October 20, 2000
WASHINGTON If the government didn't require lenders to serve low-income communities, would the poor be cut off from home mortgages? No, says Jeffrey Gunther of the Federal Reserve Bank of Dallas in a study published in the Cato Institute journal Regulation.
Under the 1977 Community Reinvestment Act (CRA), banks and other lenders are "encouraged" by federal banking regulators to make loans in the communities where they are chartered. Advocates of the CRA say the legislation is needed to protect low-income Americans from unfair denials of credit and point to the recent growth of mortgage lending in poor communities proves the law is working.
Gunther says the advocates are wrong on both counts. "Economic theory and empirical evidence both indicate the reason for the recent growth in lending to low-income neighborhoods is not the CRA but the effectiveness of market forces in breaking down the types of financial barriers prevalent when the CRA was enacted," he says. "In reality, deregulation and new technologies have promoted competition and precipitated a great broadening of the credit market. As a result, the CRA is not necessary to ensure all segments of our economy enjoy access to credit."
To assess whether the CRA is responsible for increased mortgage lending in low-income communities, Gunther compared the lending records of institutions that are covered by the CRA and those that aren't. His conclusion: "Lending in low-income neighborhoods grew faster than other types of lending at institutions not covered by the CRA, whereas for the CRA-covered lenders, low-income lending merely grew at the same rate as other types of lending activity." Non-covered lenders account for 40 percent of all mortgages in low-income neighborhoods, he notes.
Gunther says regulatory barriers 25 years ago made access to credit in low-income communities problematic. But the removal of those barriers, combined with technological advances and the boom in subprime lending, has opened the low-income market to more competition. "Forgoing profitable lending opportunities in today's financial marketplace would mean, in most cases, giving a boost to competitors," he says. "If a lender were to cut off access to credit for a low-income neighborhood, the profit motive would lead another one to move in and fill the void."