The Community Reinvestment Act Implications of Predatory Lending - Essay Example

Community Reinvestment Act Introduction During the era of 1970s, banks were held responsible for the decline of the US economy by the community along with the government (Ross 44). Money lenders stopped providing loans to individuals living in their neighborhood even if these people had good credit history because these individuals were a part of the low income earning side. These actions were questions by the law as well as interest groups and these activities were acknowledged as discriminatory activities. The outcome of such activities by the lenders resulted in the acceptance of HMDA (Housing and Mortgage disclosure Act), according to this new law, it became obligatory for the lenders to disclose their lending procedure to the common public (Squires 7). The year after the passage of HMDA experienced the acceptance of CRA (Community reinvestment Act) because analysis showed that the amount being invested in meager areas was quite low (Ross 44). The Act made it obligatory for the banking institution to provide loans to all the people available in the market; provide the facility of depositing money to limited areas and develop reports regarding the habit of lending and submit the report to the federal body. These reports aided in evaluation of the applicants when these applicants made request for conducting takeovers and amalgamations. The practices made by the Act were not implied on the credit unions as these unions were not as large as the banks of that era. According to the definition of credit unions, these unions are allowed to restrict the amount of money they lend to people sharing similar characteristics such as work and educational institute. Body Increased Lending The outcome of the CRA act was that there was a sudden increase in the amount borrowed by people living in areas that consist of low to middle income earners. The research conducted by San Francisco Fed showed that the amount of money borrowed by low income earners for the purpose of purchasing homes elevated by 37% during the period of 1993 to 1997 and during the same period, the amount borrowed by middle income earners elevated by 32% (Laderman 2). During the same era, the number of buying and selling offers of home made by lower middle income earners increased by 43% and for low income earners it increased by 43% (Laderman 2). This era even witnessed an increase in the borrowing conducted by high income earners by 17% and middle income earners by 23% (Laderman 2). Those in the favor of the act believed that these achievements were caused due to the act, while during the same period increase in technological advancements and deregulation even took place. Banks were not only the financial institutions that increased lending, level of lending even increased among other financial institutions. Study conducted by Jeffery Gunther showed that increase in level of lending conducted by institutions under the CRA and non-CRA increased equally, while non-CRA lenders lend more than CRA lenders to the people living in middle and low income areas (Gunther 58). During the period of 1993 the amount of money lend to low income earners by non-CRA financial institutions was 11% and later the percentage increased to 14.3% during 1997 (Gunther 58). While on the other hand the figures of lending for CRA financial institutions was similar to non-CRA financial institutions during 1997, but in 1993 CRA compliant financial institutions had lend .5% more to low income earners (Gunther 58). CRA Limitations CRA was not only the reason of increased lending, increased in lending even took place to heavy amount of deregulation and technological advancements during the period of 1980s and 1990s and money was being lend to any individual who wanted it. Three major acts contributed to the deregulation of financial institutions, these include: 1980s Act of Depository Deregulation and Monetary Control, 1994’s act of Reigle-Neal Interstate Banking and Branching Efficiency and last the 1999’s act of Gramm-Leach-Bliley (Welch 219). The advantages and disadvantages of CRA are dependant on the reasons due to which this Act was put into action. Study suggests that the analysis of the outcomes of the HMDA were not absolutely correct (Phillips-Patrick 13). Study conducted by Clifford Rossi and Fred Philip-Patrick shows that the model applied to the data of HMDA was not conclusive enough and ambiguous (Phillips-Patrick 14). Their study showed that the analysis was correct regarding the discrimination in lending practices but the analysis failed to recognize who was worthy of credit and who was not. They further figured out through their study that the initial analysis of the HMDA was itself biased as it was looking at the problem with a restricted view. The early analysis of HMDA discounted the factor that during that period technological advancements had not taken place and it was difficult for lending institutions to obtain timely information about applicants, due to this lending institutions refrained from lending in order to minimize their risk. Due to shortage of technological advancements, lending institutions based their decision of not providing loans to low