The myth of the community reinvestment act as the cause of the current financial crisis

Recently many commentators have blamed the current financial crisis on a law enacted under the Carter and Clinton administrations, the Community Reinvestment Act. They say that the law forced banks to issue loans to lower income an minority applicants that could not afford them. Usually there is some grain of truth to these things, but far as I can tell, not this time:

  • The Community Reinvestment Act applies only to depository banks.
  • 67% of ‘subprime’ mortgages were issued by non-depository investment banks or other firms that were not regulated by the CRA, not depository banks, which were.
  • Of those issued by depository banks, only 54% were ‘subprime.’ That means that, according to a CATO study, only 17.4% of ‘subprime’ loans, or 2.3% of all mortgages issued in the U.S.
  • Collateralized Debt securities (the drop in value of which caused the collapse of Merrill Lynch, Lehman Brothers, Bear Stearns, AIG, etc. and the present uncertainty about credit) were created by combining regular and ‘subprime’ mortgages. These securities were issued only by investment banks. Doing the math, that means that about 89% of all the securities issued had no CRA-covered loans in them.

The CRA was a very minor player in the financial crisis, issuing a small percentage of all loans. It did not apply to any of the banks that issued about 89% of the risky mortgages in the U.S. The CRA was irrelevant to the investment banks and other firms that issued risky loans.

“There has been a tendency to conflate the current problems in the subprime market with CRA-motivated lending, or with lending to low-income families in general. I believe it is very important to make a distinction between the two. Most of the loans made by depository institutions examined under the CRA have not been higher-priced loans,16 and studies have shown that the CRA has increased the volume of responsible lending to low- and moderate-income households.” — Janet L. Yellen* President and CEO, Federal Reserve Bank of San Francisco, March 31, 2008.

The markets that collapsed had almost no regulation. In fact, the Commodity Futures Modernization Act of 2000 explicitly barred their regulation; the law was written by Republicans and signed by Clinton — there is plenty of blame to go around. One of the very few completely unregulated markets in the world stopped “functioning properly” (in Bush’s words). I can’t see why anyone would look further for the cause than that uncontroversial statement.

UPDATE: My brother Michael Clemens, a Harvard economics Ph.D, says no major mistakes! Whew. He also says to keep in mind that the “very simple fact is that no one completely understands the roots of the financial crisis, because it is a complex, emergent, chaotic phenomenon” (hope it was okay to quote you Michael). That is for sure.

*Some have said that as a Clinton appointee, Yellen is biased. She was appointed after his first choices were rejected by the Republican congress; Yellen was cited as a nominee the Senate Finance Committee could support, and they ratified her appointment unanimously.

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