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Credit Where It Counts: the Community Reinvestment Act and Its Critics

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Credit Where It Counts: the Community Reinvestment Act and Its Critics CREDIT WHERE IT COUNTS: THE COMMUNITY REINVESTMENT ACT AND ITS CRITICS MICHAEL S. BARR* Despite the depth and breadth of U.S. credit markets, low- and moderate-income communities and minority borrowers have not historically enjoyed full access to credit. The Community Reinvestment Act (CRA) was enacted in 1977 to help over- come barriers to credit that these groups faced. Scholars have long leveled numerous critiques against CRA as unnecessary, ineffectual, costly, and lawless. Many have argued that CRA should be eliminated. By contrast, I contend that market failures and discriminationjustify governmental intervention and that CRA is a reasonablepolicy response to these problems. Using recent empirical evidence, I demonstrate that over the last decade CRA has enhanced access to credit for low- income, moderate-income, and minority borrowers at relatively low cost, consistent with the theory that CRA is helping to overcome market failures. I argue that the form of CRA's legal directive, more akin to a standard,is preferable to more rules- based approaches,on grounds of both efficiency and legitimacy. Comparing CRA to other credit market regulations and subsidies, I argue that CRA is a reasonably effective response to market failures and should not be abandoned. In sum, con- trary to previous legal scholarship, I contend that CRA is justified, has resulted in progress, and should be retained. INTRODUCTION ................................................. 515 I. THE COMMUNITY REINVESTMENT ACT: HISTORY AND PURPOSE ................................................ 523 II. CRITIQUES OF CRA .................................... 526 * Copyright © 2005 by Michael S. Barr. Assistant Professor of Law, University of Michigan Law School. B.A., Yale University, 1987; M.Phil, Magdalen College, Oxford, 1989; J.D., Yale Law School, 1992. I would like to thank Peter DiCola for research and editorial assistance, and Brian Greene and Kevin Smith for research assistance in Part VII. This Article was made possible through a generous grant from the Ford Foundation, for which I thank Frank DiGiovanni, and from the Cook Endowment of the University of Michigan Law School. I have benefited from assistance from the Brookings Institution, where I am a nonresident senior fellow. I would like to thank the participants at Harvard University's Joint Center for Housing Studies conference, "Building Assets, Building Credit," particularly Malcolm Bush, Edward Gramlich, Jeff Jaffee, Duncan Kennedy, and Richard Riese. For comments on earlier drafts, I thank Reuven Avi-Yonah, Omri Ben-Shahar, Steve Croley, Phoebe Ellsworth, Richard Friedman, Daniel Halberstam, Howell Jackson, Ellen Katz, Kyle Logue, Nina Mendelson, Geoffrey Miller, Sallyanne Payton, Daria Roithmayr, Dan Sokolov, Peter Swire, Mark West, Jim B. White, J.J. White, and participants in the University of Michigan's Legal Theory Workshop and Governance Workshop. Thanks also go, as ever, to Jim Krier. This Article builds on research on CRA that I directed while serving at the Treasury Department. For their contributions to that project, I thank Eric Belsky, Maureen Kennedy, Paul Leonard, Robert E. Litan, and Nicolas P. Retsinas. 513 Imaged with Permission from N.Y.U. Law Review NEW YORK UNIVERSITY LAW REVIEW [Vol. 80:513 A. No Market Failures or DiscriminationJustifying C RA ................................................ 527 B. Little Benefit, High Costs ........................... 527 C. Rules versus Standards .............................. 530 D. Geographic and InstitutionalScope Distorts Markets ............................................. 531 E. Other A lternatives ................................... 532 Il. THEORETICAL FOUNDATIONS OF CRA ................. 533 A . Market Failure ...................................... 534 B. Racial Discrimination ............................... 544 C. Problems in the Subprime Sector .................... 555 D . Sum m ary ........................................... 560 IV. EMPIRICAL EVIDENCE THAT CRA is EFFECTIVE........ 560 A. The Benefits of CRA Are Substantial ............... 561 B. The Costs of CRA Have Been Overstated ........... 580 1. Profitability and Risk ........................... 580 2. Mergers and Acquisitions ....................... 586 3. Rent-Seeking .................................... 588 4. Compliance Costs ............................... 591 V. CRA's STANDARDS APPROACH COMPARED TO A RULES APPROACH ........................................ 596 A. CRA's Standard Compared to a Rule ............... 596 B. CRA's Standard Reasonably Addresses Market Failures and Does So Better than Tradeable O bligations ......................................... 