The Community Reinvestment Act: A Welcome Anomaly in the Foreclosure Crisis

BY: TRAIGER & HINCKLEY LLP, ATTORNEYS AT LAW

Purpose of Study

Much of the responsibility for the recent spike in foreclosure rates, one of the symptoms of the “subprime crisis,” has been placed on lenders who failed to appropriately assess the risks involved in the loans they originated. Such lenders allegedly overlooked weak borrower credit histories, high loan-to-value ratios, and sketchy borrower income documentation to originate high cost loans that were promptly sold to third parties. Federal Reserve Chairman Bernanke summarized the process that led to the crisis in congressional testimony last fall:

The originate-to-distribute model seems to have contributed to the loosening of underwriting standards in 2005 and 2006. When an originator sells a mortgage and its servicing rights, depending on the terms of the sale, much or all of the risks are passed on to the loan purchaser. Thus, originators who sell loans may have less incentive to undertake careful underwriting than if they kept the loans. Moreover, for some originators, fees tied to loan volume made loan sales a higher priority than loan quality. This misalignment of incentives, together with strong investor demand for securities with high yields, contributed to the weakening of underwriting standards.1

This study isolates the 2006 performance of one category of mortgage lenders—banks originating loans in their Community Reinvestment Act (CRA) assessment areas, referred to herein as “CRA Banks.” Our hypothesis is that the CRA, which requires banks to help serve the credit needs of their local communities, including low- and moderate-income (LMI) neighborhoods, consistent with safe and sound banking practices, may have deterred banks from engaging, at least in their local communities, in lending practices that fuel foreclosures.

To test our hypothesis, we analyzed 2006 Home Mortgage Disclosure Act (HMDA) data to compare the lending performance of CRA Banks2 with other lenders in the 15 most populous U.S. metropolitan statistical areas (MSAs). Four areas relevant to the foreclosure crisis were reviewed: (1) the proportion of high cost loans; (2) the pricing of high cost loans; (3) the proportion of originated loans retained by the lender; and (4) the relationship between foreclosure rates and concentration of bank branches.

 

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TRAIGER & HINCKLEY LLP

Attorneys at Law

880 Third Avenue

New York, NY 10022

(212) 752-1161

www.traigerlaw.com

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