Why reform a lending law that we may not need at all?

The use of the term “reform” in the title of proposed legislation may portend subtle improvement in existing law. But it may, too, mask an expansion of the reach of government in ways that would distort the economy for the worse. So it is with what’s being billed as “reform” of the Community Reinvestment Act (CRA), the 1977 law used to judge whether banks are doing enough to lend money in “underserved” areas.

Momentum is building at the Federal Reserve, as well as among advocacy groups, to expand the scope and requirements of the CRA. Fed Governor Lael Brainerd wrote in July that “the law needs to be updated to better respond to inequities in credit access and to reflect advances in technology that have changed how banks operate.”

In a March 1 letter to bank regulators, 123 organizations expressed support for seven additions to existing CRA requirements, which focus on lending and other banking services in neighborhoods in which traditional, regulated banks have branches. Led by the National Community Reinvestment Coalition, the letter seeks to add explicit race-based lending requirements to existing CRA clauses because of “persistent and worsening racial inequality”; to reward banks that undertake “environmental remediation for communities of color”; and to “assist in the transition to a net-zero carbon economy.” 

In addition, these advocates say, CRA exams — which determine if deposit-taking financial institutions are meeting the credit needs of the community — should be geographically expanded not only to areas where banks have branch networks but also to their overall investment portfolios.

Such “reforms” would go far beyond ensuring that qualified borrowers can obtain credit. They would threaten to be government diktats of private capital allocation on a far larger scale than has been the case. And the stakes are high. No bank wanting to merge or engage in acquisitions could afford to have a poor CRA exam grade. As a result, mergers would offer advocacy groups the opportunity to successfully demand low-income housing financing and other progressive goals. Banks live in fear of receiving a “satisfactory” CRA rating, instead of an “outstanding” one, from any of the four regulators conducting the exam.

Instead of moving reflexively to expand the reach and character of the CRA, the Fed and congressional overseers such as the Senate Banking Committee would do better to ask first-principle questions about the law. The first important question: Is the CRA still necessary?

The banking and financial services world of today is unrecognizable from what it was when the CRA was passed more than 40 years ago. In 1977, interstate banking was not allowed, most mortgages were issued by savings and loans associations, and commercial and consumer banking were walled off from each other. Today, only 40 percent of residential mortgages are provided by traditional, regulated banks. Unregulated “nonbanks,” not covered by the CRA, now dominate mortgage lending — despite not taking deposits and having no branch network or particular community focus. Still, they are leading the way in lending to those of modest means. 

An analysis of mortgage lending by the American Enterprise Institute Housing Center shows that 71 percent of loans to low- and moderate-income households are made by nonbanks — despite the fact that they do not face regulatory pressure to do so. This should prompt regulators to ask another basic CRA-related question: In this new, hyper-competitive environment, do any qualified borrowers actually have difficulty obtaining credit?

Then there is the related matter of whether pushing banks, or conceivably nonbanks, to increase their lending to low- and moderate-income households would really be good for the poor. Regulation advocates highlight the more than $2 trillion in CRA-qualified lending between 2009 and 2018. But spending itself, as with federal appropriations, is not a measure of benefit. CRA exams notably do not include measures of CRA loan performance. This failure to track mortgage delinquencies or foreclosures is a crucial regulatory oversight. Vacant or dilapidated homes are a danger to neighboring homeowners who are working hard, making their mortgage payments, and keeping their homes in good repair. 

Granting loans to those who do not meet traditional down payment or underwriting criteria, such as those with marginal credit scores, will do more harm than good to “underserved” neighborhoods. There is a crucial need for a serious, long-term study examining the performance of CRA lending, not just spending. It has never been done. The key risk here: that an expanded CRA would spark another wave of dangerous subprime lending.

Finally, one must ask why CRA advocates remain convinced that lending discrimination persists. In today’s competitive environment, it’s hard to understand why qualified borrowers would be turned away, more than half a century after the passage of the Fair Housing Act. Banks and real estate agents are on guard, to say the least, against being tarred as “racist.”

Regulators should not shrink from the possibility that financial markets have evolved in such a way that the risks of the Community Reinvestment Act may be greater than its benefits.

Howard Husock is a senior fellow in domestic policy studies at the American Enterprise Institute. He is the author of “The Poor Side of Town — and Why We Need It.”