Letter to the Editor of CFA Magazine

Below is the text of a "Letter to the Editor" of CFA Magazine that I submitted in response to a recent article regarding the role of regulation in the current financial crises.

Raymond Niles's Point/Counterpoint in the Jan-Feb 2009 issue of CFA Institute Magazine misleads readers about the Community Reinvestment Act (CRA). He claims that regulation caused the financial crisis, which is an appropriate expression of opinion given that it was an opinion piece. However, his claim that the CRA is a regulation that caused the financial crisis, that CRA was a principal factor in the housing bubble and related collapse, and that CRA is an example of government's repeated violation of our individual rights is not supported by evidence within his article and runs counter to evidence presented elsewhere.

CRA legislation was passed in the 1970s to ensure that entities using federal insurance to gain deposits subsequently made loans in those neighborhoods where deposits were obtained. CRA is not new, it was not implemented just prior to or concurrent with subprime lending and the financial crises. There are also specific studies that challenge his argument:

1. Regarding the financial crisis and CRA's role, an analysis conducted by Federal Reserve staff in November 2008 indicates that "only 6 percent of all higher-priced loans in 2006 were made by CRA-covered institutions or their affiliates to lower income borrowers or neighborhoods in their [CRA] assessment area" (see Glenn Canner and Neil Bhutta (2008). "Staff Analysis of the Relationship Between the CRA and the Subprime Crises" at http://www.federalreserve.gov/newsevents/speech/20081203_analysis.pdf).

2. Regarding CRA's role in the housing bubble and related collapse, two studies found no conclusive evidence that CRA-related loans are more likely to have performance issues than comparable non-CRA-related loans (see Glenn Canner and Neil Bhutta (2008). "Staff Analysis of the Relationship Between the CRA and the Subprime Crises" at http://www.federalreserve.gov/newsevents/speech/20081203_analysis.pdf and see Elizabeth Laderman and Carolina Reid (2009). “CRA Lending During the Subprime Meltdown,” Revisiting the CRA: Perspectives on the Future of the Community Reinvestment Act, pp. 115-133).

3. CRA was not forced upon anyone; the choice was simple, any entity that felt the bargain was unfair could choose not to be federally insured (i.e. not be a bank). In fact, many lenders made such a choice. An analysis of the 2006 Home Mortgage Disclosure Act (HMDA) data indicates that roughly a third of applications were taken by independent mortgage companies rather than depository financial institutions or their affiliates (see Robert B. Avery, Kenneth P. Brevoort, and Glenn B. Canner (2007). "The 2006 HMDA Data," Federal Reserve Bulletin, vol. 93 at http://www.federalreserve.gov/pubs/bulletin/2007/articles/hmda/default.htm).

One thing I can agree with Niles about is that we have to understand root causes of the current situation before developing appropriate responses or else we are doomed to repeat our mistakes. Towards that end, our assessment of root causes must be based on available evidence and not just ideological opinion.