Community Reinvestment Act: The Risk of Unintended Consequences

Published October 15, 2008

As policymakers consider ways to address the current mortgage crisis, it is important to evaluate new proposals with an eye toward their future effects on the economy. The unintended consequences of government programs can have far-reaching economic and social effects. It’s important to keep in mind that government intervention played a central role in creating and elevating the current crisis: Interest rate manipulation, tax code loopholes, and “smart growth” land-use policies all contributed to artificially inflating home prices and shifting investment counter to real demand.

A prime example of a public program gone awry—and one of the key causes of the current credit crisis—is the Community Reinvestment Act (CRA). CRA was designed to ensure that all homeowners were treated “equally” by avoiding “redlining,” the deliberate shifting of financing away from low-income or high-risk areas. While CRA was designed to serve a positive goal, the economic implications of the new regulation were far more complicated. CRA required mortgage lenders to provide loans to riskier clients, often in stark contrast to what market forces may have dictated. This was done by incentivizing mortgage lenders to make loans for homes in certain zip codes and also by penalizing perceived failures to do enough.

These new loans spawned the subprime mortgage market, a financial sector that is now embroiled in controversy, whose collapse triggered the current downward economic trend. CRA is in many ways socialized financing, forcing banks to lend counter to market trends, thus increasing the risk of failure. We are now caught in a financial downturn that has emerged as a direct result of these risky loans. Any expansion of CRA that limits market flexibility and unnecessarily increases risk is not good policy: A financial collapse benefits no one.

In their efforts to combat the subprime crisis, legislators should consider scaling back CRA; the Bush administration proposed doing so in 2005. Allowing banks to determine loans without undue government influence would give the lending industry the flexibility needed to innovate and provide loans to consumers.

Far too many solutions from the government today involve simply throwing taxpayers’ money at a problem. This wrongheaded macroeconomic “leadership” is just bad public policy. The failure of CRA and its unintended consequences should serve as a lesson to legislators over the coming weeks. “The evil that is in the world almost always comes of ignorance, and good intentions may do as much harm as malevolence if they lack understanding,” noted Albert Camus, who won the Nobel Prize in Literature in 1957. His words illustrate the danger of action without first considering the consequences. Good intentions can backfire, and bad policy drives out of existence any chance for good policy.

The following articles address some of these concerns and examine the Community Reinvestment Act from a free-market perspective.

Community Reinvestment Act: Ensuring Credit Adequacy or Enforcing Credit Allocation?
This article, written by Vern McKinley and published in Cato’s Regulation magazine, examines CRA, its development and history, and the influence it gives government over the lending industry.

Should CRA Stand for “Community Redundancy Act”?  
This article, written by Jeffery Gunther of the Federal Reserve Bank of Dallas and published by the Cato Institute, examines CRA’s effectiveness, suggesting the lack of benefits may not justify the costs and possible side effects.

The CRA Scam and its Defenders  
Thomas DiLorenzo, professor of economics at Loyola College and a member of the senior faculty of the Mises Institute, examines CRA’s role in creating the subprime crisis.

The Community Reinvestment Act’s Harmful Legacy: How It Hampers Access to Credit  
Michelle Minton of the Competitive Enterprise Institute examines the role CRA can have in affecting the accessibility of credit for consumers.

How A Clinton-Era Rule Rewrite Made Subprime Crisis Inevitable  
This article, written by Terry Jones and published in Investor’s Business Daily, examines the effect of the Clinton administration’s 1995 CRA reforms on the subprime mortgage market leading up to the current crisis.

Commentary: Bailouts Will Lead to Rough Economic Ride  
This commentary from U.S. Congressman Ron Paul (R-TX) comments on the government’s role in creating the subprime crisis. Paul targets, among other government programs, the Community Reinvestment Act.

Nothing in this document is intended to influence the passage of legislation, and it does not necessarily represent the views of The Heartland Institute. For further information on this and other topics, visit The Heartland Institute’s Web site at and PolicyBot, Heartland’s free online research database.

If you have any questions about this issue or The Heartland Institute, contact Heartland Institute Legislative Specialist Matthew Glans at 312/377-4000 or [email protected].