Congress passed the Community Reinvestment Act (CRA) in 1977.  The law has many features, but its primary purpose is to prohibit the practice of ‘redlining.’ Prior to passage of the CRA, financial institutions routinely refused to lend funds for real estate purchases and improvements in certain neighborhoods. In effect, bank officials drew a red line on a city map across which funds could not cross. In some cases, loan officers used maps with certain neighborhoods marked as unbankable. The two-fold effect of redlining was to 1) exacerbate the flight of businesses and middle-class families out of inner city neighborhoods; and 2) to deny creditworthy borrowers financing for acquisition or improvement of residential and commercial properties in those areas.

The CRA requires banks to lend in neighborhoods where they accept deposits (somewhat counter-intuitively low-income households are profitable banking customers), many people blame the CRA for contributing to the proliferation of subprime loans first in the 1990’s and again in the mid 2000’s. As we all know by now, a subprime mortgage is a loan that offsets the higher risk of lending to un-creditworthy individuals with high interest rates, adjustable rates, fees, points, and other unusual repayment terms. Subprime borrowers pay more for the use of bank funds than prime borrowers and default at much higher rates.

Edward Pinto, former Chief Credit Officer at Fannie Mae, and resident fellow at the American Enterprise Institute (AEI) argues that the CRA contributed to the mortgage meltdown of 2007 and continues to generate toxic assets.  In 2009 he outlined his argument in the City Journal. Essentially, he posits that no one really knows how much the CRA contributed to the spike in mortgage defaults because regulators obscure the relevant data. Information provided by banks indicates that a substantial amount of lost capital comes from CRA related loans.

Randall Kroszner, Ph.D., former Federal Reserve Governor and professor at the University of Chicago, contends that the CRA did not contribute to the crisis. The Wall Street Journal cited Kroszner in a 2008 article after he testified before Congress about the relationship between the CRA and the mortgage meltdown. In support of his argument, he notes that most subprime loans were made outside of CRA neighborhoods, and that a substantial percentage of subprime loans within CRA neighborhoods were originated by non-bank lenders (not subject to the CRA). It is for this reason that – that much of the wreckage of the crisis in low-income neighborhoods flows from non-bank lenders – that another scholar, Dan Immergluck, recommends extending the CRA to cover all mortgage lenders in his book Foreclosed.