Many of those in the media feel that the Community Reinvestment Act (CRA) is the culprit for the recent real estate market bust. Politicians have even echoed this sentiment from the Congressional podium. What is the Community Reinvestment Act, though, and did it actually contribute to or cause the U.S. housing market demise?
First, it is good to understand the origination of the Act, the planned purpose of the Act and its intended benefits. The CRA followed three other enacted laws that addressed housing discrimination and equal opportunities for housing for all peoples; however, the CRA took it a step further. Previously, banks that had a presence in low income neighborhoods and communities would not lend to their patrons making a low income due to strict lending standards.
The CRA changed all that and made it a requirement to make loans to low income individuals in the low income neighborhoods in which the banks had a presence. Community activists pushed the use of the CRA to banks and banks succumbed under the pressure. Lending standards were lowered and more loans were made to those with low- to medium-income levels. The subprime lending market was birthed.
Banks were being pressured by large groups of community activists to make more loans to the lower income borrowers but were unable, since Fannie Mae and Freddie Mac would not buy them. Eventually, lobbyists successfully pressured officials under the Clinton Administration to lower Fannie Mae and Freddie Mac lending standards to enable even more underprivileged and disadvantaged borrowers to obtain mortgages. Subprime lending grew to astronomical proportions.
By 2000, almost half of all major businesses had an investment portfolio that mirrored risky, subprime mortgages. Simultaneously, home values were climbing and continued to skyrocket until late 2006. Other factors were at play, though, that contributed to the real estate crisis. Corporations were laying off in large numbers. Borrowers were buying homes they couldn't afford. Homeowners were refinancing to include the equity in their homes to pay for kids' college, remodeling and vacations. Other borrowers were buying homes at inflated values that would later fall dramatically.
Additional activity that played a role in the mortgage crisis was the predatory lending that arrived on the loan landscape. Stated income loans, sometimes referred to as "liar loans," became accepted in the home lending industry. All a borrower had to do was state his income and he received a home loan based on the stated income. No documentation was required to verify the applicant's income; however, after the U.S. Treasury Department took over Fannie and Freddie in 2008, stated income loans were no longer allowable.
As a result of many factors, some that include corporate layoffs, underwater home loans and buyers who were in over their heads in their mortgages, foreclosure signs became the norm in many neighborhoods. They grew like wildfires that couldn't be extinguished. Home values continue to decline in most states due to the number of foreclosures; although, some are leveling out.
Since Fannie and Freddie securities, which consisted mostly of subprime packages, were traded on the open stock market, the stock market took a huge blow when lenders had to initiate foreclosure proceedings against borrowers who were not paying their mortgages. Securities investors were losing money, big time.
What does all this have to do with the CRA? The initiators of the act had good intentions, to enable those who previously were restricted from obtaining loans to achieve the American dream. It appears that lower lending standards established in 1999; however, further exposed the nation's overall economy and caused it to become vulnerable. This led to a major meltdown in U.S. economic condition.
Was the CRA to blame? Did it cause all these problems and result in the recent real estate crisis? According to many of its critics, it did. In fact, various CRA opponents say that it has led the nation into the greatest financial crisis since 1929, the start of the Great Depression. Proponents of the law vehemently disagree. They stand by the intent of the law, and insist that it has helped many who would never have owned a home to obtain a mortgage.