Community Reinvestment Act Ensuring Credit Adequacy or Enforcing Credit Allocation?

Vern McKinley

n a July 15, 1993 speech on the South Lawn Greenspan, the Reagan-appointed Chairman of of the White House, President Clinton dis- the Federal Reserve Board (Fed), has recently Icussed the availability of credit to low and taken a more active role regarding CRA issues. middle-income areas, and mentioned what has He recently gave his first speech on the subject been a relatively obscure statute for most of its after seven years as Chairman, and cast an seventeen-year existence—the Community instrumental vote against an application for a Reinvestment Act (CRA). This statute requires proposed acquisition by Shawmut National financial institutions to reinvest deposit funds Corporation of Massachusetts. The denial was back into the communities in which they are based upon the powers granted to the Fed by located. Clinton claimed that the CRA has not the CRA. lived up to its potential. In line with this con- Rather than being a positive trend, these cern, the bank and thrift regulatory agencies, recent actions allow government and special primarily under the leadership of Clinton- interest groups to influence and even dictate appointee Eugene Ludwig of the Office of the lending decisions. Instead of being expanded, Comptroller of the Currency (OCC), have spent the CRA should be repealed. most of the past year and a half revising their regulations interpreting this statute. Even Alan Statutory Authority

The CRA is based upon the underlying notion that Vern McKinley has worked at the Federal Deposit institutions have a continuing and affirmative Insurance Corporation, the Federal Reserve Board, obligation to help meet the credit needs of the local and is currently employed at the Resolution Trust communities in which they are chartered. The fed- Corporation. The opinions expressed in this paper are eral supervisory agencies undertake a two- solely attributable to the author. This article was pronged effort to ensure that the obligation man- adapted from a more extensive paper available from dated under CRA is fulfilled. First, CRA requires the author at 1730 N. Lynn St., Suite A-67, that the appropriate federal supervisory agency Arlington, VA 22209. use its authority when conducting supervisory

REGULATION, 1994 NUMBER 4 25 COMMUNITY RE-INVESTMENT ACT examinations to encourage institutions to meet the tions avoid doing business in certain geographic credit needs of the local communities in which they areas. The CRA was enacted as a follow-up to are chartered, consistent with safe and sound oper- the HMDA, in part in response to instances in ation of the institution. The various regulatory which a poor white applicant had a significantly agencies, such as the Fed and the OCC, give each better chance of getting a mortgage loan than a institution a written evaluation of its record in wealthy black applicant. These four statutes are meeting community needs and assign a rating of designed to assure credit availability for persons either “outstanding,” “satisfactory,” “needs to of all income levels and demographic groups. improve,” or “substantial noncompliance.” A por- tion of the written report, as well as the rating, is The Regulatory Record released to the public. Second, the CRA requires that the appropri- The vagueness of the CRA is a direct result of ate financial supervisory agencies take the insti- the legislative process at work behind the devel- tution’s record into account when they evaluate opment of the statute. The CRA was proposed during the Carter Administration by Senator William Proxmire (D-Wisc.), whose primary The CRA utilizes fairly vague terms such purpose in enacting the legislation was to elimi- nate the practice of redlining. The bill focused as“convenience and needs” and “meet the on this practice because of the perceived unfair- credit needs of the local community,” and ness of “credit exportation,” whereby money thenthen explicitlyexplicitly delegatesdelegates toto thethe individuaindividuall was taken from the community in the form of agencies the power to define these terms,, deposits, but lent to borrowers outside of the while using the threat of denying applica-- community. CRA supporters thought that insti- tionstions toto assureassure compliancecompliance withwith ththe tutions should avoid such credit exportation as part of the quid pro quo for deposit insurance agency-created definition.. and a government charter. Proponents of the bill compared this requirement to the FCC require- ment that radio and TV stations serve the public an application for a deposit facility such as the in exchange for their licenses. opening of a branch, relocation of a home office, The original form of the bill that was to a merger, or acquisition. This is the “stick” the become the CRA has been described as having a agencies can wield to enforce the CRA. In short, substantive and a procedural section. The sub- the CRA utilizes fairly vague terms such as stantive section required institutions to serve the “convenience and needs” and “meet the credit convenience and needs of the communities in needs of the local community,” and then explic- which they were chartered. The procedural sec- itly delegates to the individual agencies the tion detailed very specific procedures for insti- power to define these terms, while using the tutions to follow in connection with an applica- threat of denying applications to assure compli- tion for a deposit facility. ance with the agency-created definition. Ultimately, the procedural section was Closely related to the CRA are three sibling doomed by opposition from those who were statutes, the Equal Credit Opportunity Act concerned that the bill was thinly-disguised (ECOA), the Home Mortgage Disclosure Act credit allocation and would represent a foot in (HMDA), and the Fair Housing Act (FHA), all the door toward the mandatory allocation of aimed towards eliminating “discrimination” in credit. Opponents of the bill feared that one day the lending process. The close relationship arises banks would be required to make unsound from the near-automatic determination that if loans to meet their local credit quotas. An exam- ECOA or FHA are violated, the institution is not ple of such criticism came from Arthur Burns, serving its community. The Department of chairman of the Fed at the time, who noted that Housing and Urban Development (HUD) and the proposed statutory language interfered with the Justice Department complement the efforts the first principle of the banking system model: of the bank and thrift agencies in enforcing the to facilitate the market flow of credit from areas FHA and ECOA. The HMDA focuses on the of supply to areas of demand. He argued that practice of “redlining,” whereby lending institu- this interference might inhibit lenders from

