The CRA: a component of the subprime mortgage crisis?

Author:Simmons-Mosley, Tammie X.

    In the mid-1990s, subprime mortgage products became a prominent choice for borrowers. A subprime mortgage is a loan to a borrower with a less-than-adequate credit rating and/or financial capacity. Banks and non-bank lenders (e.g. mortgage brokers) led the subprime mortgage boom. Lenders compete to make subprime loans and to sell these loans in the secondary mortgage market where Freddie Mac and Fannie Mae are primary buyers. The accumulation of high-risk subprime loans reached the maximum level at the peak of housing prices. When the housing bubble burst, defaults in subprime loans increased dramatically. One argument on the causes of subprime mortgage crisis is deregulation and/or lack of regulation in the banking industry and mortgage market.

    The regulatory focus in this paper is the Community Reinvestment Act (CRA). It was enacted in 1977 after lawmakers noticed that banks were failing to adequately lend or invest in low-to-moderate income (LMI) communities in which they were chartered. For example, Banks argued that the creditworthiness of the low-income communities was difficult to determine when using the traditional credit scoring tools. Lawmakers and activists argued that banks were discriminating or "redlining". The CRA directs the banking regulatory agencies to ensure that banks serve the credit needs of their local communities in a safe and sound manner. Federal regulatory agencies examine banking institutions for CRA compliance and use this information when approving applications for new bank branches or for mergers. CRA regulators use the Housing Mortgage Disclosure Act (HMDA) data to evaluate lender performance. Consequently, the CRA tied banks' performance evaluation to how many loans banks made available to the LMI communities.

    The majority of previous CRA studies have been focused on low-income and minority related issues. A number of recent papers have examined the effectiveness of the CRA (e.g., Gunther 2000; Bogdon 2001; LaCour-Little 2001; Gunther 2002), and its impact on lending practices towards targeted groups (e.g., Bostic and Surette 2000; Dahl, Evanoff, and Spivey 2000; Harvey, Collins, Nigro and Robinson 2001; Bostic and Robinson 2003). (1) Bostic and Surette (2000) find that there is an increase in minority homeownership rates attributed to CRA compliance. Bostic and Robinson (2003) find evidence that the CRA causes an increase in mortgage lending to minorities. However, Dahl, Evanoff, and Spivey (2000) fail to find evidence to support the hypothesis that lending institutions respond to low CRA ratings. Furthermore, Harvey, Collins, Nigro, and Robinson (2001) use data between 1991-97 to show that the overly strong influence of market factors (such as improvements in economic conditions and improvements in banks' financial condition and performance) on mortgage lending may provide an explanation as to why some lenders fail to change their lending patterns to accommodate mortgage applicants of CRA targeted groups, low-income and minority borrowers.

    This paper empirically examines the pros and cons of the CRA requirement that a bank's performance evaluation be based on how much it lends to LMI communities. Specifically, we investigate if the CRA's lender performance evaluation system had any measurable impact on the 2008 subprime mortgage crisis. This study will be of particular interest to policy makers in both housing and banking, as it provides a potential link to both economic sectors. By considering the connection between lender performance and borrower's ability to repay the mortgage, this study could also shed some light on the role the CRA may have played in the creation of the 2008 subprime mortgage crisis.

    The remainder of the paper is as follows. Section 2 assesses the evolution of the HMDA and the CRA. Section 3 discusses the data and descriptive statistics. Sections 4 and 5 contain the methodology and empirical results, respectively. Section 6 offers concluding remarks.


    Congress enacted the Housing Mortgage Disclosure Act (HMDA) in 1975. It requires certain financial institutions to disclose loan data to the public. The data include home purchases, home purchase preapprovals, home improvement, and refinance applications involving 1 to 4 unit and multifamily dwellings. Two years later in 1977, Congress enacted the Community Reinvestment Act (CRA) to ensure federally insured banking (depository) institutions financially support their service area, (2) which includes increasing financial resources to LMI neighborhoods.

    The CRA regulating agencies are the Office of the Comptroller of the Currency (OCC), the Federal Reserve Board (FRB), the Federal Deposit Insurance Corporation (FDIC), and the Office of Thrift Supervision (OTS). The OCC, FRB, FDIC, and OTS regulators conduct periodic evaluations on a lending institution's CRA performance. The OCC oversees all national institutions, the FRB primarily oversees state-chartered banks that are members of the FRB, the FDIC oversees state-chartered banks that are not members of the FRB system and the OTS oversees limited purpose or wholesale institutions.

    Public and private entities use the HMDA data for three purposes: (1) to assess if lending institutions are serving the financial needs of households within their service area, (2) to attract private investors to their service area, and (3) to help identify discriminatory lending practices. The CRA-regulators use HMDA data to rate banking institutions on a scale from 1 to 4, with 1 being outstanding.

    Since its inception in 1975, HMDA data had numerous shortfalls in that it did not contain relevant risk and price related information. In 2002, the FRB addressed one of these shortfalls by requiring lenders to report data on certain higher-priced mortgage loans. Higher-priced loans are loans for which lenders charge an interest rate above reporting thresholds set by the FRB regulation. According to HMDA data, the median points above the comparable treasury yield for loans with an annual percentage rate above the FRB's threshold for home...

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