Just over two years ago, this country was plunged into the greatest financial and economic crisis since the Great Depression. Millions of Americans have lost their jobs, businesses, homes and their hard-earned savings in the meltdown.
Recently, the Financial Crisis Inquiry Commission released its report and conclusions on what caused the financial crisis based on evidence collected through 19 days of public hearings, interviews with more than 700 witnesses and the review of millions of pages of documents. We found that this crisis was avoidable and was caused by widespread failures in financial regulation, dramatic breakdowns in corporate governance, excessive risk and borrowing, government officials ill prepared for the crisis and systemic breaches in accountability and ethics at all levels.
As the crisis unfolded, some blamed the Community Reinvestment Act as a driving force in the subprime mortgage disaster. That 1977 law was aimed at ending “redlining” by banks — the practice of denying credit to individuals and businesses in certain neighborhoods without regard to their creditworthiness. The law requires banks and savings and loans to lend, invest, and provide services to the communities in which they take deposits, consistent with bank safety and soundness.
The debate about the role of the CRA should now be over as the evidence presented in the commission’s report is clear. Indeed, nine of the 10 commissioners agreed that the CRA was not a factor of significance in the crisis.
As we detail in the report, many subprime lenders were not even subject to the CRA and the vast majority of subprime lending was unrelated to the law. For example, according to a 2008 analysis by two Federal Reserve economists who looked at 14 million loans made in 2006, only 6 percent of higher-priced loans (a proxy for subprime mortgages) were made to low and moderate income borrowers or in low and moderate income neighborhoods by banks and thrifts (and their subsidiaries and affiliates) covered by the CRA.
Importantly, another study by economists at the Federal Reserve Bank of San Francisco showed that loans made by CRA-regulated lenders were half as likely to default as similar loans made in the same neighborhoods by mortgage lenders not subject to the law.
An additional argument against the CRA is that so-called “community lending commitments” or “CRA commitments” by banks were the cause of risky loans. These commitments were generally promises by financial institutions to lend and invest in specific communities, apart from any requirements of the CRA.
Under this theory, as public scrutiny was focused on proposed mergers, banks would make these pledges to secure approval for the merger by the Federal Reserve Board or other regulators; the banks then originated unsound loans in order to meet these obligations.
Here, too, the evidence in the report clearly refutes this argument. Importantly, the Federal Reserve Board — according to both external and confidential internal documents — never considered these pledges in its decision-making on mergers.
The rules implementing the 1995 changes to the CRA made it clear that “an institution’s record of fulfilling these types of agreements [with third parties] is not an appropriate CRA performance criterion.”
For example, at the time of their application to merge in 1998, BankAmerica and Nationsbank pledged $350 billion in community lending over the following 10 years.
However, the Fed’s internal staff memorandum recommending approval states, “The Board considers CRA agreements to be agreements between private parties and has not facilitated, monitored, judged, required, or enforced agreements or specific portions of agreements.”
The public order is even clearer: “The Board believes that the CRA plan — whether made as a plan or as an enforceable commitment — has no relevance in this case.”
Even in the face of such overwhelming evidence, some still cling to their ideological theories as to the cause of the crisis. As our nation begins to recover, and as we debate the future of our financial markets in the United States, the facts should guide our way.
Phil Angelides served as chairman of the Financial Crisis Inquiry Commission.
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