Of all the factors behind the collapse of America’s financial institutions during the second half of 2008, few have been as trumpeted – or misunderstood – as the Community Reinvestment Act (CRA). This Carter-era legislation, intended to boost residential mortgage lending in lower-income urban neighborhoods, increasingly has served as a blank check for community groups to shake down depository institutions into lowering their credit standards to reach marginally qualified borrowers. In extracting such concessions, these groups have contributed to the ongoing explosion in loan defaults and foreclosures. Undaunted, House Democrats, led by Rep. Eddie Bernice Johnson, D-Tex., are proposing to make the CRA even more aggressive in rooting out “redlining,” the practice by which mortgage lenders allegedly refuse to extend credit to low-income and often nonwhite minority neighborhoods.
The bill is called the Community Reinvestment Modernization Act of 2009 (H.R. 1479). What’s being “modernized” isn’t clear. What is clear is the radical nature of this legislation. Introduced in March by Congresswoman Johnson and attracting as of this date nearly 60 co-sponsors, the measure would subject mortgage lenders to credit allocation requirements so onerous that even longtime supporters of the law might balk. The House Financial Services Committee has yet to take action. But that soon could change once Congress votes on its massive rewrite of health care policy.
What would the new CRA legislation do? For one thing, it would extend the law’s institutional reach. From the start, the act has applied only to federally-insured depository institutions; i.e., commercial banks and savings & loan (“thrift”) associations. Under current law, a non-bank institution may undergo federal regulatory agency review if it chooses to do so, but it does not have to. Rep. Johnson and her allies would mandate reviews of credit unions, insurance companies, mortgage banks and other non-depository institutions. Another key feature of the measure is that it would lay down explicit affirmative action goals. Lenders would have to show how their mortgage underwriting serves the needs of “persons of color” and women.
Sponsors are unapologetic in their support. “Congress has passed a number of laws designed to combat redlining and eliminate housing discrimination,” remarked Rep. Johnson at a September 16 hearing of the House Financial Services Committee. “Unfortunately, we all know that redlining still occurs.” Committee Chairman Barney Frank, D-Mass., for one, long has concurred with such a view. So has President Obama. Back in 1994, in fact, young Obama and a team of fellow attorneys at Miner, Barnhill and Galland used the law to file a class-action suit against Citibank Federal Savings Bank alleging “institutional racism” in its Chicago-area lending practices. (see Buycks-Roberson v. Citibank). After four years, the plaintiffs settled out of court, generated around $950,000 in fees for their lawyers.
Some House Financial Services Committee Republicans, by contrast, don’t like the Community Reinvestment Act even in existing form. Rep. Ed Royce, R-Calif., notes that for years the CRA has provided community activists such as the Association of Community Organizations for Reform Now (ACORN) with huge opportunities to stall or block bank mergers and expansions by filing complaints with federal regulators. Likening this behavior to legalized extortion, he explained on his House website: “In order to avoid these filings, financial institutions would either lower their lending requirements to meet the needs of ACORN associates or they would simply pay out funds to one of the many ACORN-affiliated organizations.” Rep. Jeb Hensarling, R-Tex., bluntly states, “Should we repeal CRA? Absolutely.”
That raises the issue of the necessity of the Community Reinvestment Act. The CRA began as a creature of moral indignation and high hopes. Passed by Congress and signed by President Carter in 1977 (P.L. 95-128), the law, like its 1975 predecessor, the Home Mortgage Disclosure Act (HMDA), came about as a result of a high-pressure nationwide campaign by community organizers to “encourage” federally-insured depository institutions to devote more assets to residential mortgages in allegedly underserved neighborhoods. Fire-breathing activists such as the late Gail Cincotta, founder of the Chicago-based National People’s Action, employed high-octane confrontation tactics such as picketing, occupying offices, and, at one point, publicly threatening to nail a “Loan Shark” sign over the door of Federal Reserve Bank headquarters in Washington.
The Community Reinvestment Act represented a major step toward mandatory credit allocation. Whereas HMDA merely requires banks and thrifts to disclose the geographic breakdown of mortgage loan applications, the CRA, amended several times through statute and regulation, pressures these financial intermediaries to step up mortgage lending to meet the putative credit needs of the areas in which they do business. To ensure compliance, four federal regulatory agencies – Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency (OCC), the Federal Reserve Board of Governors, and the Office of Thrift Supervision (OTS) – periodically examine performance based on a variety of data. Following review, a federal overseer assigns to the lender one of four ratings: “Outstanding,” “Satisfactory,” “Needs to Improve,” and “Substantial Noncompliance.”
Woe unto lenders who fall into the bottom or even next-to-bottom category. A “substantial noncompliance” or “needs to improve” rating may be the basis for denial of permission for a branch expansion, merger or acquisition. By contrast, an “outstanding” rating is the gold seal of approval, especially because it facilitates mortgage purchases by “too-big-to-fail” Fannie Mae and Freddie Mac, who pool most of the loans into marketable securities. When Congress in 1992 amended the CRA to force the two secondary mortgage market giants to devote a minimum percentage of loans to low-and moderate-income areas (a mandate to be enforced by a new office within the firms’ regulator, the U.S. Department of Housing and Urban Development, or HUD), the entire mortgage lending industry’s willingness to “play ball” became all the more imperative.