26REGULATION, 1994 NUMBER 4 COMMUNITY RE-INVESTMENT ACT opening depository institutions in locales where made by Continental Bank Corporation and they would be cornered into maintaining certain Continental Illinois Bancorp, Inc. to acquire 100 levels of credit. percent of the voting shares of Grand Canyon The final version of the CRA that was signed State Bank in Scottsdale, Arizona. The Fed into law reflected deference to the concerns of claimed that Continental did not have a plan to those who feared mandated credit allocation. meet its responsibilities under CRA, and that it However, in a compromise move, the regulatory made no effort to ascertain the credit needs of its agencies were delegated the power to assess the community. The denial was issued despite the institutions’ records in meeting the needs of fact that between 1986 and 1989 the Federal their communities, thus moving away from a Reserve had allowed Continental to acquire results-oriented approach. three banks in the Chicago area. Early CRA regulations promulgated by the Finally, the late 1980s saw an explosion of agencies directed institutions to define their CRA-related examinations by financial regulato- communities, make available information about how they serve the financial needs of these com- munities, and post notices requesting public Expressing discontent at public hearings in comments on their CRA performance. Quantitative targets were specifically rejected March 1989, Senator Proxmire com-- because it was believed they would inevitably plained that, despite passage of the CRA,, result in credit allocation and uneconomic inner-cityinner-city neighborhoodsneighborhoods werewere “starvin“starving investments. forfor credit.credit.”

The Late 1980s

A number of actions by Congress and the regu- ry authorities. For example, examinations by the latory agencies in the late 1980s signaled a turn- FDIC, the agency that conducts the largest num- ing point for the CRA. Expressing discontent at ber of CRA examinations, jumped from 1,251 in public hearings in March 1989, Senator 1985 to 4,282 in 1988. Proxmire complained that, despite passage of the CRA, inner-city neighborhoods were “starv- ing for credit.” The 1990s: Studies and Surveys A number of changes were made in response of Lending Discrimination to these hearings. In March 1989, the OCC, the Federal Deposit Insurance Corporation (FDIC), The trend toward utilizing the CRA more the Office of Thrift Supervision (OTS), and the aggressively accelerated in the early 1990s. Fed issued a joint policy statement on CRA that Consumer surveys show that recent homebuy- set forth a more detailed framework to follow in ers strongly believe there is bias in mortgage formulating an effective CRA program. The lending (whites-60 percent, hispanics-60 per- statement gave general guidelines similar to cent, and blacks-83 percent) though few had those previously issued by the regulatory agen- experienced it themselves (whites-3 percent, his- cies, and also outlined highly detailed recom- panics-7 percent, blacks-16 percent). Data col- mendations for institutions’ CRA plans. lected under the HMDA continues to show that In August 1989, Congress passed the blacks are more than twice as likely to be reject- Financial Institutions Reform, Recovery, and ed for mortgages as whites or asians, 34 percent Enforcement Act. Representative Joseph versus 15 percent. Hispanics suffer denial rates Kennedy (D-Mass.) sponsored amendments to of 25 percent, higher than whites, but lower than the Act which required a written evaluation by blacks. But the most far-reaching and oft-cited regulating agencies of the institution’s record of analysis of mortgage lending bias is an October meeting the credit needs of its community and 1992 study by the Federal Reserve Bank of required the agencies to disclose the institution’s Boston. CRA rating to the public. Also in 1989, the The Boston Fed Study sought to discover Federal Reserve Board issued its first denial of a whether differences in mortgage loan denial bank acquisition based on CRA, an application rates could be explained, controlling for factors

