The Community Reinvestment Act (CRA)

[The text below was adapted from a speech I gave recently at the 2009 Taylor Symposium at IUPUI regarding the American Promise and its relation to housing]

Another area for enhancing housing opportunities in the next decade is the Community Reinvestment Act, more commonly referred to as CRA. This federal legislation was first passed in the 1970s, revised and changed in subsequent decades, and will likely be revised again over the next year. CRA requires that banks that receive federal deposit insurance must make loans in the geographic areas from which they receive those deposits. It's pretty simple, if you want a taxpayer guarantee so you can obtain some of the cheapest funds available through bank deposits, then you have to put your money to work in the communities from which you take it.

Recently, as subprime lending has become less popular and the list of failed financial institutions grows there has been much screaming and yelling about CRA being the cause of the subprime crises. The claim is that CRA forced lenders to make loans to borrowers that otherwise were not qualified, this weakened the banks' financial position, and therefore CRA was the underlying cause of the current crises. I heard this argument as recently as this last weekend from Monica Crowley on the McLaughlin Group on PBS. The Federal Reserve has obviously heard this criticism as well, has devoted significant staff time and research to the issue, and has felt a growing need to speak out about it as recently as this week. Here's what Federal Reserve Governor Duke had to say about the subject earlier this week:

"... our recent analysis of CRA-related lending found no connection between CRA and the subprime mortgage problems. In fact, the Board's analysis found that nearly 60 percent of higher-priced loans went to middle or higher-income borrowers or neighborhoods, which are not the focus of CRA activity. Additionally, about 20 percent of the higher priced loans that were extended in low or moderate-income areas, or to low or moderate-income borrowers, were loans originated by lenders not covered by the CRA. Our analysis found, in fact, that only 6 percent of all higher-priced loans were made by CRA-covered lenders to borrowers and neighborhoods targeted by the CRA. Further, our review of loan performance found that rates of serious mortgage delinquency are high in all neighborhood groups, not just in lower-income areas...an analysis of foreclosure rates...found that loans originated by CRA-covered lenders {in that particular study} were significantly less likely to be in foreclosure than those originated by independent companies. Clearly, claims that CRA caused the subprime crisis are not supported by the facts."

The slide below provides a different type of measurement that addresses the same issue as CRA - namely, do lenders make loans in proportion to the places where they get deposits? This slide compares the percentage of deposits held by approximately 40 institutions to the percentage of applications taken by those institutions for home purchases, all as of 2007, in the Indianapolis metropolitan area. This calculation is not perfect, there are several painful and intricate adjustments that are used to get to this dataset, and lending institutions can and do provide more than just mortgage loans to the community to support their CRA activities. But it is clear, some institutions are taking more in deposits than they are providing in mortgages and we need legislation like the CRA to make sure taxpayers receive a proportionate benefit for the deposit insurance they provide.

Admittedly, CRA needs to be updated in the coming decade - but it needs to be made stronger, not weaker. For example, in 2008, 31 institutions were reviewed for CRA in Indiana, only 1 was noted as needing to improve its performance. I know of hardly anything worth measuring where a sample size of 31 would suggest everything is just as expected in all cases but 1. I have four suggestions for changing CRA:

1.Provide greater transparency of what geographic areas and customers qualify for CRA activities and how banks' evaluation results are determined. Most loan officers have no idea how their bank achieved its CRA evaluation, and their depositors know even less.

2.Make evaluations based on customers, both borrowers and depositors, rather than just deposit dollars. For example, a foreign deposit placed in a bank in South Dakota should not create a CRA obligation for the bank. But likewise, a bank that solicits for credit cards and mortgage loans in a given neighborhood should have some responsibility to be involved in that neighborhood's civic activities beyond just lending.

3.Use a relative measure of peer-based assessments rather than absolute benchmarks. It is not right that evaluations be so lop sided such as having 30 of 31 institutions needing no improvement. Bell curves are good for students at IUPUI, they are also good for banks, and can introduce a measure of market forces into the process.

4.Extend the CRA to all entities requiring government capital infusions and/or loan guarantees. This includes airlines, insurance companies, and yes, even car companies. If you take the money, you have to take the responsibility of investing in local communities.