604 C. The Standards Approach Compares Favorably with Safe H arbors........................................ 608 VI. THE SCOPE OF CRA .................................... 612 A . G eography .......................................... 612 1. CRA is Not Anachronistically "Localist" in Its Operation....................................... 612 2. CRA Does Not Cause Banks to Avoid Low- Income Communities ............................ 614 B. Applying CRA to Insured Depositories Is Justified.. 616 1. Subsidies to Banks and Thrifts .................. 617 2. Role in FinancialMarkets ....................... 620 3. Credit Unions ................................... 621 4. Affiliates ........................................ 622 VII. CRA COMPARED WITH OTHER CREDIT MARKET REGULATIONS ............................................. 624 A. CRA Compared with Fair Lending Law ............ 625 B. CRA Compared with Disclosure Law ............... 628 1. Types of Disclosure Laws ....................... 628 Imaged with Permission from N.Y.U. Law Review May 2005] CREDIT WHERE IT COUNTS 2. Problems with Disclosure Laws ................. 630 3. Disclosure Reforms Compared with CRA ....... 633 C. CRA Compared with Abusive Practice Prohibitions......................................... 634 D. CRA Compared with Subsidies ..................... 637 1. Supply-Side Subsidies Through the Government Sponsored Enterprises and the Federal Housing Adm inistration .................................. 638 2. CRA Compared with Targeted Supply-Side Subsidies ........................................ 643 3. CRA Compared with Income Transfers or Demand-Side Subsidies ......................... 645 CONCLUSION ................................................... 648 INTRODUCTION Financial markets in the United States are broad and deep.' Our capital markets are regarded as highly efficient in spurring business growth, and for most Americans, access to credit has become readily available for consumer purchases and home ownership. Our home mortgage markets are innovative and liquid, attracting investors from around the globe. Competition in the financial services sector is gen- erally vibrant, and the removal of many geographic and product restrictions on banking has given rise to diversified financial services organizations with nationwide reach. Yet the very success of our credit markets makes it easy to over- look those who may have been left behind historically-low- and 2 moderate-income communities, as well as minority households. Enormous progress has been made in expanding access to home mort- 3 gage lending for low- and moderate-income and minority households, but there is evidence that minority borrowers continue to face dis- I See generally ROBERT E. LITAN & JONATHAN RAUCH, U.S. DEP'T. OF TREASURY, AMERICAN FINANCE FOR THE 21ST CENTURY (1997). 2 This Article systematically explores themes I first worked on at the Treasury Department, and then wrote about in Michael S. Barr, Access to FinancialServices in the 21st Century: Five Opportunities for the Bush Administration and the 107th Congress, 16 NOTRE DAME J.L. ETHICS & PUB. POL'Y 447 (2002) and Michael S. Barr et al., The Com- munity Reinvestment Act, in BANKING AND SOCIAL COHESION: ALTERNATIVE RESPONSES TO A GLOBAL MARKET 214 (Christophe Guene & Edward Mayo eds., 2001). 3 In evaluating the Community Reinvestment Act (CRA), this Article largely relies on evidence regarding home mortgage lending because it is an important aspect of financial security for low- and moderate-income borrowers, has attracted the greatest attention in the literature, and has different market and regulatory features than other forms of credit. I take up issues of short-term consumer debt and transactional financial services in Michael S. Barr, Banking the Poor, 21 YALE J. ON REG. 121 (2004). Imaged with Permission from N.Y.U. Law Review NEW YORK UNIVERSITY LAW REVIEW [Vol. 80:513 crimination. 4 In addition, community advocates have long argued that "redlining"-not lending to borrowers in neighborhoods with high concentrations of minority households-has, at least historically, lim- ited the flow of capital for homeownership in minority communities. 5 Moreover, the effects of race and economics are intertwined because of the high degree of racial segregation in housing and the concentra- tion of minority households in low-income communities. Economic theories predict that low-income communities generally would have lower access to capital than they would in a fully functioning market because of market failures, in addition to discrimination. For example, information externalities, which prevent lenders from fully recapturing the costs of gathering information and developing exper- tise in lending to low-income borrowers, may have impeded the for- mation or full development of credit markets in low-income communities, which generally
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