The bill was sponsored by Senator William Proxmire in 1977 when he served as chair of the Senate Banking Committee. Proxmire had helped pass the Home Mortgage Disclosure Act (HMDA) in 1975, which had forced banks to divulge loan information based on race. Armed with HMDA data that revealed that banks were deliberately avoiding making loans in black communities, Proxmire crafted a legislative remedy. He reasoned that because banks had created the problem, they had a duty to remedy it. He also believed that banks had an “obligation to help meet the credit needs” of their local communities. He said that the CRA was based on the “widely shared assumption” that “a public charter conveys numerous economic benefits and in return it is legitimate for public policy and regulatory practice to require some public purpose. . . .” The senator claimed that banking was “a franchise to serve local convenience and needs,” and therefore “it is fair for the public to ask something in return.”95 In other words, Proxmire acknowledged that banks benefited from a healthy amount of public support, which meant that they had to serve public needs, or at least not discriminate against disadvantaged members of the public. This perspective was out of sync with the prevailing neoliberal market philosophy that held that the only obligations banks had were to their shareholders.
Specifically, the bill required banks to prepare annual reports describing whether they were meeting the credit needs of low- to moderate-income residents. Bank regulators were to rate each bank from “Outstanding” to “Substantial Noncompliance” based on the quantity of loans they were issuing in low-income areas.96 The bill did not force banks to lend or open branches in any particular community, but a negative CRA rating could be used by a bank regulator to deny a bank’s application for merger or any other change that required regulatory approval.97
When it was introduced, the law was reviled by many bankers and their allies. Republican Senator Phil Gramm called the act “an evil like slavery in the pre-Civil War era.”98 “It’s unbelievable,” fumed one anonymous southern banker, “These people are trying to enforce a change in social policy over the back of the banking industry.”99 Other opponents claimed that the bill went against efficient market forces and required banks to make unprofitable loans. Indeed, if the loans were profitable, banks would not have needed regulatory nudges to make them.100
On the other side, community groups have argued that the CRA is more about process than actual reform.101 For example, banks are rated by how many times they meet with a community group, as opposed to whether anything comes of those meetings. Loans are also measured by quantity as opposed to quality. The CRA does not ask whether the bank’s practices are building the community or are likely to produce positive results in the long run; rather, it keeps a checklist of actions meant to prove that the bank is making an effort. The law also hurt black banks as they have struggled to comply with the CRA. This seems counterintuitive—black banks had been doing the very thing the law requires other banks to do. However, since the CRA has assessed compliance by measuring the quantity of loans granted, black banks consistently fall short because they offer fewer loans than average. Many black banks thus had noncompliant CRA ratings that then entail regulatory censure.102
The CRA still sits awkwardly between a group of people who believe it does not achieve nearly enough and another group that believe it requires too much.103 As a result, the resemblance to affirmative action in college admission is striking. Much like affirmative action, there is a perceived feeling that institutions are being forced to hire lower-quality employees or make lower-quality loans to appease “PC culture,” “social justice,” “community activism,” or some vague sense of social morality that is not meritocratic and poses unjustified social burdens on the bottom line. Schools should only select students based on academic merit, and banks should only lend based on profitability. Affirmative action and the CRA, their detractors claim, conflict with a natural meritocracy or an efficient market.
Affirmative action opponents claim that the pool of minority applicants perform worse than white applicants, and therefore when underperforming minority students are admitted, there is a “mismatch” of capacity that harms both the school and the applicant.104 According to this widely cited “mismatch theory,” whites should continue to dominate elite universities until blacks catch up naturally. Banks also claim that they should avoid lending in distressed areas, not because they are discriminating, but because those areas are not profitable and those loans are riskier. Residents of such areas have fewer resources and are more likely to default on a loan. Applying the mismatch model to banking, borrowers should work to earn those bank loans instead of being offered them before they are ready—a mismatch that can hurt the bank, society, and the borrower.
Such arguments are based on snapshots of surface-level problems and fail to explore why black students and black borrowers fall behind whites in the first place. A longer historical view reveals that the reason the ghetto does not yield profitable loans is due to a history of segregation—segregation that was enacted through lending discrimination perpetuated by the very firms now being asked to mend the gap. Once the Supreme Court decided that past injustice could not justify present benefits, it seemed to erase the nation’s memory of the past injustice and allow for these types of shortsighted arguments in opposition to any program meant to address a historic wrong. The long debate over the CRA erupted after the financial crisis, with some even implausibly blaming the CRA for precipitating the financial crisis.
