Economics, Pethokoukis, Regulation

New study concludes that the Community Reinvestment Act ‘clearly’ did lead to risky lending

Image Credit: Shutterstock

Image Credit: Shutterstock

The debate over the role, if any, that the Community Reinvestment Act played in the buildup to the Financial Crisis has been heated, to say the least. Conservatives think the the CRA is a classic case of government action leading to unintended consequences — in this case a lowering in underwriting standards that helped inflate subprime housing bubble. But liberals have typically disagreed. Columnist Paul Krugman has called the CRA “irrelevant to the subprime boom.”

And most studies have tended to support the Krugman view. But an important new one does not.

Here are the conclusions of “Did the Community Reinvestment Act (CRA) Lead to Risky Lending?” by Sumit Agarwal of the National University of Singapore’s business school, Efraim Benmelech of Northwestern University’s Kellogg School of Management. Nittai Bergman of MIT’s Sloan School of Management, and Amit Seru of the University of Chicago’s Booth School of Business:

Yes, it did. We use exogenous variation in banks’ incentives to conform to the standards of the Community Reinvestment Act (CRA) around regulatory exam dates to trace out the effect of the CRA on lending activity. Our empirical strategy compares lending behavior of banks undergoing CRA exams within a given census tract in a given month to the behavior of banks operating in the same census tract-month that do not face these exams. We find that adherence to the act led to riskier lending by banks: in the six quarters surrounding the CRA exams lending is elevated on average by about 5 percent every quarter and loans in these quarters default by about 15 percent more often. These patterns are accentuated in CRA-eligible census tracts and are concentrated among large banks. The effects are strongest during the time period when the market for private securitization was booming. …

We note that our estimates do not provide an assessment of the full impact of the CRA. This is because we are examining the effect of CRA evaluations relative to a baseline of banks not undergoing an exam. To the extent that there are adjustment costs in changing lending behavior, this baseline level of lending behavior itself may be shifted toward catering to CRA compliance. Because our empirical strategy nets out the baseline effect, our estimates of CRA evaluations provide a lower bound to the actual impact of the Community Reinvestment Act. If adjustment costs in lending behavior are large and banks can’t easily tilt their loan portfolio 25 toward greater CRA compliance, the full impact of the CRA is potentially much greater than that estimated by the change in lending behavior around CRA exams.

As to the last point, the economist are saying that if lender can’t tweak portfolios to look better around the exam dates, then they may alter their lending behavior on a longer-term basis.

27 thoughts on “New study concludes that the Community Reinvestment Act ‘clearly’ did lead to risky lending

  1. JIM, I’M SHOCKED!! What took you all this time to regurgitate this report which was debunked before lunchtime yesterday!

    The report contradicts itself. As Barry Ritholtz has already noted:

    “There’s a new paper on the CRA, Did the Community Reinvestment Act (CRA) Lead to Risky Lending?, by Agarwal, Benmelech, Bergman and Seru, h/t Tyler Cowen, with smart commentary already from Noah Smith. (This blog post will use the ungated October 2012 paper for quotes and analysis.)

    This is already being used as the basis for an “I told you so!” by the conservative press, which has tried to argue that the second question is most relevant. However, it is important to understand that this paper answers the first question, while, if anything, providing evidence against the conservative case for the second.

    Where is the literature on these two questions? One starting point is the early 2009 research of two Federal Reserve economists, Neil Bhutta and Glenn B. Canner, also summarized in this Randy Kroszner speech. On the first question Kroszner summarizes research by the Federal Reserve, the latest being from 2000, arguing 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.” The CRA didn’t cause changes to banks’ portfolios, but instead required them to find better opportunities. More on this in a minute.

    What about the second question? Here the Bhutta/Canner research notes that only SIX PERCENT of higher-priced loans (their proxy for subprime loans) were extended by CRA-covered lenders to lower-income borrowers or CRA neighborhoods. 94 percent of these loans were either made by non-traditional banks not covered by the CRA (the “shadow banking system”), or not counted towards CRA credits.

    (Which is what I have been telling you cranks for months now-Max)

    As Kroszner noted, “the very small share of all higher-priced loan originations that can reasonably be attributed to the CRA makes it hard to imagine how this law could have contributed in any meaningful way to the current subprime crisis.”

