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In the current mortgage meltdown, did lenders approve bad loans to comply with CRA, or to make money?

The evidence strongly suggests the latter... In the mid-1990s, new CRA regulations and a wave of mergers led to a flurry of CRA activity, but, as noted by the New America Foundation's Ellen Seidman (and by Harvard's Joint Center), that activity "largely came to an end by 2001." In late 2004, the Bush administration announced plans to sharply weaken CRA regulations, pulling small and mid-sized banks out from under the law's toughest standards. Yet sub-prime lending continued, and even intensified -- at the very time when activity under CRA had slowed and the law had weakened. ...

University of Michigan's Michael Barr points out, half of sub-prime loans came from those mortgage companies beyond the reach of CRA. A further 25 to 30 percent came from bank subsidiaries and affiliates, which come under CRA to varying degrees but not as fully as banks themselves.... Perhaps one in four sub-prime loans were made by the institutions fully governed by CRA.

Most important, the lenders subject to CRA have engaged in less, not more, of the most dangerous lending. Janet Yellen, president of the San Francisco Federal Reserve, offers the killer statistic: Independent mortgage companies, which are not covered by CRA, made high-priced loans at more than twice the rate of the banks and thrifts. With this in mind, Yellen specifically rejects the "tendency to conflate the current problems in the sub-prime market with CRA-motivated lending.? CRA, Yellen says, "has increased the volume of responsible lending to low- and moderate-income households."

... the late Ned Gramlich, a former Fed governor ... praised CRA, saying last year, "banks have made many low- and moderate-income mortgages to fulfill their CRA obligations, they have found default rates pleasantly low, and they generally charge low mortgages rates. Thirty years later, CRA has become very good business."

It's telling that, amid all the recent recriminations, even lenders have not fingered CRA. That's because CRA didn't bring about the reckless lending at the heart of the crisis. Just as sub-prime lending was exploding, CRA was losing force and relevance. And the worst offenders, the independent mortgage companies, were never subject to CRA -- or any federal regulator. Law didn't make them lend. The profit motive did.

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... the Federal Reserve has prepared two reports for the Congress ... on the performance of lending to lower-income borrowers or neighborhoods...These studies found that lending to lower-income individuals and communities has been nearly as profitable and performed similarly to other types of lending done by CRA-covered institutions. Thus, the long-term evidence shows that the CRA has not pushed banks into extending loans that perform out of line with their traditional businesses. Rather, the law has encouraged banks to be aware of lending opportunities in all segments of their local communities as well as to learn how to undertake such lending in a safe and sound manner.

Recently, Federal Reserve staff has undertaken more specific analysis focusing on the potential relationship between the CRA and the current subprime crisis. This analysis was performed for the purpose of assessing claims that the CRA was a principal cause of the current mortgage market difficulties....

The research focused on two basic questions. First, we asked what share of originations for subprime loans is related to the CRA. ... We found that the loans that are the focus of the CRA represent a very small portion of the subprime lending market, casting considerable doubt on the potential contribution that the law could have made to the subprime mortgage crisis.

Second, we asked how CRA-related subprime loans performed relative to other loans. ... We found that delinquency rates were high in all neighborhood income groups, and that CRA-related subprime loans performed in a comparable manner to other subprime loans; as such, differences in performance between CRA-related subprime lending and other subprime lending cannot lie at the root of recent market turmoil.
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Our analysis of the loan data found that about 60 PERCENT OF HIGHER-PRICED LOAN ORIGINATIONS WENT TO MIDDLE- OR HIGHER-INCOME BORROWERS OR NEIGHBORHOODS. Such borrowers are not the populations targeted by the CRA. In addition, MORE THAN 20 PERCENT OF THE HIGHER-PRICED LOANS WERE EXTENDED TO LOWER-INCOME BORROWERS OR BORROWERS IN LOWER-INCOME AREAS BY INDEPENDENT NONBANK INSTITUTIONS--THAT IS, INSTITUTIONS NOT COVERED BY THE CRA.6

... ONLY 6 PERCENT OF ALL THE HIGHER-PRICED LOANS WERE EXTENDED BY CRA-COVERED LENDERS TO LOWER-INCOME BORROWERS OR NEIGHBORHOODS ...

Of course, loan originations are only one path that banking institutions can follow to meet their CRA obligations. They can also purchase loans from lenders not covered by the CRA, and in this way encourage more of this type of lending. The data also suggest that these types of transactions have not been a significant factor in the current crisis. Specifically, LESS THAN 2 PERCENT OF THE HIGHER-PRICED AND CRA-CREDIT-ELIGIBLE MORTGAGE ORIGINATIONS SOLD BY INDEPENDENT MORTGAGE COMPANIES WERE PURCHASED BY CRA-COVERED INSTITUTIONS.

I now want to turn to the second question concerning how CRA-related subprime lending performed relative to other types of lending.... An overall comparison revealed that the rates for all subprime and alt-A loans delinquent 90 days or more is high regardless of neighborhood income.

... In other words, we compared loan performance by borrowers in two groups of neighborhoods that should not be very different except for the fact that the lending in one group received special attention under the CRA.

When we conducted this analysis, we found essentially no difference in the performance of subprime loans in Zip codes that were just below or just above the income threshold for the CRA.9 The results of this analysis are not consistent with the contention that the CRA is at the root of the subprime crisis, because delinquency rates for subprime and alt-A loans in neighborhoods just below the CRA-eligibility threshold are very similar to delinquency rates on loans just above the threshold, hence not the subject of CRA lending.

...The final analysis we undertook to investigate the likely effects of the CRA on the subprime crisis was to examine foreclosure activity across neighborhoods grouped by income. WE FOUND THAT MOST FORECLOSURE FILINGS HAVE TAKEN PLACE IN MIDDLE- OR HIGHER-INCOME NEIGHBORHOODS

Two key points emerge from all of our analysis of the available data. First, only a small portion of subprime mortgage originations are related to the CRA. Second, CRA- related loans appear to perform comparably to other types of subprime loans. Taken together, as I stated earlier, we believe that the available evidence runs counter to the contention that the CRA contributed in any substantive way to the current mortgage crisis.
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Contrary to the assertions of critics, the evidence does not support the view that the CRA contributed in any substantial way to the crisis in the subprime mortgage market.

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