How About That: Government-Mandated Declines in Lending Standards Led to Lower Lending Standards

Over at the Circle Bastiat, Peter Klein writes:

There has been a persistent dispute among mainstream economists about the role of government housing policy, particularly the Community Reinvestment Act which was used, in the 1990s, to make banks increase their lending to particular low-income neighborhoods. Paul Krugman asserts, for example, that the “Community Reinvestment Act of 1977 was irrelevant to the subprime boom.” Actually, no. A new NBER paper(gated) on the CRA is causing quite a stir. Authored by four economists from NYU, MIT, Northwestern, and Chicago, the paper is the first to use instrumental-variables regression to distinguish changes in bank lending caused by the CRA from changes that would likely have happened anyway. (The authors use the timing of loan decisions relative to the dates of CRA audits to identify the effect of the CRA on lending.) The results suggest that CRA enforcement did, contra Krugman, lead banks to make substantially riskier loans than otherwise.

Read all of Peter’s post “ABCT and the Community Reinvestment Act.” These questions are also covered in my 2009 book Meltdown; read a free chapter.

http://TheInterventionistParadox.wordpress.com/ Bharat

Yeah I never really understood this. People often bring up the fact that banks were making stupid loans and then proceed to blame the banks. For some reason they don’t make the connection to the fact that governments were MANDATING these risky loans.

Sigh. Makes me want to facepalm.
http://twitter.com/daleholmgren Dale Holmgren

I agree, but only up to a point. The CRA, contrary to Bharat’s contention, was not mandating the risky loans, it was only putting a very strong emphasis on it by evaluating it, leading banks to “read the tea leaves”. Slight difference, but still. But no one is mandating the risky bets put on the stock market today; this is all being done by pension funds and other outfits that have to find yield somewhere and are willing to crawl further out on the branch to get it. Wall Street will always have players crawl too far; the key is not to have the net underneath when the branch breaks, so the next guy learns from watching what the consequences are.
solly gratia

Thomas Sowell covered this in ‘Housing Boom and Bust’; not only the Acts themselves, but the heavy handed tactics in bringing banks to ‘accept’ the new policies, or suffer ‘the consequences’. This ‘leaning on’ came from the Democrat and Republican presidents, notably the Bush’s.
Rob Nabakowski

I really do love empiricism. I know that might sound odd coming from an advocate of Austrian economics, but to prove a fact, empiricism is needed.
Rob Nabakowski

Banks are guilty, if by nothing else, association. They have made their beds by cronying (new word, I think!) up to the state, so they do definitely share culpability. But, I do understand your point