Few areas of economic activity in the United States aremore politicized than housing finance. Yet the intellectual left has gone togreat lengths to absolve regulators, governmentlending mandates, and agencies like Fannie Mae and Freddie Mac of anyresponsibility for the housing boom and the subsequent bust.
The rationale is clear: if these officials, institutions,and policies were held accountable, the reform agenda would necessarily shiftfrom regulating greedy bankers and their bonuses to asking broader questions.Might government mandates contribute to bad behavior by private players? Canregulators be trusted to make appropriate trade-offs between financialstability and mandates that have wide political support? Indeed, can centralbankers be truly independent? Unquestioning acceptance of a greater governmentrole in taming markets would, in short, give way to askingwhether that role can sometimes be part of the problem.
The left has had an easy task in dominating the debate,partly because the intellectual right’s attempt to place all the blame for thecrisis on government is thoroughly implausible.It is far more defensible and correct to argue that everyone – bankers,households, regulators, and politicians – contributed to (and took credit for)the boom while it lasted, only to point fingers at one another when itcollapsed.
But bankers’ political tin ear inthe aftermath of the crisis – first taking public bailouts and then payingthemselves huge bonuses as if nothing had changed – ensured that they got the lion’s share of the blame, with everyone else willingto pose as their unwitting victims. As a result,the public-policy response has been dominated by “the bankers did it”narrative. The risk is that this approach is incomplete – and thus unlikely tobe effective.
It is therefore refreshing to see a careful econometric study take on an assertion by Paul Krugman, perhaps the most influentialleft-leaning US economist, that “the Community Reinvestment Act of 1977 wasirrelevant to the subprime boom.” TheCRA instructs federal financial supervisory agencies to encourage theinstitutions that they regulate to help the communities in which they are chartered to meet their credit needs, while also conforming to “safe and sound” standards. In practice,regulators measure the volume of lending to CRA target tracts – poor areas withmedian income less than 80% of the median income of the local community – as well as tolow-income and minority borrowers in non-CRA tracts to verify compliance withthe Act.
The left has dismissed anyclaim that the CRA played a role in the housing boom by pointing out that itwas enacted in 1977, while the subprime boom played out in the early 2000’s.But this ignores the possibility that regulators may have started to enforcethe CRA rigorously only later.
To enforce the statute, regulators periodically examinebanks for CRA compliance. To hone in on the“regulatory enforcement” effect, the recent study compares the behavior ofbanks that are undergoing examination (which takes place over several quarters)to that of banks that are not undergoing examination in a particular tract in aparticular month.
The findings are clear. Compared to banks that are notundergoing examination, the volume of loans by banks in the six quarterssurrounding a CRA examination is 5% higher, and these loans are 15% more likelyto be delinquent one year after origination. In other words, banks undergoingexamination lend more and make riskier loans – and these findings are even morepronounced in CRA-eligible tracts.
Good econometric studies examine secondary effects topersuade readers that the main effect is what it is. Regulators’ primary toolto enforce compliance was their authority to reject non-CRA-compliant banks’requests for new branches or mergers. During the subprime boom, large bankswere more likely to want to expand, and thus had greater incentive to comply.The study finds that CRA lending by larger banks does indeed respond more to aCRA examination.
At the height of the lending frenzy (2004-2006), the studyfinds that banks loaned even more in response to an examination, and that theoutcomes were even worse. The authors speculate that easier loan securitizationmay have made risky CRA-compliant loans seemless costly. Finally, like all good studies, this one explains why the authorsmore careful analysis produces results that differ from those in previousstudies.
Because of the way it is structured, the study onlysuggests a lower bound on the effects of CRA compliance. It focuses on thedifferential impact of the CRA on banks undergoing examination and those notundergoing examination. In fact, all banks are likely to have upped their CRA-compliant lending. The study cannotmeasure this increase.
There is room in economics for grand speculation – somepart intuition, some part common sense, and some part ideology. If economistswere to wait for careful studies before offering opinions about policy, wewould never have anything timely to say. And it is certainly better to have some economicintuition guiding policy than none at all.
But there is a danger that the public mistakes speculationfor truth, only because of the speculator’s credentialsand assertiveness. Studies like this one areuseful in setting the record straight.
More broadly, the study suggests that we should move beyondblaming the bankers. We must recognize that in the desire to broaden homeownership, essential checks and balances broke down. Households, politicians,and regulators were also complicit. As we goabout the process of reform, we should bear in mind that the only thing worsethan fighting the last war is fighting the wrong last war.