The government compels banks to make loans in poor neighborhoods even if the applicants are not considered prime borrowers. You may not know about that because the Community Reinvestment Act is not exactly a household (excuse the pun) name.
But the commercial banks do know about it. They have a CRA department. They get a CRA rating. They know that the way to get a high CRA rating is to make loans to poor applicants or in poor urban neighborhoods regardless of the financial prudence of the loans.
They know that if they don't do this, they will be punished severely by the regulators when they try to make any major change which is dependent on regulatory approval. And they know that pretty much every major change a traditional bank makes is, in fact, subject to regulatory approval. So, they grit their teeth and stamp a big inky "yes" on an application which they know, according to traditional financial standards, deserves a "no."
Up until 1995 the Community Reinvestment Act was largely a requirement to support "community groups" in poor neighborhoods. Of course, this often meant left wing groups like ACORN, etc. But after 1995 the scope of the law was dramatically increased.
Over the strenuous objections of the banks themselves and some Republicans in Congress, CRA was renewed and modified in such a way that it gave far more power to the federal government to punish banks for not lending more widely in poor neighborhoods.
The classic "fair housing" laws from the Martin Luther King Jr. era of civil rights were deemed insufficient. Under CRA, not only were realtors required to sell to qualified buyers regardless of race, which they should have been, but banks were accused of a new kind of "financial redlining" if they didn't provide the funds. Income, credit history, assets, debts were out. Urban neighborhoods were in. The Home Mortgage Disclosure Act pushed things along too by requiring banks to ask about and disclose the race of its mortgage applicants. In effect, banks were forced to provide the evidence of their own alleged discrimination.
Subprime loans to minority applicants exploded ten fold in the mid-1990s as a result. In fact the Clinton administration found a rapid increase in subprime loans in minority neighborhoods. Their principle worry was that, even then, not enough lending was going on in these communities. More was needed. And they got what they asked for.
Under New Deal-era regulatory rules of Glass-Steagall, commercial banks and investment banks were separated. When that act was repealed as part of banking deregulation in 1999, commercial banks and investment banks were able to merge, subject to approval by regulators.
However, the banks' CRA rating was taken into account in the decision. This meant that a high CRA rating became an important prerequisite for mergers, which increased the pressure on the banks to make these risky loans. The banks also were given permission to put these loans into packages of securities that could then be sold into investment markets.
Last week, a front page Wall Street Journal article set off a national debate about the legacy of Alan Greenspan. Critics have been taking the former chief of the Federal Reserve to task for failing to see the alleged excesses of the marketplace and neglecting to issue new diktats to punish those excesses accordingly.
But it is not Mr. Greenspan's fault that Congress substituted identity politics for financial prudence, although his easy money in 2003 didn't help much. If anything, Mr. Greenspan regulated too much.
