When Donald Trump takes office in January he’s promised a long list of executive orders and federal regulations he’ll unwind or eliminate. And if he wants to avoid another economic meltdown driven by the housing market, he should rapidly start undoing the regulatory misapplication of the Community Reinvestment Act (CRA) that has evolved over the past several decades. No law has been so distorted, or used as such a bludgeon by liberal administrations to shape their agenda as the CRA. The results have been disastrous.
The end of World War II began the first migration of American homeowners from the inner city to the suburbs. Simultaneously, a new dynamic took shape in the banking industry: Banks were continuing to gather deposits from the remaining inner city residents but lending those funds out in the suburbs. By the mid-1970s this shift of capital had garnered the attention of not only banking regulators, but Congress as well.
In 1977, Jimmy Carter signed into law the Community Reinvestment Act. Its initial purpose was simply to stem this flow of deposits to the suburbs, and was viewed by banks as just a guideline to “lend where the money came from.” After it became law the various regulatory agencies added a small CRA component to their annual bank safety and soundness examinations. At the time it wasn’t viewed by regulators or bankers as much more than a few additional boxes to check.
The CRA as it was applied in the ’70s and ’80s was more of a process-oriented approach. Regulators focused on the “how” of making inner-city loans, not the “how many.” Results were not what mattered. Examiners looked for positive steps taken by banks to generate more loans in areas matching their deposit base. Advertising, marketing, and home ownership seminars were the path to a successful CRA rating. As long as banks were reaching out, and as long as they weren’t discriminating by turning down good loans in bad inner-city neighborhoods, they were seen as fulfilling their CRA duties.
That changed with Bill Clinton’s election. During the early years of his administration a few amendments to the law were pushed through Congress. At the time they were hardly noticed, but they ended up laying the groundwork for the housing and mortgage collapse a decade later. The primary shift was to move from considering the process to considering performance. As regulators interpreted the new direction coming from the Clinton administration, they began rating banks on how many loans they made—and not just in inner-cities, but anywhere there were low or moderate income communities or census tracts.
By the end of the Clinton presidency, bank CRA examinations had their own separate report. And unlike safety and soundness reports which are confidential, CRA reports were not only now public, but regulators required banks to solicit input and comments on their lending performance from various community groups. And there was some teeth in the regulators’ new direction. With a less than satisfactory CRA rating a bank could find itself shut out of getting approvals to open new branches, or acquire or merge with other institutions. And this where the seeds of economic destruction were sown.
As interest rates declined in the early 2000s, and the housing boom took shape, banks were happy to feed the frenzy. But this lending bonanza came with an interesting twist. As more people flooded their banks with refinance requests and new purchase applications, home mortgage volume increased dramatically. But the CRA requirements meant that a certain portion of all lending needed to be in low and moderate income areas. And here’s the rub. To get enough of these loans to balance the math, lenders began to lower credit standards.
Bill Clinton’s housing secretary, Mario Cuomo, announced a push for the federal mortgage lending giants Fannie Mae and Freddie Mac to purchase $2 trillion in affordable housing loans— and banks were only too happy to go along since the risk wasn’t theirs’ to hold. And to achieve this mis-directed goal, the government agencies announced programs to buy loans that were underwritten with alternative methods to verify income and credit histories. By the time George W. Bush took office, Fannie Mae had publically stated that its goal was to buy 50 percent of its volume as CRA loans. Eventually this mad dash resulted in the now infamous “no-documentation” loans where borrowers could just write any amount for their income and net worth without anyone verifying it.
But by 2008 the end was nigh. Bank of America, for example, reported that while the CRA portion of their portfolio amounted to just 7 percent, over 29 percent of their loan losses came from it. The seeds of destruction had sprouted and we all know where this crazy government driven lending was headed. The meltdown in housing, and the near collapse of the global economy, may have begun with Jimmy Carter signing the CRA in 1977, but it hasn’t ended yet.
While slowly recovering from the recession, the Obama administration is again pushing bank regulators to distort the CRA. As recent as July of this year comments were solicited from banks and banking groups regarding them being held accountable for loans made anywhere, not just in the areas of their branches like the original intent of the CRA. And certainly not learning from history, the FHA has now taken up the void left by Fannie and Freddie’s tumultuous exit and increased its low and moderate income lending volume by over 300 percent the past 8 years. It’s often said that “history repeats itself,” but Donald Trump now has a chance to change that. On the long list of policy reversals and do-overs he can initiate, the CRA should be at the top of the list.
Kevin Cochrane teaches business and economics at Colorado Mesa University, and is also a Permanent Visiting Professor of Economics at The University of International Relations in Beijing.