    (Again: Makes the same point I made repeatedly- ON SHEER LOAN VOLUME ALONE, the theory has absolutely NO PLAUSIBILITY. IT’S A JOKE.)

    How did those loans do? Here the research compared the performance of subprime and alt-A loans in neighborhoods right above and right below the CRA’s income threshold, and found that there was no difference in how the loans performed. Hence the idea that a CRA-driven subprime bubble isn’t found in the data. (The FCIC’s final report, starting at page 219, has more on this and other research.)

    (That’s ANOTHER point I made: the default metrics for these loans aren’t bad at all)

    So what does this new research do? It takes banks that were undergoing a normal examination to see if they were in compliance with the CRA, and thus under heightened regulatory scrunity, and compares their loan portfolios with banks that were not undergoing a CRA examination. It finds that the CRA exam increases loans 5 percent every quarter surrounding the event and those loans default 15 percent more often, under the idea that those banks were ramping up their loans to pass the CRA exam.

    But this is question 1 territory. 94 percent of higher priced loans came outside CRA firms and outside CRA loans, and this research doesn’t really change that. Since we are talking about regular mortgages – more on that in a second – that higher default isn’t that scary. To put that in perspective, loans made in the quarter following the initiation of a CRA exam in a non-CRA tract are 8.3 percent more likely to be 90 days delinquent. That sounds scary, but it is an increase of 0.1, from 1.2 percent to 1.3 percent.

    (This was ANOTHER point I made- if you’re comparing CRA to conventional Fannie/Freddie conforming loans, go ahead and double the default rate, if you like. It STILL doesn’t amount to anything)

    In the CRA tract it is 33 percent more likely to default, going from 1.2 percent to 1.6 percent. FICO scores drop 7 points from 713.9 to 706.9. That’s an increase I wouldn’t want in my portfolio, but it is light-years away from 25%+ default rates, and very low FICO scores, on actual subprime.

    (As Max Planck HIMSELF once said: “Yup.”)

    This research, if anything, pushes against movement conservative CRA arguments. In light of the evidence in question 2, many conservatives argue that regulators used CRA to push down lending standards, which then impacted other firms. But this paper finds that extra loans aren’t more likely to have higher interest rates, lower loan-to-value, or be balloon/interest-only/jumbo/buy-down mortgages, although there is a slight increase in undocumented loans. And their borrowers aren’t more likely to have risky characteristics themselves. The authors conclude that “this pattern is consistent with banks’ strategic attempts to convince regulators that the loans they extend that meet CRA criteria are not overtly risky.”

    Read that again. The authors argue, from their empirical evidence, that regulators were trying to make sure these loans had high standards, and CRA banks tried to comply with that as best they could on the major, visible risks of their loans. This is the opposite argument made by people like John Carney, who believes the CRA “encourag[ed] lenders to adopt loose standards for mortgages.”

    It also pushes against people like Peter Wallison, who, in his FCIC dissent, argued that CRA loans were more likely to have subprime characteristics or riskier borrowers in ways not captured by a higher-price variable. NOT THE CASE.

    It also finds that loan volume and risk increases the most during 2004-2006, and points to the private securitization market as an important channel.

    (ANOTHER POINT I MADE: By the end of 2003, SubPrime originations were supplanting traditional loans, especially government affiliated ones.)

    This, along with characteristics above, pushes back against the idea that the CRA primed a subprime pump in the late 1990s and early 2000s, another favorite of movement conservative finance writers. If anything, banks undergoing CRA exams were caught up in the same mechanisms that were causing the housing bubble itself.

    I’m not sure I buy all of the research. If CRA banks take on too many loans during examination, why wouldn’t they just loan less afterwards, balancing out? The paper jumps to argue the opposite, as it is worried that “adjustment costs may cause banks to keep elevated lending rates even after the CRA exam is formally completed.” This is meant to establish their results as a lower-bound, rather than an upper-bound. But really? They managed to ramp up their lending in enough time during this time. Either way it would throw a very different set of interpretations on their research. I’m interested in seeing how other researchers react to these problems. But for now these results don’t change the way we approach the financial crisis.



    And it flows into the same racist pathologies espoused by Charles Murray: when the economy is blown up by predatory lenders working with rating agencies who don’t perform any due diligence and sell mortgage paper guaranteed to default in the trillions to banks all over the world and have the American taxpayer back stop the insurance contracts written by AIG, there is only one thing for the AEI to do:

    Blame the poor and the colored.

