Community Reinvestment Act and the Mortgage Crisis

On my way to work, and again on my way back home everyday, I pass through the south side of Bethlehem, an area that has been ravaged over the years with massive disinvestment that is just now beginning to come back. Part of the reason that this area is beginning to bounce back has to do with local enforcement of the Community Reinvestment Act. For those of you that are not up on your 1970’s community development policy, CRA was created during the Carter administration with the purpose of putting pressure on banks to invest a good portion of their deposits in the form of loans to the communities in which their branches exist. CRA was also meant to take further action on banking practices of “red lining,” in which areas of cities were literally marked off with red marker to advise lenders not to disperse credit to those areas. This redlining was essentially what happened to South Bethlehem, a community composed of mostly minority citizens. It wasn’t until various community organizations began to act as holistic financial institutions that things took a turn for the better. These nonprofits used private and public grant funds to begin loaning money to local entrepreneurs and homeowners to start businesses, buy homes, and make building façade improvements, while at the same time providing comprehensive financial education, expert support, and other such services that make it extremely difficult for the borrowers to fail. Not only has this strategy helped the community invest in itself, but it has spurred demand for outside investments, such as the new Sands casino. I can’t help but think that banks who have a history of redlining missed out on a great amount of future capital.

CRA has come under a lot of scrutiny lately, with many people calling for its repeal based on the belief that it led to our mortgage meltdown. The argument goes like this: CRA forced banks into an abundance of sub-prime loans, which were unsustainable for the new homeowners once the fine-printed rate increases came due. I don’t think that CRA, at least the way it is currently structured, is faultless in this whole matter, but I can’t put much stock in this argument. CRA forced banks into ridiculous loan practices? No more than banks forced sub-prime mortgages on prospective homeowners. The fact is, there was no force involved with any party. CRA was encouraging sub-prime loans without actually placing any enforcement on the way in which those loans were structured or distributed. Originally, because housing values kept increasing (to the point where some people actually began to believe that they would keep increasing forever), banks were making gobs and gobs of money off of these unconventional loans. They could hand out a high rate, variable loan, or an ARM that would balloon in the near future, and fully expect that the recipient would soon come back and either refinance or take out a home equity loan, further making money for the bank. Homeowners also had little reason to second guess the system, because everyone seemed to be benefiting from it. I could stop throwing away my money on rent and start paying a mortgage, without any money down, and start building equity. And since I assumed that my home value would keep increasing, I could take a loan backed by that equity to improve my quality of life. This was a system that seemed to benefit everyone. Then, of course, everything crashed and it was all exposed as a sham.

Many would say that CRA should be the one with the most blame here because it is at the top of the process; however, I have a hard time giving it too much blame. Again, the law isn’t perfect, and it is in the process of being improved considerably, but I believe the blame lies mostly on the banks, and somewhat less on homebuyers. I could make the greed argument against the banks, and it would be true, but it is so overdone that it has little effect anymore. My argument is that the banks were focusing too much on their short-term investments that they completely ignored the fact that they could make so much more in the long run (by averting a housing bubble) by taking the kind of holistic approach in more credit-risky neighborhoods that the South Bethlehem nonprofits have taken. Instead of making it a point to deceive homebuyers in order to potentially make a lot more later, why not work with the homebuyers to help them succeed, which would in turn lead to more wealth creation in the area. I fault the homebuyers to a lesser extent because of the deception practices of the banks, but I still do fault them. Many were innocent victims, but some were just plain stupid. It’s one thing to be duped into a bad mortgage, but it’s quite another to deplete their equity. The “American Dream” came back to bight many of them in the ass. But as far as the CRA is concerned, I place the least amount of blame on the intent of the law itself because increasing investment in neighborhoods that need it and eliminating redlining is simply the right thing to do. Forget about profits; forget about the “virtues of the free market.” There are some things that are more important than money, and this is one of them.

Now, if only the law could make sure that the right investments are made… but that’s a subject for another post. Anyone want to refute me? I welcome your comments.