprime lending could be related to the CRA.

Our analysis of the loan data found that about 60 percent of higher-priced loan originations went to middle- or higher-income borrowers or neighborhoods. Such borrowers are not the populations targeted by the CRA. In addition, more than 20 percent of the higher-priced loans were extended to lower-income borrowers or borrowers in lower-income areas by independent nonbank institutions–that is, institutions not covered by the CRA.

Putting together these facts provides a striking result: Only 6 percent of all the higher-priced loans were extended by CRA-covered lenders to lower-income borrowers or neighborhoods in their CRA assessment areas, the local geographies that are the primary focus for CRA evaluation purposes. This result undermines the assertion by critics of the potential for a substantial role for the CRA in the subprime crisis. In other words, the very small share of all higher-priced loan originations that can reasonably be attributed to the CRA makes it hard to imagine how this law could have contributed in any meaningful way to the current subprime crisis…

His assumption is that only CRA loans should have the greatest impact in lower income areas, however areas not served by the CRA had little impact or no impact.  He also states the long-term evidence shows that the CRA has not pushed banks into extending loans that perform out of line with their traditional businesses. Rather, the law has encouraged banks to be aware of lending opportunities in all segments of their local communities as well as to learn how to undertake such lending in a safe and sound manner.

…now want to turn to the second question concerning how CRA-related subprime lending performed relative to other types of lending. To address this issue, we looked at data on subprime and alt-A mortgage delinquencies in lower-income neighborhoods and compared them with those in middle- and higher-income neighborhoods to see how CRA-related loans performed.An overall comparison revealed that the rates for all subprime and alt-A loans delinquent 90 days or more is high regardless of neighborhood income. This result casts further doubt on the view that the CRA could have contributed in any meaningful way to the current subprime crisis…

When we conducted this analysis, we found essentially no difference in the performance of subprime loans in Zip codes that were just below or just above the income threshold for the CRA.9 The results of this analysis are not consistent with the contention that the CRA is at the root of the subprime crisis, because delinquency rates for subprime and alt-A loans in neighborhoods just below the CRA-eligibility threshold are very similar to delinquency rates on loans just above the threshold, hence not the subject of CRA lending.

Conclusion

Our findings are important because neighborhoods and communities affected by the economic downturn will require the active participation of financial institutions. Considering the situation today, many neighborhoods that are not currently the focus of the CRA are also experiencing great difficulties. Our recent review of foreclosure data suggested that many middle-income areas currently have elevated rates of foreclosure filings and could face the prospect of falling into low-to-moderate income status. In fact, 13 percent of the middle-income Zip codes have had foreclosure-rate filings that are above the overall rate for lower-income areas.

Now for the counter argument that CRA was one of the key reasons the housing bubble or really credit bubble formed, from John Carney.  John Carney was once a supporter of the position above, then changed his mind and now believes that the CRA play key a role in easing credit credit standards.

Here’s How The Community Reinvestment Act Led To The Housing Bubble’s Lax Lending

It’s true that the CRA requirements were relaxed during the Bush administration. But at this point the lax lending standards were already in place. In any case, the relaxation took a peculiar form that actually made CRA lending more important rather than less. You see, the government let banks drop things like putting in ATMs in rural areas in favor of letting their compliance be judged entirely on CRA loans. This means the CRA had more of an influence on home lending after the requirements were relaxed, not less.

What’s more, George W. Bush was a major proponent of the kind of mortgages that banks had started making under the CRA. He urged low-to-no doc mortgages and the elimination of downpayments, just like the CRA regulators had long done. “We certainly don’t want there to be a fine print preventing people from owning their home,” the President said in a 2002 speech. “We can change the print, and we’ve got to.”

Again, the regulators told banks that much higher LTVs was an appropriate way to meet the CRA obligations.

Regulators instructed banks to consider alternatives to traditional credit histories because CRA targeted borrowers often lacked traditional credit histories. The banks were expected to become creative, to consider other indicators of reliability.

Similarly, banks were expected by regulators to relax income requirements. Day labors and others often lack reportable income. Stated-income was a way of resolving the gap between actual income of borrowers and reported income. The problem, of course, comes when the con-artists and liars come into the game.

The government pushed for greater mortgage securitization in an effort to increase CRA lending. At the behest of HUD Secretary Andrew Cuomo, Fannie and Freddie promised to buy $2 trillion of “affordable” mortgages. The government was intentionally decreasing the risks to the original lenders in order to increase loans to low-income borrowers, and minorities in particular. In short, you can’t blame securitization without coming back around to the CRA.

This is true. But it is largely beside the point. A huge driver of the demand for subprime loans was the demand for CRA bonds. Banks operating under the CRA could meet their obligations by buying up CRA loans or MBS built from CRA loans. The CRA created a demand that the mortgage servicers were meeting.

What’s more, many smaller mortage service companies hoped to be acquired by larger banks. Increasing their CRA lending made them more attractive take-over targets.

A study put out by the Treasury Department in 2000 found that the CRA was encouraging the mortgage servicers to provide loans to low-income borrowers, in part because the CRA loans had been so successful.

Finally, the Clinton adminstration threatened to subject the mortgage companies to the CRA if they didn’t comply voluntarily. They promptly agreed to increase their CRA-type lending in order to escape the kind of public scrutiny that comes with official CRA regulated status.

He really doesn’t end with a closing statement, because argument is organized more like a Q and A, so it ends a little abruptly.

 Now, I really don’t have a strong opinion either way.  The CRA eased credit standards, but I think the ending of the Glass-Segal regulations on the banking industry had a bigger impact than CRA.  The banking industry was stronger due to these mergers creating bigger companies that had the political power to push more risk onto the taxpayers through the GSE’s.  The government also played a role by pushing homeownership, since the housing industry contributed to the economy allowing politicians to point to the “robust” economy during reelections. however this economy based on a one time easy credit pyramid scheme that couldn’t sustain itself.   Finally the bankers are not as smart as they think they are.  I see these banksters as college versions to the snake oil men of the 1800’s. They are just much more polished, in fancier suits, and a bit more organized.  Their belief that homeowners could always refinance from one affordability product to a new affordability product was flawed.  I wanted to revisit this CRA debate, because it’s on-going news story with political over tones and after 6 years it still invokes strong opinions in people.  If readers that had any addition evidence or new articles I welcome them to link them in the comments.

Lastly, this ongoing CRA debate is sort of foreshadowing the Qualified Residential Mortgages  (QRM) and Qualified Mortgage QM debates and regulations.  QRM was deemed to restrictive so then the regulators just sort of came to the conclusion,  hey let’s match it with the QM standards that don’t require a down payment.  That’s is a least what the regulators wanted to push, hopefully some politician will step and say Fannie and Freddie will have tight standards and a downpayment requirement.  But in 30 years will the QRM and QM evolve into affordability products again like the CRA is accused of becoming?   Well, let’s hope not, people have short memories and bankers love to sell and invent new products they can market to muppets.  I’m skeptical that QRM regulations will really be effective because it’s been 6 years from bubble and these power financial industries interests are already trying to easy the underwriting standards to sell more loans.

Mike