      • The numbers speak for themselves, so laugh all you want.

        Ritholtz has more respect from the financial community than the entire fetid lot of AEI “scholars” and “fellows.”

        And THAT is a fact.

        • maxie boy claims without a shred of evidence to back it up: “Ritholtz has more respect from the financial community than the entire fetid lot of AEI “scholars” and “fellows.”“…

          Respect? Where? Media Matters maybe?

  2. This is along the lines of what I was saying yesterday:

    Markets are already prone to acts of exuberance (ex. bubbles). When a policy comes along and distorts incentives (in this case, the CRA), it fuels the fire. It could create a bubble where there wasn’t one before, or it could inflate a bubble that was already forming.

    • You’re response only underlines the cognitive dissonance of the “true believer.”


  3. I cannot believe the ignorance and propaganda being spouted here.

    CRA applies to banks doing business in redlined neighborhoods where they take deposits and no where else.
    Almost all of these banks are FDIC banks.

    As Max has provided ample evidence – 94% of the loans were made by banks that were not FDIC and not subject to CRA.

    this is just plain propaganda for the willfully ignorant and gullible.

    What the AEI has figured out is that there is no shortage of whackos who will believe anything as long as it conforms to their pre-conceived idea – no matter the facts.

    At first I thought MR. Pethokoukis was simply gullible himself.. Now it’s becoming clear, he is one of the AEI folks who willfully engages in disinformation.

    • “At first I thought MR. Pethokoukis was simply gullible himself.. Now it’s becoming clear, he is one of the AEI folks who willfully engages in disinformation.”

      That is the AEI’s only function.

      • re: that is AEI’s function. AEI functions like a modern day internet vandal… on public policy issues. Instead of providing facts and informing people comprehensively about the facts, they pander with sound-bite disinformation.

        And, sadly, it is effective because most people are too lazy to actually get the facts and tend to look only as far as they can find “something” that confirms their biases.

        That seems to be AEI’s stock in trade these days.

  4. Here is Mark Zandi saying that Freddie and Fannie didn’t do it, in fact lost market share big time to private syndicators.

    Zandi, a cofounder of, was among the few economists to call the bubble before it burst.

    Not that any opinions are being changed here. If the cause isn’t dumb govt policies, then, as Zandi says, it’s out-of-control markets that — gasp — lacked regulation.

    • “Here is Mark Zandi saying that Freddie and Fannie didn’t do it, in fact lost market share big time to private syndicators”

      Which again, I pointed out ad nauseum. As Zandi properly reflects, it is impossible for a financial conduit whose market share is collapsing to pump up the market it is serving. Both things cannot exist at the same time.

      Never mind- the morons won’t let go of it.

  5. It’s funny.

    Re-reading the post here, I am reminded of what Henry Hazlitt said nearly 70 years ago:

    The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the con- sequences of that policy not merely for one group but for all groups.

    Policies like the CRA need to be scrutinized by economists for the long term consequences. Yet, all too often this simple lesson is forgot, even by Mark Zandi who is otherwise a brilliant man.

    I am glad someone took the time to fully research this topic, and not do the lazy man analysis of “well, it couldn’t have been this because this was around for a while!”

    The “good” economists look at a policy’s long and short term implications for all groups, not just a specific group. The “bad” economists fail to do this.

    • re: long term vs immediate facts

      CRA is very narrow and very specific and only applies to banks that took deposits but did not make loans in neighborhoods that were “redlined”.

      The banks were FDIC and the homes were not Condos in Florida and Arizona or million dollar houses but rather in lower income neighborhoods.

      96% of sub-prime loans were not made by FDIC banks subject to CRA rules.

      these are facts and factual history – not “long term’ outcomes.

      No govt regulation required that sub-prime loans be given to unqualified borrowers – none.

      In fact the CRA regs specifically say that the recipients need to have a documented good credit history.

      what does it take to basically ignore the facts and push on anyhow?

      • The CRA was just one of many straws that broke this camel’s back.

        As this study showed, the CRA did clearly change bank’s behavior regarding loan practices (in fact, that was a stated goal of the CRA: to encourage lending to low- and moderate-income areas).

