The Blame Game Continued: Is CRA at Fault?

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Is it possible that a law enacted to ensure banks serve the needs of the communities the are located in might be at the root of the current financial crisis? The idea that any one thing, be it an agency, a law, an event or a person, bears total responsibility for the situation is patently false. It is, however, important to understand what role each played in getting us here. Preferably before taking drastic measures to repair what may never have been broken or worse, break one of the few things still working.

When the Community Reinvestment Act (CRA) was enacted in 1977 it was intended to curtail a practice called red-lining in which banks and other depository institutions were reluctant or refused to make loans based the borrowers address. It didn’t matter if the borrower was could repay the loan, nor did it matter whether the loan was a mortgage, home-improvement loan or small-business loan. If the borrower resided or intended the loan to be used in an area the lender did not wish to lend in, such as a low or moderate income neighborhood, small town or rural area, well then the borrower faced significant challenges in getting a loan if they could get one at all. As a result, potential borrowers in these areas relied heavily on mortgage banking companies for financing.

As it was originally written, the CRA was a very general piece of legislation. So of course, scarcely a year has gone by that legislators, regulators or the financial industry have not tried tinkering with it. None of these subsequent adjustments ever required depository institutions to make loans that were unsound.

?Any loan that is made must be mindful of the sacred obligations in preserving the integrity of funds,? Robert Buchard, then executive vice president of Keycorp, a holding company based in Albany, NY told ABA Banking Journal in 1989. ?These can be self-serving investments in our communities, but it isn’t a hand-out program.?

How then did we reach the point where the CRA is a potential scapegoat for the current crisis?

In part it is from the same misconception Buchard was fighting nearly two decades ago. Because CRA is associated with loans made in low- or moderate-income neighborhoods, it is easy to say the loans are high risk or that CRA forced banks to make unsound loans to borrowers incapable of repaying those loans. This perception was perhaps reinforced by loan solicitations promising homeowners cash grants or equity disbursements as part of a CRA program. These solicitations appear to be an effort to get homeowners to apply for mortgage loans using their home as collateral and are NOT part of any CRA nor does the Federal Reserve endorse programs.

?Point of fact: only about one-in-four higher-priced first mortgage loans were made by CRA-covered banks during the hey-day years of subprime mortgage lending (2004-2006),? said Federal Deposit Insurance Corporation Chairman Shelia Bair in a speech made at the New America Foundation conference on Wednesday. ?The rest were made by private independent mortgage companies and large bank affiliates not covered by CRA rules.?

Put another way, three quarters of the loans many experts say played a significant role in creating this crisis were not made under CRA. By virtue of sheer numbers, it would appear blaming CRA entirely is unfair.

This does not mean CRA is perfect with no room for improvement. That quarter of loans that were made by banks under CRA demonstrates this. It also indicates there are better candidates for reform and regulation than CRA.