Over time, Leftist agitprop nonprofit maestros such as ACORN, National People’s Action, and Neighborhood Assistance Corporation of America (NACA) came to realize they had a powerful weapon in their arsenal. As these groups were well-schooled in guerrilla-style confrontation, it was a snap for them to confront lenders on the eve of a merger or expansion and demand a “contribution” to make federal approval go more smoothly. In 2000, when Chase Manhattan Corp. announced plans to buy J.P. Morgan for $36 billion, it donated several hundred thousand dollars to ACORN. Lenders have found this brand of “greenmail” isn’t the only expense associated with expansion plans. Typically, they conduct expensive public-relations campaigns in order to stave off community organizer opposition and possibly a Justice Department lawsuit.
Some might call this extortion or at least federal enabling of bad behavior. Prominent economists such as Gary Becker and Thomas DiLorenzo have. Yet major banks from Fleet to NationsBank to First Union preferred to adhere to pay-the-toll policy, preferring to enter into coerced “agreements” so as to obtain permission to expand operations. As the Gramm-Leach-Bliley Act of 1999 made bank acquisitions easier and more lucrative, paying this shakedown tax increasingly became an expected cost of doing business. Even in the aftermath of the banking meltdown, the volume of CRA commitments remains high. This February, for example, Bank of America, recipient of $45 billion in Troubled Asset Relief Program (TARP) emergency loans to stave off bankruptcy (recently paid off), announced “a 10-year, $1.5 trillion investment in low-to-moderate income and minority communities – the largest investment of its kind in America.” In other words, BoA is escalating the very practices that got it into hot water in the first place.
Several times over the years Congress has amended the law. Crucially, lawmakers have raised the percentage requirements of loans to “underserved” areas and required Fannie Mae and Freddie Mac to devote larger portions of their loan purchases to high-risk borrowers. Missing from such actions was an understanding that banks don’t derive pleasure much less profit from turning down mortgage applicants. If lenders “discriminate” against a particular neighborhood, it might be because that area has high rates of robbery, murder, vandalism, arson and other crimes that adversely affect property values. It also might be that most of its residents lack sufficient assets to come up with even a modest down payment. While the CRA asserts that meeting community credit needs must be consistent with safe and sound institutional operation, the reality is that banks and thrifts have been pushed into choosing one or the other.
Supporters of the Community Reinvestment Act frequently point to success stories, noting as well that the CRA over the years has routed trillions of dollars of loans toward depressed communities. But such estimates are more imprecise than they let on. In a paper written last year for the Competitive Enterprise Institute, CEI policy analyst Michelle Minton noted that the surge in CRA-driven lending has occurred simultaneously with a surge in lending generally. And the primary reasons for the overall rise have been vast improvements in information technology and federal deregulation of assets and liabilities. More problematic, CRA defenders place a higher priority on loan volume than sound risk evaluation. As Manhattan Institute researcher Howard Husock, a strong critic of the law, notes: “This (CRA) starts to stand traditional lending on its head. In sharp contrast to the traditional regulatory emphasis on safety and soundness, banks were now judged not on how their loans performed, but on how many loans they made.”
Another weakness in the case for the CRA is that lender agreements are products of intimidation by community groups. ACORN has been aggressive enough. But Neighborhood Assistance Corporation of America (NACA), headed by self-described “banking terrorist” Bruce Marks, may be even more effective. The Boston-based nonprofit group, with some three dozen offices across the U.S., prides itself on its guerrilla methods “to combat discrimination and exploitation of working people by lenders and financial institutions.” In 1995, the group bullied Fleet Financial (now part of Bank of America) into committing itself to $8 billion in loans for low-income neighborhoods, plus another $140 million going directly to a NACA-run loan program. In 2003, NACA organized 300 Citigroup borrowers to attend the bank’s annual shareholders’ meeting and demand more funds for mortgages in allegedly underserved areas. Not long after, Citigroup announced it would provide $3 billion over 10 years for low- and moderate-income loans whose borrowers would be screened by NACA counselors. “Banks now surrender without a fight,” ruefully noted Washington, D.C. journalist David Hogberg.
Lenders could afford this “tax” during heady times – such as the first half of this decade. But during 2006-07, the party ended and Americans were stuck with the bills. Supporters of the Community Reinvestment Act remain adamant about the necessity of the law. The house price and mortgage meltdowns, they asserted, overwhelmingly resulted from aggressive and often criminal practices by non-CRA institutions. John Taylor, president of the National Community Reinvestment Coalition, noted: “If the CRA applied to the institutions that made these high-cost loans, we wouldn’t have had them because the examiners wouldn’t have tolerated them…Almost always the problematic loans came from a mortgage company or a non-CRA affiliate.” He and other CRA advocates frequently cite a paper by University of Michigan law professor Michael Barr concluding that only about one in four subprime loans during this decade were made by CRA-covered institutions.