REGULATION, 1994 NUMBER 4 27 COMMUNITY RE-INVESTMENT ACT such as financial, employment, and neighbor- below their proportion in the population of the hood characteristics. The study concluded that community. Furthermore, the practice is not overt discrimination, whereby minorities with strictly justified by business necessity or because unblemished records are denied credit, is not other, less disparate criteria are not available. pervasive—97 percent of such applicants are Examples of disparate impact practices include: approved. However, the study concluded that minimum loan amounts; property standards even controlling for these other factors, there such as size and age that exclude homes in remained a “statistically significant” gap associ- minority and low-income areas; commissions ated with race. for lending officers that shift their efforts toward high balance as opposed to low balance loans; The Regulatory Response the existence of application fees; and the lack of minorities as front-line employees. Since the Boston Fed Study, the Federal Reserve The other form of agency-defined discrimina- Board has intensified its scrutiny of applica- tion, disparate treatment, is said to occur when a tions. A high profile case underscoring this lender who has loan applicants that may be scrutiny was the Fed’s December 1993 denial, described as marginal or close calls treats appli- the result of a three-to-three tie vote, of cants differently. One of the more colorful Shawmut National Corporation’s proposal to examples of this form is the “thick loan file” acquire New Dartmouth Bank. Chairman phenomenon. Under this scenario, a non-minor- ity loan officer has two potential borrowers of roughly equivalent credit quality: one minority, and one non-minority. The loan agent will The Boston Fed Study found that overtt “coach” the non-minority applicant, that is, sug- discrimination, such as redlining, is nott gest ways that the applicant might make a better pervasive. Thus, in recent years, regulators case for the loan. The applicant will usually gather more supplemental material to support have targeted what they maintain are more his loan request. The result will be a flood of subtle forms of discrimination.. documentation and paperwork which will be noticeable in a much thicker loan file. Thus, it will be more likely that the non-minority bor- Greenspan, Vice-Chairman Mullins, and rower will be approved for a loan. This phe- Governor Lindsey voted to deny. Shawmut was nomenon has been described by Fed Governor under investigation by the Justice Department Lindsey as fairly solid, albeit anecdotal, evi- as a result of data compiled under the Boston dence that white marginal applicants have Fed Study. The Fed later reversed its disap- thicker loan files than marginal black applicants. proval after Shawmut settled the case for approximately $1 million to compensate black The Results of Increased Enforcement and hispanic applicants turned down for mort- of CRA gages by the bank, and acted to take further steps to prevent future discrimination. Advocates of a strengthened CRA maintain that stronger enforcement has had an enormous posi- The New Concepts of Discrimination tive impact. For example, Allen J. Fishbein, in a Fordham Urban Law Journalarticle, claims that CRA As noted previously, the Boston Fed Study has resulted in new credit commitments of $30 bil- found that overt discrimination, such as redlin- lion; and this figure is cited by regulators as an ing, is not pervasive. Thus, in recent years, regu- indication of how their efforts are paying off. A lators have targeted what they maintain are December 1993 proposed CRA rule accepts this more subtle forms of discrimination, usually premise when it notes that tens of billions of dol- classified either as “disparate impact” or “dis- lars have flowed to low- and moderate-income parate treatment.” In a case of disparate impact, areas as a result of CRA. Such results have led a lender applies a practice uniformly to all some to believe that the CRA should be expanded applicants. Yet the practice results in a distribu- to include credit unions, insurance companies, and tion of loans to designated protected groups other nonbank and thrift companies such as mort-

28REGULATION, 1994 NUMBER 4 COMMUNITY RE-INVESTMENT ACT

gage banks. This would “level the playing field” vulnerable to CRA protests, a phenomenon among institutions subject to CRA and those not described as “megamerger CRA megapledges.” subject to CRA. These commitments range from a few hundred Increased lending levels resulting from CRA thousand dollars up to the largest CRA come from two sources: commitments from institu- megapledge of $12 billion by Bank of America, tions having CRA problems as a result of com- made when it sought to purchase Security plaints by community groups or regulators, and commitments made by banks during the course of application procedures that fall under CRA, espe- cially mergers. In perhaps the most ambitious com- Attorney General Janet Reno said that “no munity reinvestment plan yet, Fleet Financial loanloan isis exempt,exempt, nono bankbank isis immune.immune. FoFor Group of Rhode Island announced that it would thosethose whowho thumbthumb theirtheir nosenose atat us,us, I lend $8 billion over three years to low-income peo- promise vigorous enforcement.” ple throughout the country. Fleet had recently reached settlements in Massachusetts and Georgia after charges of unfair lending to low-income bor- rowers had been made. The high-profile announce- Pacific Corporation. There is even a rule of ment was made in the presence of Clinton staffers, thumb for calculating such CRA commitments community activists, and lawmakers, including of around one half of 1 percent of assets per Senator Edward Kennedy, (D-Mass.) not in the year. home of Fleet, but in Washington, D.C. Lending commitments have also been The Clinton Administration extracted by community groups in connection with merger applications, when banks are most The Clinton administration favors expanded