income earners on the basis of the fact that these individuals were living in areas where all individuals were earning low. This issue even made it almost impossible for the banks to calculate the values of homes in these areas and it was believed that if one home in the area was not in proper condition, the value of other homes would even decline. Under the HMDA, the incidences of discriminatory lending practices were to be reported to the Justice system, but during that period very few cases were reported which clearly showed that the analysis was wrong in figuring out that financial lending patterns were discriminatory. Negative Outcomes Those financial organizations that were CRA compliant became very risky and the non-CRA compliant financial institutes even experienced similar risks. Gunther conducted a comparison of the ratings of CRA and CAMELS and figured out that those lenders who were assigned positive ratings by CRA were assigned negative ratings by CAMELS (Gunther 60). Smaller sized banks which had to comply with the CRA experienced increased cost of writing selling and buying offers of houses and the compliance even resulted in increase in cost. CRA complaint large banks had the ability to charge very low interest rather to the borrowers due to which the smaller banks were not able to compete and fulfill the requirements of the CRA, while larger banks easily fulfilled the requirement and gained the acceptance for mergers. Smaller banks failed to get good CRA ratings due to which they were not allowed to open branches in lower to middle income earning areas and these banks even experienced increased cost if they closed their branches in these areas. Due to this pressure on the smaller banks, the policy makers exempted smaller banks from reporting their lending activities and made it compulsory for larger banks to report their lending activities. This approach was made to decrease the risk experienced by the smaller banks and to create standard tests for all financial institutions. CRA even increased the cost of lending money for financial institutions as CRA compliant institution had to spend ample amount of time and money on documentation of their activities. CRA ratings were provided to lending institutions on the basis of the degree of compliance achieved by the financial institutions and this usually used to take several months. Due to increase in documentation, speed of depositing money declined and lending to special interest groups in lower middle income areas increased and heavy sums of money was lend to finance projects created by these groups. Lenders found it profitable to lend to people living in areas where lending was not encouraged because the rates obtained from people living in such areas were higher because people living in these areas had bad credit ratings. Study showed that those individuals who gained access of such loans could have easily gained access to loans that were provided at much relaxed terms if CRA was not in operation (Engel). The number of foreclosures even increased due to CRA because CRA decreased the standards of underwriting. Lending conducted by commercial banks even depreciated during the era of 1995 because people started borrowing loans that were backed or financed by the government. Research conducted by Patricia McCoy and other individuals of the university of Connecticut Law School showed that the main purpose of the CRA was to promote banks to lend to underserved communities but the CRA failed in fulfilling this purpose as out of the total of money lend as subprime mortgage, 15% of these loans were provided by banks and rest by other financial institutions (Engel). Conclusion The CRA failed to achieve its purpose of lending money to people living in areas of lower income, this purpose could have been fulfilled in a better way if CRA would not have existed. CRA have not helped smaller banks, it has rather increased the burden and risk of smaller banks and helped larger banks in taking over the smaller ones as due to CRA, smaller banks did not have better ratings than the larger ones. CRA failure to take into account whether lower income areas should be given loans or not made the banks more riskier. Works Cited Engel, Kathleen C, and Patricia A. McCoy. The Cra Implications of Predatory Lending. Hartford, CT: University of Connecticut School of Law, 2002. Internet resource. Gunther, Jeffery W. "Banking and Credit - Should Cra Stand for "community Redundancy Act"?" Regulation. 23.3 (2000): 56. Print. Laderman, Liz. Has the Cra Increased Lending for Low-Income Home Purchases?San Francisco, CA: Economic Research, Federal Reserve Bank of San Francisco, 2004. Print. Phillips-Patrick, F J, and C V. Rossi. "Statistical Evidence of Mortgage Redlining?: a Cautionary Tale." Journal of Real Estate Research. 11.1 (1996): 13-24. Print. Ross, Bernard H, and Myron A. Levine. Urban Politics: Cities and Suburbs in a Global Age. Armonk, N.Y: M.E. Sharpe, 2012. Print. Squires, Gregory D. Organizing Access to Capital: Advocacy and the Democratization of Financial Institutions. Philadelphia: Temple University Press, 2003. Print. Welch, Patrick J, and Gerry F. Welch. Economics, Theory & Practice. Chicago: Dryden Press, 1982. Print. Read More