In recent writing on the causes of the subprime crisis I have mentioned the Community Reinvestment Act as one of the mandates and subsidies for riskier lending, noting that it was “hard to judge how much each of these contributed” because I hadn’t seen any estimate of how many nonprime loans were CRA-related.

In a speech today on “The Community Reinvestment Act and the Recent Mortgage Crisis” Governor Kroszner cites findings from a recent Fed study (apparently not yet publicly available, because he doesn’t link to it) indicating that only a very small share (less than 8%) of subprime loans can be directly tied to CRA-related lending.

Kroszner notes that 60% of subprime loans went to middle- or high-income neighborhoods, not covered by the CRA. Many of the loans to lower-income neighborhoods were extended by independent mortgage originators or other non-CRA-bound institutions. Thus the key findings (where “higher-priced loans” is a measure regarded as a proxy for subprime loans):

Only 6 percent of all the higher-priced loans were extended by CRA-covered lenders to lower-income borrowers or neighborhoods in their CRA assessment areas, the local geographies that are the primary focus for CRA evaluation purposes. … [In addition] 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.

Kroszner comments that this finding “makes it hard to imagine how this law could have contributed in any meaningful way to the current subprime crisis.” Putting aside the puzzle of why an 8% share is not meaningful, it can be noted that Krozner himself earlier in the speech provides a possible indirect route for CRA lending to have contributed to the expansion of risky mortgage lending, though a “demonstration effect” (during the period before the post-2001 expansion of subprime lending) that persuaded lenders of the safety of CRA loans. He cites two earlier Fed studes (1993 and 2000) as providing evidence that, before more recent years, CRA-prompted “lending to lower-income individuals and communities” was “nearly as profitable and performed similarly to other types of lending done by CRA-covered institutions.” In this way the CRA, backed by the Fed’s research, “has encouraged banks” to pursue “lending opportunities in all segments of their local communities” that by implication they would not have pursued absent the CRA. After all, if the CRA never compelled or persuaded banks to make loans that they otherwise would have avoided, then the CRA would be completely ineffectual. Kroszner clearly believes that the CRA did have an effect on the types of mortgages that banks and non-banks were willing to take on:

Given the incentives of the CRA, bankers have pursued lines of business that had not been previously tapped by forming partnerships with community organizations and other stakeholders to identify and help meet the credit needs of underserved communities. This experimentation in lending, often combined with financial education and counseling and consideration of nontraditional measures of creditworthiness, expanded the markets for safe lending in underserved communities and demonstrated its viability; as a result, these actions attracted competition from other financial services providers, many of whom were not covered by the CRA.

But if this demonstration was misleading because the period it covered was atypically low in default rates – if it inspired an over-expansion of subprime lending in the 2001-2006 period based on mistaken inferences about the safety of lending based on “nontraditional measures of creditworthiness” – then the 8% subprime share that may be directly tied to meeting CRA requirements would be a lower-bound, not an upper-bound estimate of the CRA’s contribution to subprime lending. Of course, it is hard to imagine measuring the size of the demonstration effect, the volume of loans that were “inspired” by the CRA’s demonstration effect. An upper-bound estimate might be the difference between lower-income neighborhoods’ share of subprime lending (20%) and their share of prime lending (anybody know what that is?).

HT: John Grigorian