REGULATION, 1994 NUMBER 4 29 COMMUNITY RE-INVESTMENT ACT use of the CRA, believing that a governmental But the most interventionist members of the response to economic problems in inner cities is Clinton Administration in this area are HUD generally more effective than a market solution. Secretary Henry Cisneros and Assistant Eugene Ludwig, Comptroller of the Currency Secretary Roberta Achtenberg. Cisneros’ depart- and head of the OCC, has been a strong propo- ment has developed rules for lenders that nent of expanding the reach of CRA and its sib- encourage them to increase approval rates for ling statutes. He said in his confirmation hear- loans to minority applicants by 20 percent with- ing that his first priority as Comptroller would in one year; increase minority hiring by 5 per- be to eliminate “discrimination from our finan- cent; increase the purchase of goods and ser- cial system, root and branch.” Recently, he told vices from minority and female-owned busi- bankers that “If you seize this issue as an oppor- nesses; and adjust compensation structures to tunity, you will reap the benefits in the form of award staff who effectively serve lower-income new business and heightened respect from the applicants or those applicants unfamiliar with press, the Congress, and your communities. But the lending process. Achtenberg, a former civil if you reject it as a burden, you run the risk that rights lawyer, has pushed for a new arsenal of weapons to combat what HUD sees as discrimi- nation, including new regulations under the FHA. Among these weapons are: new rules for The clearest indicator that the CRA has government-sponsored enterprises, a program become a system of credit allocation is the to encourage fair-lending agreements between market share approach, which implements lenders and HUD, and a new unit of HUD dedi- a quota-based system intended to change cated exclusively to banking issues. lendinglending behaviorbehavior.. The December 1993 and September 1994 CRA Proposals fair lending concerns will spread like a cancer The Clinton administration’s first attempt at across the industry’s reputation.” His imprint revising CRA regulations came in December on a December 1993 proposed rule to make 1993, in the form of a proposed rule issued joint- CRA more performance-based was especially ly by the OCC, the Fed, FDIC, and the OTS. The noticeable in a speech given July 15, 1993, the new approach they proposed was decidedly day Clinton announced that he wanted the CRA more performance-based, judging an individual regulations revised. In the speech, Ludwig laid financial institution’s CRA compliance based on out almost verbatim the three tests that were to lending, investment and service tests. become the core of the agencies’ proposals. This A lending or “market share” test was pro- was a full five months before the first joint pro- posed to determine whether a retail institution posal was announced by the financial agencies. (which lends more to the general public for pur- Clinton administration appointees at agencies chases of homes, automobiles, and other con- responsible for enforcing the ECOA and the sumer products) makes sufficient loans in low- FHA have also indicated an intensified interest and moderate-income areas by evaluating its in the issue of lending discrimination. At the performance in comparison with other lenders Justice Department, Janet Reno appeared at a subject to CRA in its service area. An investment number of high-profile press conferences test judges an institution’s level of “qualified” announcing fair-lending settlements. At one investments that benefit low- and moderate- such press conference in January 1994, announc- income areas for institutions characterized as ing a settlement with the First National Bank of wholesale (which lend more to businesses). A Vicksburg and the Blackpipe State Bank, Reno service test requires a showing that the percent- said that “today’s actions demonstrate that we age of branches located in or readily accessible will tackle lending discrimination wherever and to low- and moderate-income areas is sufficient. in whatever form it appears. No loan is exempt, Small institutions would be eligible to choose a no bank is immune. For those who thumb their more streamlined assessment method by main- nose at us, I promise vigorous enforcement.” taining a reasonable loan-to-deposit ratio, with 60 percent suggested as a benchmark.

30REGULATION, 1994 NUMBER 4 COMMUNITY RE-INVESTMENT ACT

Finally, under this proposal, larger institu- tions would be required to collect and report Table 1 data on the geographic distribution of housing, consumer, small business, and farm loans along Application Denial Rates at Minority-Owned Banks with application, denial, origination, purchase, sale, and retirement information. Race of Applicant Rejection Rates In September 1994, the Clinton administra- asian 7 percent tion modified its earlier proposed rule, changing black 25 percent the lending test to reduce emphasis on the mar- hispanic 26 percent ket share analysis. Rather than using the market white 16 percent share test as the sole measurement of lending performance, other measures such as the level of Source: Glenn Canner to Griff Garwood, 1991 HMDA community development loans would be Data for Minority-Owned Commercial Banks, Memo-Board assessed. Community development loans of Governors of the Federal Reserve (March 9, 1993) . include those that address the need for afford- able housing or other community development needs even if such loans are not made within the institution’s community. The exact mix of the assessment factors would largely be left to the judgement of the individual examiner share institutions will try to bid away such lend- assessing the CRA performance of the institu- ing from the 35 percent market share institu- tion. The 60 percent loan-to-deposit ratio for tions. The market share test presumes the desir- small institutions was dropped and replaced ability of one-size-fits-all regulation, whereby a with a reasonableness test to be administered by formula-driven system dictates that every insti- examiners. Reporting on the geographic distrib- tution in the relevant market should lend rough- ution of housing, consumer, small business, and ly the same portion to the lower-income market small farm loans was altered in favor of report- as all other institutions in the relevant market. ing on the geographic distribution, race, ethnici- ty, and gender of small business and small farm borrowers. Chevy Chase was criticized by the Justice Critical Analysis of the Recent Department for not having enough CRA Developments branches in minority communities. This The clearest indicator that the CRA has become expands the ever-changing definition off a system of credit allocation is the market share lendinglending discriminationdiscrimination toto thethe pointpoint ofof didic-- approach, which implements a quota-based sys- tatingtating thethe communitiescommunities inin whichwhich institinstitu-- tem intended to change lending behavior. This tionstions mustmust locatelocate theirtheir facilitiesfacilities.. was, of course, the inevitable result of President Clinton’s desire to move from a process-based system to a performance-based system. Consider an example of how the system would function if the agencies’ proposals are adopted. Such a system would leave little room for those Assume that a community has five banks. who want to specialize in low-income lending The shares of total low-income loans that each or those who choose not to specialize in low- bank makes in the community are 35, 30, 20, 10 income lending. and 5 percent, respectively. The imposition of The September 1994 proposal backs down the market share test, at a minimum, would from the strictness of the earlier market share mean that the banks with only 5 percent and 10 proposal but tries to straddle both sides of the percent of the market would seek to bring their issue by reducing reliance on formula-driven share up to 20 percent, the average of the five assessments while still allowing their use at an banks. A premium would likely be placed on examiner’s discretion. Such discretion will likely low-income lending and the 5 percent market lead to uneven application across the regulatory

