Friday, February 15, 2013

Tease it out

Which these scholars did;
Did the Community Reinvestment Act (CRA) Lead to RiskyLending?
Sumit Agarwal (School of Business, National University of Singapore)
Efraim Benmelech (Kellogg School of Management, Northwestern University, and NationalBureau of Economic Research)
Nittai Bergman (MIT and National Bureau of Economic Research)
Amit Seru (University of Chicago and National Bureau of Economic Research)
And it'll make the Housing Cause Denialists miserable
Using exogenous variation in bank incentives to conform to CRA standards around exams, we find that the CRA [Community Reinvestment Act] did indeed induce riskier lending by banks. First, we find that in the six quarters surrounding a CRA exam, lending by treatment group banks (i.e., those undergoing the CRA exam) is elevated on average by 5 percent as compared to lending by control group banks.
Second, using data that track loan performance, we show that loans originated by treatment group banks around CRA exams are 15 percent more likely to be delinquent one year after origination as compared to those originated by control group banks. The evidence therefore shows that around CRA examinations, when incentives to conform to CRA standards are particularly high, banks not only increase lending rates but appear to originate loans that are markedly riskier.
What a surprise!  Banks responded to incentives to lower their lending standards when banking regulators had a club in their hands (the ability to give a grade of non-compliance with CRA, that could be used to deny a bank the right to expand or merge with another bank) to see that they did what powerful political forces wanted; more 'affordable housing' loans.

The reasoning being neatly summarized here;
We provide several pieces of evidence that support our interpretation of these findings. 
First, CRA assessments place particular weight on the fraction of loans targeted to low-income areas – i.e., so-called CRA-eligible tracts. We therefore expect the differential lending behavior between treatment group and control group banks to be more pronounced in these CRA-eligible tracts. This is precisely what we find in the data.
Second, we exploit the fact that all loans within a CRA-eligible tract are taken into account in a CRA assessment, regardless of borrower income.
We hypothesize that in attempting to comply with the CRA, banks take advantage of this regulatory feature by concentrating lending in CRA tracts to higher-income borrowers, who presumably are less risky. Consistent with this hypothesis, our results show that the effect of aCRA exam in CRA-eligible tracts indeed rises with borrower income.
Third, we find that large lending institutions drive our main findings on the impact ofCRA exams on the quantity and quality of extended loans. This is to be expected: federal regulatory agencies consider depository institutions’ CRA scores when considering applications for deposit facilities, including branch openings as well as mergers and acquisitions. To the extent that larger banks are more heavily engaged in mergers and acquisitions activity and expansion through branch openings, they will have a greater incentive to maintain a high CRA score and thus to adjust their lending behavior to satisfy CRA exams.
Fourth, we find that the reduction in loan standards associated with elevated lending around CRA exams is based primarily on unobservable characteristics. In other words, there is no meaningful change in the observable characteristics of loans made by treatment group banks relative to the control group banks around the CRA exam.
This, again, is to be expected under our interpretation of the results, since banks have an incentive to convince regulators that loans extended to meet CRA criteria are not overly risky. This would be consistent with the CRA mandate of “encouraging financial institutions to help meet the credit needs of the local communities in which they are chartered, consistent with safe and sound operation" (CRA 1977, Section 802). 
Which should be so obvious that (pace Wealth of Nations) it should be unnecessary to even have to point it out, except for the interested sophistry by denialists confounding the common sense of mankind.

Finally, the authors also point out that the total impact of the CRA is probably higher (worse).  They're only measuring the minimum distortions by their method;
We note that our estimates do not provide an assessment of the full impact of the CRA. This is because we are examining the effect of CRA evaluations relative to a baseline of banks not undergoing an exam. To the extent that there are adjustment costs in changing lending behavior, this baseline level of lending behavior itself may be shifted toward catering to CRA compliance. Because our empirical strategy nets out the baseline effect, our estimates of CRA evaluations provide a lower bound to the actual impact of the Community Reinvestment Act. If adjustment costs in lending behavior are large and banks can’t easily tilt their loan portfolio toward greater CRA compliance, the full impact of the CRA is potentially much greater than thatestimated by the change in lending behavior around CRA exams.

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