This view, up to a point, does have credibility. Mortgage fraud among non-depository lenders was rampant for several years, especially in the area of “subprime” loans tailored to borrowers with a weak or nonexistent credit history. And misdeeds haven’t gone unpunished. Angelo Mozilo, co-founder and ex-chairman and CEO of Countrywide Mortgage, the leading subprime lender in the U.S., was indicted in 2008 on federal criminal charges of mortgage fraud and insider stock trading; the Securities and Exchange Commission this year filed civil fraud charges. But there is another side to the story. Many non-bank institutions operated as subsidiaries or servicing partners of CRA-covered institutions, especially following the Gramm-Leach-Bliley law in 1999. In 2000, for example, Citigroup launched a program to allow securities customers with uninsured accounts to “sweep” their funds into FDIC-insured accounts, thus expanding the pool of available funds for its subprime lending subsidiary, CitiFinancial/Associates.
Even more damning to the case for exonerating the CRA, depository lenders covered by the law have taken a bath on the very kinds of loans demanded by community activists. During 1977-97 – the first 20 years of the CRA’s existence – lender commitments under the law totaled a combined $200 billion. But during 1997-2007, cumulative commitments to nontraditional borrowers were more than $4.2 trillion. Such investments had a serious downside. Roughly half a dozen years ago, the Washington Mutual Savings & Loan pledged $1 trillion for mortgages to persons whose credit histories “fall outside typical credit, income or debt restraints.” In 2008, federal regulators seized the now-insolvent Seattle-based lender and sold off most of its operations to JPMorgan Chase. Bank of America in 2004 agreed to provide $750 billion in CRA commitments. By 2008, those loans accounted for only 7 percent of its mortgage portfolio, yet 29 percent of its losses. A Boston Federal Reserve study revealed that in urban minority neighborhoods, borrowers had foreclosure rate seven times that of the general population. That major banks collapsed in 2008, as opposed to 1998, in other words, was no coincidence.
The stark reality, then, is this: Mortgage borrowers in record numbers bought homes they couldn’t afford. And though the Community Reinvestment Act was not the only contributor to this trend, it was a contributor all the same. Even if CRA played only a minor part, can anyone sensibly argue that Congress should loosen credit standards in the name of “affordability,” especially during a recession? Consider the following indicators: Foreclosure filings nationwide are up 18 percent from a year ago. More than 14 percent of all homeowners with a mortgage are either delinquent or in foreclosure. And according to the real estate trend tracking firm First American CoreLogic, 23 percent of U.S. homeowners owe more on their mortgages than their properties are worth, a condition which in real estate argot is known as being “underwater.”
About the last thing Congress and the executive branch should be doing is bailing out creditors and/or borrowers, thus enabling them to engage in a new round of unwise investment. Yet that’s what they’ve been doing for the last year and a half. In late July 2008, Congress, at the strong urging of the Bush administration, passed rescue legislation to expand Fannie Mae/Freddie Mac purchase limits, expand Federal Housing Administration (FHA) loan insurance limits, establish a national affordable housing trust fund, and create a new homebuyer tax credit. Only two months later, the Treasury Department took control of Fannie Mae and Freddie Mac and persuaded Congress to pass the $700 billion TARP legislation to bail out collapsing financial institutions. And early this year, under the guise of economic “stimulus,” President Obama persuaded Congress this February to create a $75 billion program, Homeowners Affordability and Stability Plan (HASP), to modify loans for eligible struggling homeowners, $50 billion of which would be diverted from TARP funds and the other $25 billion from Fannie Mae, Freddie Mac and HUD. Meanwhile, FHA has been ratcheting up its low-down payment home mortgage insurance volume even though its cash reserves have fallen below the legal limit for the first time since 1994. And HUD’s in-house secondary mortgage lender, Government National Mortgage Association (“Ginnie Mae”), has more than tripled annual issuances to investors since 2007, and at substantial risk; fully 16 Ginnie Mae-approved primary lenders have been cited by regulators for unsafe practices.
Nothing will change until public policy moves away from the assumptions that homeownership is a right and that banks have an obligation to loan money for that purpose. Yes, other factors besides the Community Reinvestment Act explain the mortgage debacle – Merrill Lynch, AIG, Lehman Brothers and other powerhouse investment houses buying high-risk securitized mortgages at a furious pace; Fannie Mae and Freddie Mac selling these securities to them; and non-depository lenders, such as the now-bankrupt New Century and Ameriquest, turning mortgage fraud into a high art. But that doesn’t absolve the CRA. The law has politicized the allocation of credit in dangerous ways that have spilled over into all mortgage lending. If Congress passes Rep. Johnson’s proposed CRA amendments, lawmakers will be perpetuating the conditions responsible for today’s hardships. That the measure would mandate discrimination against whites and males ought to render it unconstitutional as well.