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The Global Financial Crisis and the Community Reinvestment Act

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The role of Community Reinvestment Act in the "Global Financial Crisis" has been an ongoing debate that effectively revolves around the debate about potential unintended consequences from government actions in encouraging home ownership and lending (with the CRA being the current topic). A late 2012 paper concludes the CRA did encourage risky lending. The paper follows-up on the FCIC report and its discussion(s) of the CRA's contribution (or lack thereof) in the Crisis with the Majority report dismissing any significant link between the CRA and the crisis, but Wallison's dissent suggesting otherwise. See Did the Community Reinvestment Act (CRA) Lead to Risky Lending? (10/1/2012) by Sumit Agarwal, Effi Benmelech, Nittai Bergman, and Amit Seru (NBER version)

"Yes, it did... We find that adherence to the act led to riskier lending by banks ... The effects are strongest during the time period when the market for private securitization was booming."

"Krugman (2010) argues that “the Community Reinvestment Act of 1977 was irrelevant to the subprime boom.”

"Most empirical studies find that the CRA had little or no effect when looking into a battery of dependent variables (e.g., Dahl, Evanoff, and Spivey 2000 and Kroszner 2008). This lack of results makes it hard to conclude whether the CRA truly had no impact on lending standards or, alternatively, whether the empirical approaches used employed insufficient variation to identify the causal effect of the act. In this paper we attempt to fill this gap ... By tracing out banks’ responses to CRA evaluations in terms of both the quality and the quantity of mortgages originated, we show clearly that the CRA did lead to riskier lending."

"In interpreting our results, it should be stressed that while we find that the Community Reinvestment Act led to increased origination rates of risky loans, it may still be an efficient policy due to other, desirable consequences. Perhaps most important of these is the provision of credit to potential borrowers who would otherwise have been denied access to credit markets for reasons such as redlining or pure discrimination. However, by showing the costs that are associated with the regulation, we provide evidence that can help inform the debate on the overall desirability of CRA."

Some additional links and excerpts of note (on both sides) include the following. Gary Karz, CFA Follow GKarz on Twitter
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