Friday, April 30, 2010

The CRA is not the reason for the mortgage meltdown

While the mortgage melt down is now a couple of years out, it is still producing zombies. In a couple of articles about Goldman Sach’s grilling in Washington, the CRA was brought up as if it was the reason for the meltdown.

People are just looking for easy targets to explain the problems.

One of the easy targets in the mortgage debacle is the Community Re-investment Act (CRA). The legislation requires banks to make mortgages available to people living in the communities they service, or the branch assessment area. But, the act made it clear that banks were not required to loan the money if it would place the institutions in jeopardy.

There were two reason for the CRA. First, it is an attempt to keep banks from taking deposits from low income areas and investing the money in mortgages in high income areas. It was also designed to get more people in homes they own. If people own a home in a community they will take a greater role in its developed.

It is suggested that since the people that received the CRA mortgages were not worthy of the credit extended to them, they began to default. It was this mass defaulting on these mortgages that made the mortgage backed securities sold to Wall Street firms nearly worthless. This, according to the zombie legend that won’t go away, created the mortgage crisis that nearly bankrupt the system.

The reality is something very different according to research released by Harvard University’s Joint Center for Housing Studies. Only a small percent of the subprime mortgages made to low income borrowers, about 9%, were made by the banks that fell under the CRA. The remaining 91% of the subprime mortgages to low income borrowers were made by independent mortgage companies or by banks from outside of the assessment area. The CRA did not have any effect on independent mortgage companies and did not direct banks to make loans outside of their assessment area.

Once the mortgage banks not under CRA control made all the mortgages they could by regulation, they sold securities back by their mortgages to Wall Street financial institutions. By clearing the inventory of mortgages they were then allowed to seek more.

Then, mortgages began to default. The CRA mortgages failed no worse than the national average, about ten percent. The mortgages that had the worse default rate were those not from banks under CRA control.

This was where the melt down began.

Providing mortgages in a bank’s assessment area, is a great way to get people invested in their communities. The CRA has been successful at that. But the Harvard Study illustrates that it wasn’t the CRA mortgages that created the crisis. Those mortgages were no worse than the average at defaulting. It was the mortgages from the other banks not under CRA control that defaulted at a high rate.

The CRA zombie lives on, despite the passage of time and research available. Let’s hope the Harvard Study is its death knell.

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