REGULATION, 1994 NUMBER 4 31 COMMUNITY RE-INVESTMENT ACT system. Under either approach, the regulatory able, the entire underlying justification for tak- agencies will dictate the desired mix of lending ing such an interventionist stance is flawed. for an institution to follow. Analysis of the raw data compiled under The investment test is another method by HMDA, which reveals that rejection rates for which allocation choices are dictated to institu- blacks and hispanics are higher than those for tions. Such a method of channeling the makeup whites and asians, on its own does not prove of the asset portfolio is a clear instance of micro- that racial discrimination is occurring. The loan managing the investment process by setting denial rate for blacks and hispanics is also sig- forth a blanket statement that certain “qualified nificantly higher than for whites and asians at investments” are more desirable than others. As minority-owned banks (see Table 1). Merely Professors Macey and Miller have noted, most analyzing acceptance rates, unadjusted for such investments are of a “politically correct” income, net worth, and credit history, ignores nature. the reality of the credit evaluation process. The Boston Fed Study took such factors into account and still found that black and hispanic mortgage applicants in the Boston metropolitan Bruce Marks, executive director of Union area are roughly 60 percent more likely to be Neighborhood Assistance Corporation turned down than whites. Yet despite the authors’ warning that the study had a limited and self-styled “urban terrorist,” threatt-- focus, many community groups, banking con- ened that, if banks aren’t willing to meett sultants, regulators and, of course, the media thethe newnew standardsstandards ofof communitycommunity invesinvestt-- have hailed it as conclusive proof of racial dis- ment, then, “we’ll have to start making itt crimination. The comments of bank consultant inin theirtheir interestinterest [to[to dodo so].so].” Kenneth H. Thomas, for example, are typical, “[This] landmark study documented that racial discrimination in mortgage lending is a wide- spread phenomenon.” But the Boston Fed study is open to question, since there has been no con- The service test, which judges community firmation of the findings by other studies. reinvestment performance based upon the loca- Critics of the study have found a number of tion of branches and delivery of services to mar- serious problems with its methodology and ket segments, is yet another form of government quality (see Regulation1994, No. 2). For example, credit allocation. Such a step is well beyond the David Horne, an economist with the FDIC, CRA’s initial requirement of reinvestment in the sought to resolve the seeming paradox between community from which deposits are drawn, as the fact that 90 percent of the institutions in the the proposals actually dictate the choice of com- Boston Fed study received satisfactory or better munity served. CRA ratings and the study’s purported proof of Finally, even though President Clinton is lending discrimination. The FDIC analysis cov- supposedly committed to reducing paperwork, ered the seventy institutions under its supervi- the proposals impose an entirely new reporting sion that were among the 131 institutions in the requirement. Boston Fed study, and checked the loan files of The American Banker, a trade publication, these banks for accuracy and to determine made clear its assessment in a headline after the whether the data were interpreted consistently September 1994 proposal was released: “CRA and appropriately. Overall, 57 percent of all Proposal Would Mean More Jobs for applicant files contained data errors, including Examiners.” Obviously, it takes a lot of bodies to critical information that could not be verified, implement a government credit allocation sys- debt that was underreported, inaccurate income tem. figures, and assets that could not be verified. The FDIC analysis concluded that it is not possi- A Rebuttal: Another Look at the ble to establish whether the racial discrepancies Boston Fed Study identified in the Boston Fed Study reflect racial bias or methodological problems with the Not only is the proposed regulation unwork- study’s statistical approach. Unfortunately, the

