Practical Distributism - Looking at the CRA

by Joe Hargrave - September 4, 2009

Reprinted with permission.

Those of us who have argued for alternatives to individualistic capitalism and the bureaucratic welfare state are often told that we are good at pointing out problems but come up short on solutions – it's a charge distributists hear often. Nevertheless, Pope Benedict XVI's latest encyclical, Caritas in Veritate, challenges us to overcome the "market-plus-State" model, arguing that "when both the logic of the market and the logic of the State come to an agreement that each will continue to exercise a monopoly over its respective area of influence, in the long term much is lost… "

But there is a policy in place that takes up the pope's challenge – one with a distributist angle that not only helped lessen the severity of the sub-prime mortgage meltdown, but could also serve as a model for the development of businesses that – following the suggestions of Rerum Novarum, Quadragesimo Anno, Mater et Magistra, Laborem Exercens, and Caritas in Veritate – include more workers in the ownership and management of business. I am talking about the unfairly maligned Community Reinvestment Act (CRA).

The CRA was passed by Congress in 1977 to encourage banks to lend to low-income and minority neighborhoods and to prevent "redlining," or discrimination against those groups. Contrary to common assumptions made about the act, all banks following CRA guidelines were federally mandated to practice safe and sound lending practices that were also profitable.

Hence, the truth about the CRA and the rhetoric surrounding it are two very different things. On the basis of ideological predispositions alone, a number of commentators immediately sought to blame the CRA to varying degrees for the sub-prime crisis as it unfolded last fall. The CRA regulations, it was claimed, encouraged lenders to make unsafe, risky loans to low-income clients in order to meet government quotas. While it is possible that CRA incentives might have been abused during recent years, the truth is that the CRA, since its inception in 1977, has insisted on safe, sound, and profitable lending practices.

Evidence has shown that, instead of deepening the sub-prime crisis, the CRA actually helped to lessen its impact in areas where banks regulated by CRA guidelines were more heavily concentrated. Randall S. Kroszner, then governor of the Federal Reserve Board of San Francisco, presented the findings of the board's analysis in December of last year:

Only 6 percent of all the higher-priced loans were extended by CRA-covered lenders to lower-income borrowers or neighborhoods in their CRA assessment areas, the local geographies that are the primary focus for CRA evaluation purposes. This result undermines the assertion by critics of the potential for a substantial role for the CRA in the sub-prime crisis.

As for the role the CRA played in lessening the impact of the crisis, a study conducted by the law firm of Traiger & Hinckley concluded the following:

The sub-prime crisis, and related spike in foreclosures might have negatively impacted even more borrowers and neighborhoods. Compared to other lends in their assessment areas, CRA banks were less likely to make a high cost loan, [and] charged less for the high cost loans that were made… [M]oreover, branch availability is a key element of CRA compliance, and foreclosure rates were lower in metropolitan areas with proportionately greater numbers of bank branches.

What the analysis finds is that local bank branches dedicated to serving their communities were far less likely to play fast and loose with their customers' money than independent lenders and mortgage brokers, who were the primary culprits in repackaging and selling bad loans to bigger lenders. Toxic debt was not created, in other words, by the CRA. Rather, Federal Reserve Chairman Ben Bernanke testified to Congress that it was virtual anarchy in lending practices that bears much of the blame:

When an originator sells a mortgage and its servicing rights, depending on the terms of the sale, much or all of the risks are passed on to the loan purchaser. Thus, originators who sell loans may have less incentive to undertake careful underwriting than if they kept the loans. Moreover, for some originators, fees tied to loan volume made loan sales a higher priority than loan quality. This misalignment of incentives, together with strong investor demand for securities with high yields, contributed to the weakening of underwriting standards.

We can learn a valuable lesson from this episode: Institutions that derive their profit from the service of the community as opposed to raw self-interest are less likely to engage in the sort of behavior that will lead headlong into catastrophe.

Meanwhile, the CRA itself could be merged with the Employee Ownership Act (EOA) into a policy that would foster the development of business models that fulfill the requirements of Catholic social teaching and meet the needs of struggling American workers and families. Each focuses on one necessary ingredient but is missing the other: The CRA creates incentives to lend to low-income borrowers and enable them to acquire property for themselves; the EOA creates tax incentives to establish firms that are owned in varying degrees by workers.

A guidepost for a federal policy that would integrate these two approaches might be sought out in the lending priorities established by the U.S. Federation of Workers Cooperatives. Priority could be given to those applicants who seek to establish employee-owned firms in economically depressed regions such as Michigan, or who would seek to boost employment in urban or rural areas where unemployment has been particularly steep. Like the local credit unions and CRA-regulated lenders that served their communities while making a profit, such firms would be provided with incentives to meet certain community goals. Firms that make a notable contribution to the economic and social health of their communities will in turn have easier access to credit and government resources for further expansion, while preserving the basic model of ownership and control.

Pope Benedict reminded us in Caritas in Veritate that the principles of subsidiarity and solidarity need one another – and that they have the potential for harm when one is exaggerated at the expense of the other. Subsidiarity means that social functions ought to be performed at the lowest possible level, but it also presupposes that those functions can be performed at that level. Throughout this country (and certainly throughout the world), there are many areas as yet incapable of ideal levels of self-sufficiency. It is in such areas that the state has a positive role to play – not through bureaucratic management but rather through the establishment of guidelines and incentives for capital to find its way into businesses that explicitly aim to serve their communities.

Joe Hargrave lives in Orange County, CA, and blogs for The American Catholic and his personal blog, Non Nobis.