CRA and the housing bubble

There's an interesting new paper out on the role of the Community Reinvestment Act and the housing bubble. The paper, called "Did the Community Reinvestment Act (CRA) Lead to Risky Lending?" is by Sumit Agrawal, Efraim Benmelech, Nittai Bergman, and Amit Seru (ABBS). It is a serious economic analysis, which is a major departure from much of the post-2008 grumbling about the CRA. By exploiting the differences in lending behavior within census tracts between banks that are undergoing CRA exams and those that aren't, ABBS find that undergoing a CRA exam is correlated with a rise in mortgage lending and that those loans perform more poorly than those made in the same census tract by institutions not undergoing CRA exams. In other words, the CRA encouraged more lending and as a result it resulted in less prudent lending.

There's already some smart commentary on the paper from Mike Konczal. I would add this. There are two separate issues with the CRA. The first is whether CRA caused the bubble, and the second is whether CRA is a good idea generally. My take from ABBS is that the answer to the first question is clearly no--indeed, it seems to provide further evidence of the key role of private-label securitization--while the second question is unanswered.

Assuming ABBS's analysis is correct, the paper shows pretty clearly that the CRA did not play a significant role in fomenting the housing bubble. While the CRA may have lead to more risky lending, what is most striking about the paper's findings are how small in magnitude the CRA's effects are. While ABBS find statistically significant impacts, the magnitudes are really small:  5% more lending in the six quarters surrounding a CRA exam and 15% higher default rate.  That's not a 15% default rate.  That means a 1.15% default rate instead of a 1% default rate or a 6.9% default rate instead of a 6% default rate. This sort of change is a drop in the bucket relative to what happened during the housing bubble.   To this small magnitude we can run a cross-check against the "other bubble"--commercial real estate.  The CRA has little application to commercial lending; low-to-moderate income individuals aren't taking out commercial loans. Yet there was a near identical bubble in commercial real estate. The implication of the CRA's non-involvement in the commercial real estate bubble was that it probably did not play much of a role in the parallel residential real estate bubble. Instead, ABBS find that the effects of the CRA in both lending volume and defaults were greatly elevated during the 2004-2006 period, when the private-label securitization market was in full bloom. That suggests that the CRA by itself had a much more minor effect, but the ability to shift risk to MBS investors changed the effect of the CRA. The role of private-label securitization in the bubble also tracks with the commercial real estate market, where there is only private label securitization and where securitization really took off at the same time as the start of the bubble.

Still, the CRA had its critics well before the housing bubble. These critics argued that the CRA encouraged banks to make riskier loans. ABBS would seem to provide some support for this argument. But this argument hardly resolves the debate on the CRA. Instead, it points to a cost from the CRA that must be weighed against the CRA's benefits, such as access to credit for low-to-moderate income households and decreased redlining. Regardless of how one resolves this analysis, what's clear is that the CRA wasn't driving the housing bubble.