32REGULATION, 1994 NUMBER 4 COMMUNITY RE-INVESTMENT ACT

FDIC study has not received very much atten- Table 2 Megapledges (Billions), # Years, and Final Year tion. The Federal Reserve Bank of Boston has made Amount of Over X Final no formal response to the Institution Commit. years Year FDIC study. Bank of America $ 12.0 12 2003 NationsBank 10.0 10 2001 Shawmut and Chevy Security Pacific 2.4 10 2000 Chase Cases First Interstate 2.0 10 2000 Total $ 26.4 NA NA If the Boston Fed Study’s Source: Center for Community Change, Thomas. underlying premise is ques- Note: These four represent most of the $30 billion of such commitments. These commit- tionable, so are the criti- ments were made in 1990-1991. The Fishbein article was written in 1993 but no adjustments cisms of a lack of communi- were made for actual lending. ty reinvestment put forth against Shawmut National when it sought permission to merge with New Dartmouth Bank. The Shawmut referral to the and disparate treatment. Each of these rests on Justice Department was prompted by findings questionable ground. The disparate impact doc- in the Boston Fed Study. The only statistics con- trine reaches beyond intentional discrimination, tained in the Justice Department’s complaint as actions widely recognized as common, racial- were raw HMDA data that show that blacks and ly-neutral financial decisions are labeled as dis- hispanics are roughly twice as likely to be criminatory. denied for applications as whites. What the In the employment context, where the dis- complaint failed to mention was that these rates parate impact doctrine originated, an employer are comparable to nationwide statistics for accused of implementing policies that have a financial institutions and that they do not take disparate impact can argue that there is an into account income or other financial attributes underlying business necessity for having a par- of borrowers. The Shawmut case clearly would ticular selection policy in place. Similarly, a have been an excellent opportunity for the financial institution may, for example, establish Justice Department to clarify its more interven- tionist stance under Janet Reno. But instead, Justice extracted a $1 million settlement from Shawmut. As bank robber Willie Sutton would say,, The case of Chevy Chase Federal Savings big banks are targeted because that’s took the Shawmut precedent one step further. where the money is.. Chevy Chase was criticized by the Justice Department for not having enough branches in minority communities. This expands the ever- changing definition of lending discrimination to a minimum loan amount, arguing that profits the point of dictating the communities in which from smaller loans would not cover the cost of institutions must locate their facilities. paperwork, staff time, and credit risk involved; Furthermore, Bernard Siskin, a statistics consul- or it may charge higher interest rates to less tant the Justice Department enlisted during its creditworthy borrowers because of the higher pursuit of Shawmut, prepared a study of Chevy risk of losses. Yet these legitimate business prac- Chase that did not reveal lending bias. tices come under attack under the disparate impact doctrine if it is found that these practices Questionable Lending exclude low income borrowers. Such policies Discrimination Doctrines may be unwise from a business standpoint if there is a profit opportunity available and finan- The two forms of discrimination on which most cial institutions are foregoing it. It is, however, charges of lending bias rest are disparate impact quite a stretch to label as discriminatory policies

REGULATION, 1994 NUMBER 4 33 COMMUNITY RE-INVESTMENT ACT

vidualized nature of the lending process by making broad assumptions about potential bor- Table 3 rowers, based upon their racial or ethnic status, Percentage of Resolutions Resulting in Payoff-1989-1993 before they even apply for loans. The evidence in support of the existence of Type of Institution Banks Thrifts disparate treatment is largely anecdotal, as is Minority-Owned 27 percent 19 percent illustrated by the thick loan file phenomenon. Non Minority-Owned 5 percent 13 percent But even if this practice were commonplace it Source: FDIC Annual Reports, RTC Review, GAO Study on does not follow that the best solution is to estab- Minority-Owned Financial Institutions. lish quotas that force bankers to lend because they somehow cannot “identify” with certain borrowers. A market solution would be to make it easier to have niche institutions available that specialize in minority or low-income lending, as which on their face are clearly racially neutral black members of the House Banking and supported by business necessity. Committee such as Floyd H. Flake of New York, In fact, the existence of the CRA in conjunc- Bobby L. Rush of Illinois and Albert R. Wynn of tion with the fair lending laws effectively pre- Maryland, all Democrats, have urged. cludes an institution from successfully asserting a business necessity defense. For example, Community-Based Organizations and Chevy Chase had the choice either to endure Their Tactics years of expensive litigation with near-certain The loan commitments that community groups set forth as proof of the positive economic impact resulting from active CRA enforcement The CRA tells a financial institution that iff are labeled by them as “regulation from below” itit movesmoves intointo suchsuch anan area,area, financialfinancial regregu-- or “negotiated settlements.” A more accurate latorylatory agenciesagencies andand communitycommunity groupsgroups wilwilll characterization would be codified extortion. In dictate how its “community” will be fact, comments by those who utilize such agree- defined, how its performance will be ments to extract negotiated settlements often resemble utterances of organized crime figures. judged,judged, andand mostmost importantly,importantly, howhow itit wilwilll Typical is a statement by Bruce Marks, executive make its lending decisions.. director of Union Neighborhood Assistance Corporation and self-styled “urban terrorist,” who threatened that, if banks aren’t willing to meet the new standards of community invest- denials for any applications that fall under CRA; ment, then, “we’ll have to start making it in or settle with the government quickly and with their interest [to do so].” less expense. The prospect of no branch or The CRA sets up the conditions for a classic merger approvals for a number of years in the case of handing out other people’s money. current environment of industry consolidation, Bankers distribute loan dollars for a living, tak- when mergers and consolidation often are ing on risks that can get them fired, cost them essential to a bank’s survival, is not very entic- their investments as stockholders, or subject ing. The choice was simple: Chevy Chase chose them to lawsuits from the FDIC. No similar dis- settlement. cipline constrains the community groups or reg- Finally, implicit in the disparate impact ulatory agencies. Coercion enters the picture analysis is an assumption that minority status is because these community groups know that equated with low income status. Such logic fol- time is of the essence in merger transactions, lows from the reasoning that if an action has an and that any source of delay means more time adverse effect upon low income individuals and, thus, money, is consumed. As a representa- then it is discriminatory, because minorities tive of the Association of Community make up a disproportionate share of low income Organizations for Reform Now (ACORN) put it, borrowers. Such an assumption ignores the indi- “When you’re talking a billion-dollar merger,

