How the Community Reinvestment Act and the Mortgage Crisis Are Linked
What was the purpose of CRA mortgages?
What role did the Community Reinvestment Act (CRA) play in the mortgage crisis? Before weighing the impact of this legislation on the crisis, it's first necessary to understand its purpose and origins. With this review, familiarize yourself with the act.
The CRA was designed to make money available to underserved areas. Banks took deposits in low-income areas, but they did not make many loans in those areas.
Congress passed the Community Reinvestment Act to encourage lending, home ownership and business expansion. In short, the CRA came into being to promote economic growth in long depressed areas.
Evolution of the CRA
In the 1960s and 1970s, lawmakers noticed that banks were not offering favorable loans to low-income communities. Banks argued that the borrowers in those areas were higher risk borrowers who they did not want to serve and that it was difficult to evaluate creditworthiness with traditional credit scoring tools. People in low-income areas may be less likely to have loans of any kind in their names, since generally a certain income is required to obtain loans.
Lawmakers and activists argued that the banks were discriminating or 'redlining.' That's because many of these underserved areas were also areas with large populations of racial minorities. Unfortunately, the United States has a long history of residential housing segregation, which prohibited people of color from buying homes where they pleased.
The Community Reinvestment Act was passed so that banks would have an incentive to do more business in these previously ignored areas.
Since the Community Reinvestment Act came into being in 1977, it has been updated several times.
Community Reinvestment Act Evaluation
In order to prove that they don’t discriminate, banks keep records showing their lending activity.
If they show that they lend freely in low-income areas, they get a better ‘rating.’ The bank’s Community Reinvestment Act rating is important in gaining favor with regulators regarding mergers and bank expansion.
Community Reinvestment Act and the Mortgage Crisis
Those who favor less regulation blame the Community Reinvestment Act for causing the 2008 mortgage crisis. They argue that banks were prodded to lend to subprime borrowers and that a larger number of homebuyers helped fuel a housing bubble (which lured more buyers into the bubble). Lawsuits, however, have found that banks gave subprime loans to racial minorities with credit histories that qualified them for prime loans. In other words, giving these loans to individuals who deserved better loans set them up for failure.
Those who defend the Community Reinvestment Act argue that it was actually a lack of regulation that caused the mortgage crisis. They also state that loans made as a result of the Community Reinvestment Act are not the problem loans that brought down the economy.
Depending on your views and your sources of information, there are plenty of arguments to back either position. Critics of the CRA argue that the government stoked the mania leading to the mortgage crisis and that the feds invited the mortgage mess.