CRA: A “SOLUTION” IN SEARCH OF A PROBLEM

The Home Mortgage Disclosure Act (HMDA) of 1975 and the Community Reinvestment Act (CRA) of 1977 were enacted to address perceived discrimination against minorities and the poor by banks and thrifts while making mortgage loans. George J. Benston has recently published, through the CATO Institute, a detailed and carefully reasoned critique of the evidence presented to justify these acts and their effect on the mortgage market. Benston concludes, “there is no case for and every case against retaining CRA and HMDA.” Our summary covers only the highlights of his study and omits the detailed references he supplies to support his analysis, but they may be found in his Policy Analysis, which may be obtained for $6.00 from the CATO Institute, 1000 Massachusetts Ave. NW, Washington, DC 20001. 

Evidence of discrimination

The noted economist, Gary Becker, has addressed the issue of discrimination by sellers of goods or services. He explained that a firm that discriminates in a competitive market is self-destructive. By foregoing available profits, management deprives the owners of profits and lowers the firm’s market value. There are undoubtedly managers who follow such uneconomic policies, but competition will eventually weed them out without government intervention. Conversely, if some lenders discriminated against minorities, other lenders will be able to realize above-market profits by serving them. However, Federal Reserve Board Economists Canner and Passmore tested this theory in their 1997 study. They found that banks specializing in mortgage loans to consumers living in poor or minority areas were no more profitable than banks that generally had very few loans in such areas. In short, minority consumers were being adequately served and extra profits could not be gained in that market.

While there may be residential mortgage markets where there is insufficient competition, they must be rare. Even in the late 1970’s, there were thousands of banks and savings institutions as well as thousands of mortgage bankers and credit unions. Given the evidence of a competitive market and Becker’s argument that significant discrimination could not exist in such a competitive market, writers seeking to find discrimination in the market for residential mortgages were hard-pressed to find evidence of discrimination.

Probably the most publicized study was that published in 1992 by economists at the Federal Reserve Bank of Boston. They based their analysis on 30 variables that they thought were related to denial rates on applications for mortgage loans. After considering all of the non-racial variables, they concluded that the remaining difference in rejection rates (17 percent for blacks vs. 11 percent for whites) was associated with race.

Subsequent researchers raised serious about the Boston study. Among others, David Horne of the Federal Deposit Insurance Corporation found significant flaws in the data used. Further, when other factors related to credit risk, such as the applicants’ past delinquencies, were included in the analysis, “there was no evidence of racial discrimination.” 

Effect of CRA on residential mortgage lending

We have seen that a pattern of racial discrimination in mortgage lending would be entirely inconsistent with basic economic theory and that the evidence of racial discrimination was far from persuasive. Hence, we would expect that researchers would find it difficult to show that the passage of CRA would significantly increase mortgage lending in poor or minority areas. Most of the research on this issue focused on the early 1990s, when CRA enforcement and reporting requirements became more rigorous than in earlier years. Douglas Evanoff and Lewis Segal, economists at the Federal Reserve Bank of Chicago, found that growth in mortgage lending during this period “was not much different than that experienced earlier.” A rather striking finding was that by Federal Reserve researchers in 1999. They found that “lenders not subject to CRA made a somewhat higher percentage of the mortgages obtained by minority borrowers and neighborhoods than did banking organizations—about 55 percent compared to 45 percent.”

Adverse effects of CRA

Lenders covered by CRA bear substantial costs of maintaining compliance records and filling out HMDA and CRA reports. Additional costs are incurred by “hiring compliance officials, dealing with CRA examiners, and meeting with community groups.” To some extent loans made by banks attempting to meet CRA requirements have been drawn from other lenders. In fact, minority banks have complained that they have been disadvantaged by CRA because other banks have subsidized loans to minorities in order to maintain their CRA ratings. In a similar vein, banks have chosen not to close unprofitable branches in minority neighborhoods, thus discouraging other financial institutions from entering to provide financial services. Finally, under CRA, all banks must make loans to certain minority groups. But, “if all banks must show that they seek to serve a specific group, non-specified groups are likely to be served less well.”