34REGULATION, 1994 NUMBER 4 COMMUNITY RE-INVESTMENT ACT every day of delay costs lots of money. It’s highlighted in Alan Fishbein’s law review arti- cheaper to negotiate than to fight.” cle, which urged tougher enforcement of the The community groups that negotiate these law. The article clearly notes that these are commitments are simply well-organized politi- merely “commitments by lenders.” But support- cal interest groups that have a clear stake in the ers of a strong CRA have distorted these com- outcome of their negotiations. For example, one mitments to represent actual lending resulting of the recent high profile announcements of from CRA. Although community groups may such commitments involved Fleet Financial be knowledgeable about the various agreements Group. Bruce Marks showed up at the that have occurred, accepting their evaluation of announcement to praise the commitment, which the actual amount lent as a result of CRA is included a $140 million initiative to be adminis- analogous to letting a schoolboy fill out his own tered by Marks’ own organization. The group report card. In fact, the $30 billion figure was was to be paid a sum to administer the program derived by totalling up commitments made in but the exact sum was not disclosed. Marks several dozen agreements between community denied that his enthusiasm for the initiative had groups and lenders between 1978 and 1993. anything to do with the resources his organiza- There are some serious methodological prob- tion stood to gain. lems with merely totalling up the individual Regulators and politicians also profit from lending agreements in this manner, as it appears these tactics. With high-profile press confer- that the individual estimates are highly overstat- ences to announce big-dollar commitments and settlements, they can look tough and grand- stand without having to spend much money. However, such tactics amount to a tax on The CRA should be repealed. Altering lenders, and even those innocent of discrimina- thethe underlyingunderlying regulationregulation merelymerely leaveleaves tion will be willing to pay such a “regulatory thethe wayway openopen forfor futurefuture administrationsadministrations tto tax” in order to avoid the costs of investigations utilize the statute as a government creditt and adverse publicity. allocation scheme.. As bank robber Willie Sutton would say, big banks are targeted because that’s where the money is. Unfortunately, the implicit assumption in this approach is that larger institutions such as Fleet, ed. Even Kenneth H. Thomas, a bank consultant Bank of America, Shawmut, and Chevy Chase who is sympathetic to a strengthened CRA, dis- Federal Savings, the primary targets of CRA action, cusses what he calls CRA “megapledge infla- are the best institutions to make these loans to tion.” Thomas questions whether these banks lower-income or minority groups. This increase in are meeting the pledges with actual CRA loans. lower-income lending by larger institutions is In his book Community Reinvestment potentially at the expense of smaller, niche institu- Performance—Making CRA Work, he cites one tions that would not be involved in a merger or are case in which a bank counted every retail, busi- not large enough for such groups to get involved ness, or other loan normally made in a low- and with. These agreements result in clear instances of moderate-income area as a CRA loan, even government credit allocation brought about by the though many of those loans would have been existence of CRA. As Glenn Canner, a member of made without CRA. the staff of the Fed, recognized over a decade ago, Another problem with the $30 billion figure is “Negotiated CRA settlements in the future are like- that much of it represents future commitments, ly to continue to involve some elements of geo- that is, lending that has not yet taken place (See graphic credit allocation.” Table 2). Further, as in the case of the bank cited above, even if these loans are made, they might not Is It Really $30 Billion of New Lending? be the result of CRA. The General Accounting Office (GAO) has brought attention to the difficulty Regulators and community activists claim that in estimating the results of CRA, noting in an CRA has resulted in $30 billion in new lending. analysis that it is impossible to establish the extent This figure comes from a community group to which changes in lending patterns are the result called Center for Community Change and was of CRA, as opposed to other factors.

