The Thought Refuse

A Virtual Repository for the Mind

How Much Blame To Throw At the CRA?

with 4 comments

Some experts and some non-experts have pointed a finger at the Community Reinvestment Act as part of the reason behind the housing bubble bursting and setting off an economic crisis.  I afforded it due consideration, but when all is said and done holds minimal blame in the grand scheme.

The failures in government regulation undoubtedly played a part in the economic crisis.  However, compared to other government action, the CRA accounts for a tiny share of the pie in more ways then one.  It was a mistake to change CRA compliance requirements to be measured on a quantitative basis and away from a qualitative value judgement.  This forced lending institutions to require meet an annual lending quota or risk jeopardizing government benefits.  The CRA most definitely encouraged lending to those who could not afford.

But looking at the percentage what the government qualified as CRA loans pales in comparison to the total share of outstanding subprime loans.  Between 1993 and 1998, only $467 billion dollars qualified as CRA loans – a tiny slice of the trillions and trillions of dollars in outstanding home loan mortgages.  Present day estimates indicate that CRA home mortgages only account for about 20% of all home mortgage loans.  Even taking into account the higher default rates of subprime loans, a 9% default rate on CRA loans doesn’t even begin to approach the aggregate value in total defaulted home mortgages.

Numbers aside, it’s questionable whether or not a repeal of the CRA would have stopped the subprime lending spree.  In fact, two other government actions greatly encouraged subprime mortgage practices far more then the CRA.

Combined, Freddie Mac and Fannie Mae has either bought up or issued nearly half of all outstanding home mortgages by buying up loans from other lending institutions.  Freddie Mac and Fannie Mae were able to begin buying up large amounts of outstanding home loans because they could now sell mortgage backed securities.  Prior to the passage of the Gramm-Leach-Billey Act(which repealed the Glass-Steagall Act), banks were prohibited from offering investment services.  But now Freddie Mac, Fannie Mae, and all banks could begin leveraging their outstanding home mortgage loans to raise additional capitol.

It was a new way to raise capitol revenue and a new way to increase profits.  It’s natural for all businesses to exploit their profit margins while managing risks.  However, the risks of mortgage backed securities were lessened by the nonbinding understanding in the financial sector that the government implicitly guaranteed the securities issued by Freddie Mac and Fannie Mae.  The federal government has long provided these two instutitions with tax breaks, subsidies, low interest loans, and a reduction in capitol backing regulations.

Believing the mortgage backed securities issued by Freddie Mac and Fannie Mae would always be liquid, believed, to some degree, that the risk of subprime lending were offset by the implicit government backing.  With the ability to leverage loans as capitol and the perceived invunrability of Freddie Mac/Fannie Mae, fueled an increase in subprime lending.  It was a fantastic short term way to spur growth in the housing market, but miscalculated the risk involved based on assumptions.  It was not the need to meet CRA requirements that caused banks to make high-risk loans, it was the incentive to raise capitol.  The CRA could have been nonexistent and lending institutions would have still pursued those avenues which appeared profitable.

Government missteps played a role in where we are today.  Banks should have never been allowed to enter the investment market through government deregulation.  And the government never should have allowed Freddie Mac and Fannie Mae become the lynch pin in the home mortgage market.

Instead of pointing our finger at a single, politically self-serving source lets all grow 90 more fingers, so we can point the blame in all directions where it rightly deserves to be.  This wasn’t the CRA’s doing.  This was a confluence of events ranging from government to free market to populace none of which are to be used to gain the political upperhand.


4 Responses

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  1. […] Read the rest of this great post here […]

  2. […] have examined the share of CRA home loans compared to the total value of outstanding loans previously, and need […]

  3. I think you underestimate the effect that a 9% higher default rate can have, when certain institutions are buying up and concentrating mass quantities of these loans in order to satisfy CRA requirements.

    Specifically, as you mentioned, Fannie Mae and Freddie Mac were undertaking such an endeavor. But they weren’t doing it for profit, as you suggest. They were doing it for two reasons:

    First, as I already mentioned, they needed to satisfy their CRA requirements. Clinton’s 1995 CRA revamp brought non-bank institutions, including the two cooperatives in question, under its jurisdiction.

    Secondly, after the unprofitability of CRA-related loans was uncovered during debates in 1999 and confirmed in a March 2000 report, the Clinton administration urged Fannie Mae and Freddie Mac to further concentrate CRA loans beyond their mandatory quota. The intent was to use these government-backed institutions as insurance on the high-risk loans that the government was making lenders pick up.

    But, as we now know, Fannie Mae and Freddie Mac, even with the power of the government behind them, were not strong enough to withstand that much poison in the system.

    So, certainly it was the banking institutions that were picking up the bad loans, but to say that they did it for profit ignores how the government basically gave them very little choice.

    I’ve written a full article on the matter here:

    Tristan Brown

    December 8, 2009 at 5:48 am

    • I can have a qualitative value of 9% within the context of the following fact: the total percentage of sub-prime loans issued as CRA compliant totaled under 25%. That is an increase of 2.25% in defaulted loans created by the CRA. Such a small percentage increase is not an underestimation, however you want to slice it. To put that in perspective, in 2008 lending institutions wrote down $501 billion in sub-prime securities. As an estimate, $11.2 billion of those write-offs would have been CRA related loans.

      The change you note made to the CRA actually occurred in 1999 and was the Graham-Leach-Bliley Act. For posterity sake, please note that it was introduced by three Republican senators and passed by a Republican congressional majority. It was signed by Clinton. It is deceptive to paint the changes made by the GLB Act as an action understaken by Democrats.

      I’m assuming your referring to the 1999/2000 report issued by the Federal Reserve to support your claim CRA loans are not profitable(it should be said that the report itself minimized it’s own findings by saying “Although better than anecdotal information, the report falls short of being a rigorous, data-based scientific study.”) The report does not say CRA loans are unprofitable. It only states that CRA loans are not as profitable as non-CRA related loans. There is an important distinction between not profitable and not as profitable. The term “not as profitable” does not prohibit profits. It’s worth noting the same report concluded that only 1% of responding lending institutions issued CRA loans to meet satisfactory or outstanding CRA compliance with the federal government.

      I have yet to see any study or findings which show that CRA loans were the poison in the system. The poison in the system was the sub-prime mortgage market(75% of which were not CRA regulated) and the subsequent over leveraging of mortgage backed securities.

      I ask you, why did for-profit lending institutions issue sub-prime loans 75% of the time when the CRA did not require them to issue these loans?


      March 22, 2010 at 6:36 pm

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