On this we agree: CRA loans weren’t the bad loans

By Felix Salmon
June 26, 2009

John Carney and I, not content with blogging the CRA, ended up IMing about it as well this afternoon. Here’s one of the more interesting bits of the conversation, in which Carney concedes that CRA loans performed rather well, and that it was banks’ move into non-CRA subprime loans which was the real problem. Which really makes his recent crusade against the CRA all the more puzzling.

Felix Salmon: You have no evidence at all for a causal relationship between lending to lmi [low and middle-income] borrowers and inflating the subprime/housing bubble

John Carney: Oh, I’m not at that claim yet.
I’m only at loose lending standards.

FS: but only for lmi, which was not the locus of the problem

JC: I don’t think you get the bubble without the Fed holding down interest rates and a global savings glut
You would have had loose lending standards but not a huge demand for mortgage products.
It was when the investor demand combined with loose lending standards that you got the bubble.
So I’ve been explaining how we had loose standards all set up when the money started pouring in to mortgages.

FS: but how do you explain how the loose lending standards jumped the wall over to non-CRA loans?

JC: Because the CRA loans were performing so well!


JC: So, ironically, the poor were paying off their loans so well that bankers made similar loans to the relatively wealthy.
And that blew up the world.

FS: So really the CRA worked — it got banks to make good loans to people who would pay them back
and then the banks, fools that they were, started extrapolating

JC: I don’t have data on that.
But, yes.
Bankers believed they were working.
There’s also another angle: CRA meant banks who believed in loose lending standards grew, while the stingy types didn’t.

FS: Or maybe it was the banks which were making good loans who grew…

JC: Well, those who didn’t do big LMI lending were barred from growing.

FS: Um, I am vaguely familiar with CRA requirements. “Big” is putting it a bit strongly I think.

JC: Bigger?
Anyway, there was a lot of pressure to acheive an O rating

FS: CRA is actually pretty weak, any halfways-decent bank should be in compliance anyway

JC: That’s an entertaining argument that was strenously denied by CRA supporters until recently. They stressed its effectivensss.
search “CRA” on the Brookings Institute website

FS: It was effective precisely because it acted in banks’ self-interest

JC: Again, I agree that banks agree with you. I still haven’t seen the data to know (a) if it was in their self-interest and (b) whether that was just a function of rising prices.

FS: But you’ll agree that there’s a very strong possibility that the consequences of CRA were positive for banks, and for lmi borrowers,
and that it was non-CRA lending which caused substantially all of the problems

JC: Oh, sure. As long as they confined their loosey lending standards to CRA loans, they’d probably have been okay. Even if those were loss making, it wouldn’t have been catastrophic.
The broad application of CRA standards was a disaster.

FS: well, no. If banks had underwritten their subprime loans with the same assiduousness they applied to their lmi borrowers, there wouldn’t have been a problem. There was never any such things as a NINJA CRA loan

JC: Well, there’s also the problem that to make CRA loans you had to market them, which brought in borrowers who wanted No Money Down but weren’t CRA candidates.

FS: that’s a real stretch
I don’t think there was ever any lack of demand for CRA loans which had to be countered by lots of marketing for these things
if you wanted to make more CRA loans, you could always just call up your local CDFI
much easier

JC: I think you over-estimate the ease of making CRA loans.
It was hard!

FS: the underwriting is hard. Finding the borrowers in the first place is easy
as someone who sits on the board of a cdcu with effectively zero marketing budget, I can assure you of that


We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/

I have to say that I didn’t really believe that anybody was seriously blaming the CRA, since it’s supposed to work against discrimination. In other words, it’s meant to stop practices of zero loans going to qualified buyers. Nothing in the law suggests that you have to lose money to be in compliance.

“The Act requires the appropriate federal financial supervisory agencies to encourage regulated financial institutions to meet the credit needs of the local communities in which they are chartered, consistent with safe and sound operation.”

The amount of loosening needed to fulfill this requirement seems minute, and, frankly, it’s not even clear that you’d have to make a significant amount of loosening.

I thought that this was really a proxy argument about the government causing Fannie, for example, to loosen its standards because of new rules about the CRA, allowing the private sector to do so as well.

The point that I was trying to make was that, even in this case, what’s being put forth is a subsidy. Namely, you can lower your standards ( if that’s what happened ) because the government is implicitly guaranteeing the loan.

Now, I can understand that private business can lower its standard a bit because of this, but I cannot understand that a business would try and go beyond the government’s standards. After all, the govt program is subsidized. In other words, I simply cannot follow the logic of a business model that tries to undercut a subsidized competitor, unless that competitor puts a huge reserve aside, or, and this could lead to problems, buys insurance on these loans. But, if you do that, it will have an impact on your profits, and might not be worth it.

Somebody needs to explain to me how a sensible private business strategy can follow from a govt subsidized program lowering standards. I’ll try one more time: the lowering standard, to the extent that it existed, was because of the govt subsidy, or guarantee. Without that, the lowering makes no sense. The govt can do it because it’s the govt.

In some businesses, I can see competing against a govt subsidized competitor by offering various incentives. In this case, I can’t.

The govt wanted to help less well off people. To the extent that it did so, you need to look at the program. To say that the govt program influenced the private sector, it’s not enough to do that. You have to show that what the private sector did makes sense. Otherwise, it’s simply a case of idiotic investing.

So, there might be such a connection, but what’s the sense of it? Excuse me if quoting from people who are proven investment imbeciles doesn’t work. That’s the point. They created a fantasy narrative. You can blame the govt for allowing it, but not creating it.

Or maybe I’m missing the point yet again. If I am, sorry.

It does bring up the question of where and when these loan types originated. I believe stated income was around for a long time but was limited in application and carefully examined before granting, even to the point of requiring past tax returns for them. Some of the other types like no income were quite recent, and the loan constraints and qualifications were significantly lowered over the bubble. It would be interesting to see an insiders chronology.

To summarize, the problem wasn’t the CRA because those loans have been ok but it was the CRA’s “fault” because those loans have been ok and that somehow means all those intelligent people in finance thought they could make any loan to anybody with any terms they could imagine.

So, I drove down a street and didn’t hit anyone so that means it’s my “fault” when someone else drives down the street through a crowd of people hitting a bunch because my driving down the street meant that guy had a license to use no sense at all.

Posted by jonathan | Report as abusive

The Carney IM exchange here is very funny. Carney himself seems savvy enough to recognize the absurdity of his argument, but I find myself wondering what’s in his head – why he wants to align himself with this nonsense.

What is it that Carney thinks but can’t admit? I keep coming back to Sailer in the other thread. I think Sailer understands the real basis for the anti-CRA argument.

Posted by politicalfootball | Report as abusive

Is there any data on what percentage of non-CRA originated loans ended up in CRA-Eligible and/or CRA-Investments Funds purchased by the GSEs and CRA-regulated institutions to bolster CRA targets?

Dow Jones Newswire (05/20/03) ; Kopecki, Dawn
Freddie Mac has embarked on a plan to aggressively purchase and repackage mortgages originated by small lenders. The government-sponsored enterprise is reselling them at a premium to banks that are looking to bolster their low-income investment scores with federal regulators.

Pitch from Freddie Mac, Mortgage-backed Securities &
Collateralized Mortgage Obligations:
Prudent CRA INVESTMENT Opportunities

Posted by Lola | Report as abusive