Some critics, desperate for a way to explain the current mortgage crisis, have been blaming it on the 1977 Community Reinvestment Act (CRA). Under the CRA, banks receiving federal insurance are encouraged to lend within their own communities, even if those areas are economically depressed. The CRA was meant to provide low-income Americans with more affordable housing.

According to some vocal critics, the Community Reinvestment Act (CRA) is the straw that broke the proverbial camel's bank in terms of the current credit meltdown. The CRA was signed by President Carter back in the 1970s, and targeted low-income neighborhoods with affordable mortgages.

It may sound like a stretch to blame our current banking problems on legislation passed more than 30 years ago by a president who has spent much of his post-presidential life building homes for Habitat for Humanity. But the people who are passionate in their criticism of the CRA, say that it led to an increase in risky subprime lending to unqualified homeowners-who have now defaulted and caused a national foreclosure epidemic.

Pointing fingers at subprimes

Rather than debate the issue, it may be sufficient to point out that the U.S. mortgage market is valued at about $12 trillion. Subprime loans account for approximately $1 trillion. More importantly, the Community Reinvestment Act only applies to banks that receive coverage from federal insurance, and the vast majority of institutions who sold subprimes didn't qualify for that kind of taxpayer-backed coverage. Even if bank subprimes caused the crisis, the CRA isn't responsible for the sloppy and negligent underwriting that led to handing out high-risk loans to unqualified homeowners. Lending standards decayed, but not because of something as isolated and antique as the CRA legislation. That kind of regulation is the job of the banks and the government agencies tasked with auditing and monitoring their business practices. Deregulation of the banking industry is, therefore, a more suspicious culprit than the CRA.

Deregulation as culprit

Several significantly important deregulations happened within the past decade:

  • In 1999, Congress passed the Financial Services Modernization Act, allowing commercial banks to operate investment banking businesses.
  • A year later, Congress passed the Commodities Futures Modernization Act, which deregulated the market for credit-default swaps-exotic products that insure risky loans.
  • Four years later, the Securities and Exchange Commission exempted the largest investment banks from leverage constraints, letting them borrow 30 times the value of their capital.

Loans were made to people who didn't have enough income to repay them. But many of those subprimes were not made to low-income borrowers, but to wealthy real estate speculators who bought upscale properties and tried to flip them into an overheated market that soon burned out and collapsed. As Judith Kennedy, President and Chief Executive of the National Association of Affordable Housing Lenders in Washington, says, "The CRA isn't the problem. It's been a critical part of the community and economic development solution for 31 years."

Published on November 11, 2007