REGULATION, 1994 NUMBER 4 35 COMMUNITY RE-INVESTMENT ACT

In addition, loans supposedly made as a the problem of a lack of community reinvest- result of CRA might otherwise have been made ment. One would assume that such institutions by other institutions, ones that specialize in low- would do well under the CRA, as they are to moderate-income lending. Thus, there is no essentially engaging in “reverse redlining.” definitive showing that low-income or minority However, the reality is that a number of minori- lending in the aggregate has been increased. ty-owned institutions, including the largest Finally, the formulaic approach whereby institu- black owned bank, Seaway National Bank of tions are encouraged to make megapledges of Chicago, the largest black owned thrift, Carver one half of 1 percent of assets per year is yet Federal Savings of Harlem, and a disproportion- another example of the one-size-fits-all regulato- ate number of asian-owned institutions, have ry system whereby institutions are encouraged been criticized by regulators over the past few to look and act alike with no diversity or spe- years. Such institutions have come under criti- cialization. cism primarily because they have not been Many of the negative effects of CRA, while aggressive enough in lending to low-income not fully documented, can nonetheless be identi- borrowers within their communities. These fied as a burden to the economy. For example, institutions have also been criticized by regula- CRA undoubtedly causes many financial insti- tors for focusing on too narrow a segment of the tutions to avoid opening facilities in lower- “community.” income or minority areas because of the proba- ble CRA burdens awaiting them. The CRA tells Remove Governmental Barriers to a financial institution that if it moves into such Low-Income and Minority Lending an area, financial regulatory agencies and com- munity groups will dictate how its “communi- Many governmental barriers exist that prevent ty” will be defined, how its performance will be lending in low-income and minority areas by judged, and, most importantly, how it will make discouraging the chartering of small financial its lending decisions. institutions. These regulations are especially The recent, highly-publicized example of harmful to lower-income areas, because they Freedom National Bank of Harlem, which was place a greater weight on smaller institutions, resolved by paying off depositors, has been cited as the very type of institution most likely to open support for such a view. If an institution is resolved in such neighborhoods. Eliminating very small by paying off depositors, it is a good indicator of institutions leads to a large gap in size between the undesirability of locating in that area, as no non-regulated institutions (currency exchanges, acquirers are even willing to take on the deposits, pawn shops, and second mortgage operations) much less the assets, of the failed institution. In and the smallest of institutions existing in the fact, over the past five years, the timeframe of current environment. These barriers have been enhanced enforcement of CRA, two other minori- increased over the past five years, as the regula- ty-owned banks and five minority-owned thrifts tory pendulum has swung back with a have had their depositors paid off in a manner sim- vengeance. Among these barriers are: barriers to ilar to Freedom National Bank. This compares entry erected by the compliance costs imposed unfavorably with all bank and thrift closings dur- by laws such as CRA and fair-lending statutes; ing a comparable time period (See Table 3). These the administrative burden of organizing a bank disparities occurred despite the implementation of or a thrift; dollar-denominated capital require- aggressive legislative initiatives to maintain owner- ments that go well beyond the level dictated by ship of financial institutions in minority areas, safety and soundness concerns; and the recent especially in the case of RTC thrift resolutions. aggressiveness and expanded powers utilized in These initiatives likely account for the smaller gap pursuing suits against directors. for such thrift resolutions. Repeal CRA A Market Response to Lack of Investment The CRA should be repealed. Altering the The strangest result of the CRA is its treatment underlying regulations merely leaves the way of minority-owned institutions that target low- open for future administrations to utilize the income or minority groups, a market solution to statute as a government credit allocation

36REGULATION, 1994 NUMBER 4 COMMUNITY RE-INVESTMENT ACT scheme. CRA has discouraged entrepreneurs been recognized for what they are: arbitrary who seek to open financial institutions in lower, geographical limitations on the flow of financial middle income or minority communities; has resources from where they are available to led to criticism of minority institutions for tar- where they are needed. geting an underserved segment of their commu- Meeting the convenience and needs of the com- nity (the very segment the creators of CRA had munity is more appropriately left to market mech- targeted); it has created incentives to bid away anisms. Financial institutions should strive to satis- market share from institutions that specialize in fy convenience and needs as defined by their cus- low-income lending; and it has prevented insti- tomers and the marketplace around them, not tutions from asserting the business necessity community organizations or regulators. defense when accused of implementing policies having a disparate impact upon borrowers. Repealing CRA would level the playing field Selected Readingss between those subject to and those not subject to its provisions by assuring that no institutions Fishbein, Allen J., “The Community Reinvestment are required to follow a scheme of reinvestment Act After Fifteen Years: It Works, But rules. Strengthened Federal Enforcement Is Needed,” CRA was established under the faulty eco- Fordham Urban Law Journal(Volume 20-1993).. nomic premise that the equivalent of a wall Macey, Jonathan R. and Miller, Geoffrey P., “The should be built up around the ill-defined notion Community Reinvestment Act: An Economic of a “community,” preventing an outward flow Analysis,”Virginia Law Review(Volume 79, of deposit dollars, and forcing inefficient and March 1993). contrived reinvestment. The statute ultimately Thomas, Kenneth H.,Community Reinvestment leads to an economic balkanization that is truly Performance-Making CRA Work for Banks, an anachronism in our complex, interrelated, Communities and Regulators,1993-Probus global economy. Similar geographical barriers, Publishing.. such as state and interstate branching laws, have tumbled over the past decade because they have

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