the Future of Change

Since its passage in 1977, the Community Reinvestment Act (CRA) has charged federal bank regulators with “encourag[ing]” certain financial institutions “to help meet the credit needs of the local communities in which they are chartered consistent with [] safe and sound” banking practices.  Even before the CRA became law—and ever since—it has become a flashpoint.  Depending on your perspective, this simple and somewhat soft directive has led some to charge that it imposes unfair burdens on financial institutions and helped to fuel the subprime mortgage crisis of 2007 and the financial crisis that followed.  According to this argument, the CRA forced banks to make risky loans to less-than creditworthy borrowers.  Others defend the CRA, arguing that it had little to do with the riskiest subprime lending at the heart of the crisis.

Research into the relationship between the mortgage crisis and the CRA generally vindicates those in the camp that believe the CRA had little to do with the risky lending that fueled these crises.  At the same time, recent research by the National Bureau of Economic Research attempts to show that the CRA led to riskier lending, particularly in the period 2004-2006, when the mortgage market was overheated.

My most recent paper reviews this and other existing research on the subject of the impact of the CRA on subprime lending to assess the role the CRA played in the mortgage crisis of 2007 and the financial crisis that followed.  This paper also takes the analysis a step further, and asks what role the CRA played in failing to prevent these crises, particularly their impact on low- and moderate-income communities: i.e., the very communities the law was designed to protect.  Based on a review of the best existing evidence, the initial verdict of not guilty—that the CRA did not cause the financial crisis, as some argue—still holds up on appeal.  At the same time, as more fully described in this work, an appreciation for the weaknesses inherent in the law’s structure, when combined with an understanding of the manner in which it was enforced by regulators, lead one to a different conclusion; although the CRA did not cause the crisis, it failed to prevent the very harms it was designed to prevent from befalling the very communities it is supposed to protect.

The defects in the CRA that emerge from this review, in total, suggest not that the CRA was too strong, but, rather, too weak.  In the end, with many gaps in coverage and regulators unwilling to enforce its terms, the CRA proved to be a financial Maginot Line: lightly defended, easily circumvented, and quickly overrun.

The law’s shortcomings also point to important reforms that should be put in place to strengthen and fine-tune it to so that it can meet its important goal: ensuring that financial institutions meet the needs of low- and moderate-income communities, communities for which access to capital and banking services on fair terms is a necessary condition for economic development, let alone economic survival.  Such reforms could include: (1) expanding its scope to cover more financial institutions (the overwhelming majority of subprime lending took place beyond the scope of the CRA, and thus the law was powerless to prevent it); creating a private right of action so that community members and public litigants, like state attorneys general, could enforce the law in the courts; and using the CRA to apply more pressure on banks to modify underwater mortgages.  Although some of these reforms will take legislative action, and its unlike Congress, given its current makeup, would approve them.  Regulators could take action on underwater mortgages right now, without Congressional intervention.