Center for American Progress

Setting the Record Straight: Blame Conservatives, not CRA, for subprime mortgage mess

Setting the Record Straight: Blame Conservatives, not CRA, for subprime mortgage mess

Tim Westrich details why conservatives are responsible for the subprime mortgage mess, not the Community Reinvestment Act.

The root cause of the financial mess the country now faces is the failure of Bush administration officials to take action when they saw what was happening in the U.S. housing market and the overall economy to prevent disasters from happening. Ideological bedfellows of the Bush administration are now desperately trying to direct attention away from the failure of their hands-off approach to the economy as it sinks into recession alongside deeply stressed financial markets.

One particularly strained attempt at misdirection is to blame the Community Reinvestment Act, a law passed in 1977 intended to eradicate discrimination in lending. Fringe right-wing blogs first started spreading the idea that the root cause of the crisis was that CRA forced banks into making imprudent loans to exceptionally risky borrowers. This charge now has made its way into major newspapers by way of their sympathizers among columnists (see Larry Kudlow, George Will, and Charles Krauthammer).

The idea that CRA is the cause of the financial crisis simply does not pass the laugh test. First and foremost, CRA was enacted in 1977 to reverse so called “redlining” in the 1960s and 1970s—long before subprime mortgages at the heart of the current crisis were ever made—at a time when commercial banks would not extend credit to entire neighborhoods, usually minority neighborhoods. The Community Reinvestment Act imposes a duty on banks that operate under CRA to lend to borrowers in the census tracts in which it takes deposits, including poor neighborhoods.

Second, when CRA was passed in 1977, it was designed to cover only depository institutions—commercial banks and savings-and-loans institutions, or thrifts—that made the lion’s share of home mortgages back then. As subprime lending exploded in this decade, CRA lost its relevance because it doesn’t cover the more loosely regulated non-bank mortgage companies, which increasingly took the mortgage market away from banks and thrifts.

Non-bank mortgage companies, which aren’t covered by CRA, originated an estimated 50 percent of subprime loans in 2005, for example, according to testimony from Center for American Progress Senior Fellow Michael Barr. It is these institutions that mostly started to collapse at the beginning of the crisis. Another 30 percent of loans were made by subsidiaries of banks or thrifts, which are allowed—at their option—to use loans made by these subsidiaries to count toward their CRA rating.

As the New America Foundation’s Ellen Seidman rightly points out, bank regulators were raising red flags on bad subprime lending since before 2000, and warned that bad loans made by the banks they regulated were not acceptable. Lenders not subject to CRA did not get similar warnings. And, as Center for American Progress Senior Fellow Robert Gordon writes, lenders themselves haven’t blamed CRA. As he says, laws didn’t make them lend—the profit motive did.

Moreover, the Bush administration could have taken steps in this decade to further regulate subprime mortgage practices. It wasn’t until July 14 of this year that the Federal Reserve finally cracked down on "unfair, abusive or deceptive home mortgage lending practices” and restricted “certain other mortgage practices," power given to it under the Home Ownership and Equity Protection Act of 1994. The Fed finally prohibited practices that they had ignored for years, such as so-called “stated-income loans,” in which the lender makes a loan without verifying a borrower’s ability to repay from income and assets, or charging exorbitant prepayment fees.

Studies done by respected institutions—not just CRA’s cheerleaders—show that CRA works at what it was intended to do: overcoming market failures in low-income communities. Case in point: CRA-regulated lenders operating in their so-called assessment areas (census tracts where they maintain deposit-taking operations) have shares of conventional, prime home purchase loans that exceed the equivalent shares for out-of-area lenders or non-covered organizations, said a study by Harvard’s Joint Center for Housing Studies in 2002. And as late as 2005, when Bush-appointed bank regulators were trying to water down CRA, an evaluation by the Brookings Institution concluded that by fostering competition among banks in serving low-income areas, CRA generates larger volumes of lending from diverse sources and adds liquidity to the market, decreasing the risk of each bank’s loan.

Finger-pointing conservatives ought to realize that their attempt to find the boogeyman in bank regulation simply can’t be proven by the facts. They need to accept the fact that their cries for less government persuaded regulators they appointed to their posts to turn the other way as lending abuses piled up in the subprime mortgage market.

Tim Westrich is a Research Associate on the Economic Policy team at the Center for American Progress. For more information on the Center’s housing policies, please go the housing page of our website.

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