Loose Loans

Subsidized home ownership

Did government policies designed to encourage home ownership in lower-income neighborhoods contribute to the spectacular housing meltdown? A new study from the National Bureau of Economic Research says yes.

Economists Sumit Agarwal of the National University of Singapore, Effi Benmelech of Harvard, Nittai Bergman of the Massachusetts Institute of Technology, and Amit Seru of the University of Chicago looked at the impact of the Community Reinvestment Act (CRA), a 1977 law that was designed in part to encourage lending to low-income individuals. "We find that adherence to the act led to riskier lending by banks," they write.

The study compared the actions of banks facing CRA compliance audits with the actions of banks not facing such scrutiny. During the six quarters surrounding CRA audits, banks under examination made loans at a rate 5 percent higher than usual. Loans in those quarters defaulted about 15 percent more often than other loans. Enhanced lending and defaults were most apparent at large banks and in census tracts that were singled out for application of the CRA.

Lenders faced enormous government pressure. In a 2012 editorial, Investor's Business Daily described a 2000 banking conference held after the government increased the affordable housing quota—the percentage of mortgages that government-sponsored mortgage lender Fannie Mae had to purchase that were made to people at or below median income—from 30 percent to 50 percent. Fannie Mae Vice Chair Jamie Gorelick told lenders, "We want your CRA loans because they help us meet our housing goals." Gorelick, who later resigned amid reports of accounting improprieties, described "CRA-friendly products" as mortgages with less than "3 percent down" and "flexible underwriting."

Agarwal et al. caution that their study may understate the CRA's impact, since they assumed it would be mainly confined to periods when banks were undergoing CRA examinations. If banks found it difficult to shift gears in preparation for such exams, they may have altered their overall behavior to satisfy politicians and regulators.