        Look, all that is being said is the CRA changed the behavior of lending institutions. This is not a scandal. No one is saying the CRA was the sole cause of the crisis, but rather that it did play a part. There is more than enough blame to go around (the banks, the borrowers, Fannie & Freddie, the Low-Interest Rate Fed, Adjustable Rate Mortgages, etc), but if one is unwilling to look at all aspects of a crisis, then the problems cannot be fully known.

        The overwhelming majority of the analysis on this past recession has been on the “lazy” side. Someone picked an arbitrary point, and claimed it was the sole cause: “It was the banks fault!” “It was the Fed’s fault!” It is the job of the economist to come in and say “there is more here then meets the eye.”

        What y’all are focusing on is the “seen” consequences. You are completely ignoring the “unseen” behavioral changes that occurred.

        • “The CRA was just one of many straws that broke this camel’s back.”

          Once again: the data IN THE REPORT ITSELF PROVES IT ISN’T SO.

          The numbers aren’t there to back you up.

      • “what does it take to basically ignore the facts and push on anyhow?”

        It takes on all of the similarities of a mental illness. When you flatter yourself as a “economist” and you ignore the HARD DATA IN FRONT OF YOU AND DISCARD IT IN YOUR ANALYSIS, you obviously are delusional.

        It’s good to see people like Bruce Bartlett and David Frum relentlessly bitch slapping the AEI hacks, basically for the crime of CONSTANTLY LYING.

    • “Yet, all too often this simple lesson is forgot, even by Mark Zandi who is otherwise a brilliant man.”

      Right- Zandi, who is a man of genuine accomplishment is “otherwise brilliant,” except when a 23 year old loner living in the middle of nowhere finds fault with him.

      Again: the numbers are the numbers. There was absolutely no way, BASED ON THE EVIDENCE, that such a small program could in any way affect the housing market.

      This has been studied to death- we have the default numbers, and the only thing a REAL credit analyst needs to know is how the loans performed.

      Apparently, you don’t know much about that either.

      • is religiously apolitical, to the point of declining assignments that may be seen as grinding a specific policy ax. One suspects that the Heritage Foundation would love to take back its study saying that good times following the Bush tax cuts would retire the federal debt by 2010. One also suspects that, given a equal historic perspective, AEI’s Peter Wallison will want to disremember that he was the only person on the Financial Crisis Inquiry Commission who said Bill Clinton did it in the Rose Garden with a pen.

  6. In the end, lenders were enticed and/or compelled to take on far more risk than they would have if they’d been left alone. Whether it be in the form of CRA or the various initiatives pushed by the myriad other government agencies, government policy had a decisive hand in creating this debacle. Funny, or not, how little press this is given in the mainstream media here in the US. Reframing government policy to allow mortgage lending to carry on in a more natural way (with enforced full recourse mortgages the norm) would go a long way in preventing this type of thing from occurring again.

    • show where the govt ‘enticed’ or ‘compelled’ NON-FDIC banks to take risks?

      there is no evidence – it’s more mythology from folks who want to believe what they what to believe and screw the facts.

      What the investigations have shown is that there was NOT ENOUGH regulation on the non-FDIC banks who got into trouble while the FDIC banks did not.

      the funny thing here is that your “solution” is what – more govt regulation to fix what you believe was govt regulation?

  7. What the study found is that banks with assets over $50
    billion were “gaming the system” around their CRA exams.

    There are are only a couple dozen banks that large.

    Of the other 6000 banks the study looked at they found no
    significant change in lending patterns around CRA exams.

    In other words the study found evidence that the biggest banks are corrupt. That is no surprise

  8. Amazing how little is known about the CRA and the changes to bank lending this gov regulation caused. The liberal comments here denying it was the cause as proof.
    Fact: CRA was forced on not only banks, but mortgage lenders and credit unions as well. The mortgage and credit union regs went by different names, yet still an extension of CRA.
    FACT: if the lenders didn’t comply they would lose their FDIC insurance thus “Forcing” them to comply.
    FACT: altering the lending requirements for low income loans spilled over into ALL loans making any study that compared CRA to any other loan a moot point.
    FACT: Fanny Mae and Freddy Mack were also under CRA obligations and encouraged the mortgages to keep coming in.
    CRA changed the lending habits of the financial system.

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