Though the CRA is still in effect, Proxmire’s view of banks as public-serving community institutions soon became a historical relic. During the 1980s and 1990s, the very nature of U.S. finance and banking changed fundamentally, with profound and surprising repercussions for black wealth accumulation
One of the most consequential financial innovations of the century was the mortgage-backed security (MBS), which fundamentally changed the secondary mortgage market. In 1938, Fannie Mae, the first government-sponsored enterprise (GSE), was created to facilitate the sale of mortgages in the secondary market. The 1968 Fair Housing Act privatized Fannie Mae and spun off a new entity, the Government National Mortgage Association (GNMA, or Ginnie Mae), which was to remain under government control. Fannie Mae mortgages would no longer be counted on the government’s books. The third GSE, Freddie Mac, was created in 1970 to help expand the private secondary market for mortgage loans. Freddie Mac was never sponsored by the government, but it had the warm glow of government support because of its association with the other two giants.
In 1971 Freddie Mac issued a product called a participation certificate, which grouped mortgages together and allowed an investor to buy a slice of a bundle of mortgages and receive a proportion of dividends on the entire bundle. This innovation diminished investor risk by spreading out the losses from defaults onto multiple parties. Fannie Mae improved on the idea in 1981 with the mortgage-backed security, which was similar to the participation certificate, but was more easily tradable and accessible to investors. Lower risk of loss led to more investments, which led to more capital flowing through the mortgage market, which led to more mortgage lending. The MBS accelerated the mortgage market and became an attractive vehicle for large investors, including pension funds, foreign countries, and corporations. Banks could now originate a mortgage and immediately sell it on the secondary market, where it would be bought and traded by a variety of new MBS investors.
Mortgage-backed securities rescued the mortgage market from a severe capital shortage. By 1970, bank withdrawals had surpassed bank deposits at thrifts and banks around the country. According to Robert Pease of the Mortgage Bankers of America in a 1970 statement, “except for FNMA, there is almost no money available for residential housing. We are in a real honest-to-goodness housing crisis!"105 Thanks to Fannie Mae’s creation of the MBS, capital from around the world began pouring into American mortgage markets, and capital became plentiful once again. The transformed mortgage market was built on a chain of transactions that sepa
rated borrowers from investors across a coordinated world market. It resembled the eighteenth-century cotton market, where capital from abroad flooded U.S. markets and created financial innovations, new products, and new sources of profits.
Lending decisions were no longer made based on a relationship between lender and borrower, but through objective numerical formulas. Banks or other mortgage originators would make any loan the secondary market would buy. Because banks were not keeping these loans on their books, they worried less about whether the borrower could actually repay. Their main objective was to issue loans that conformed to the standards set by Fannie and Freddie, which made them tradable. Lending became standardized and hassle-free. Some believed that the new market was also risk-free. The secondary mortgage market soon developed an insatiable appetite for mortgage loans. Banks kept originating them. Investors kept buying. There were not enough loans to feed the beast, so ingenious bankers created products that were based on other products. For example, the collateralized debt obligation (CDO) was a complex bundle of tradable debt based on mortgage securities. These derivative products created new investments based on “tranches" of mortgage debt. Derivatives split and spliced mortgage loans that were so far removed from the actual mortgage loan that the whole system resembled a house of cards.106
Even with the bundling and splitting of tranches, Wall Street needed more mortgage borrowers, so it created the subprime market. These were loans to borrowers who did not meet the underwriting standards set forth by the GSEs, or “prime" loans. Subprime borrowers were riskier borrowers, either because they had fewer assets, lower credit score, or lower incomes. But in finance, higher risk is rewarded with higher yield, so mortgage brokers made even higher premiums from subprime loans.107 So they went looking for a group of potential borrowers who had heretofore been deemed too risky. And they found them in black communities.
The flip side of deprivation has always been exploitation. After years of being a banking desert, as barren as Death Valley itself, the ghetto became a hub for casinos. The black population found itself courted by, or more accurately targeted by, subprime lenders. Just as contract sellers had exploited the credit-starved and redlined ghettos, once again, high-priced lenders filled the void. High-interest mortgages were made legal by Congress and the courts, who, guided by the ethos that fewer government regulations would produce a healthier banking industry, lifted caps on interest rates. The 1980 Depository Institutions Deregulation and Monetary Control Act (DIDMCA), the 1982 Garn-St. Germain Depository Institutions Act, and other deregulatory legislation paved the way for subprime loans, and the 1978 Supreme Court case Marquette National Bank v. First of Omaha made state usury laws practically ineffectual, leading to a steady rise in interest rates. Some of these mortgage interest rates—34 percent APR with fees and balloon payments—were in loan shark territory.108
As early as the 1980s, studies confirmed that another Jim Crow credit market had formed—this time in mortgages. Whites systematically received lower interest rates and longer repayment periods than blacks.109 A 1991 study by the Federal Reserve of 6.4 million home mortgage applications found that there was widespread and institutionalized racial discrimination in the U.S. banking system.110 Blacks who qualified for prime mortgages were being disproportionately sold subprime loans. A HUD study found that subprime loans were five times more likely in black neighborhoods than in white ones between 1993 and 1998. In other words, “high-cost subprime lending accounted for 51% of home loans" in black neighborhoods, versus only 9 percent in white ones. Moreover, “homeowners in high income black neighborhoods [were] twice as likely as homeowners in low income white neighborhoods to have subprime loans."111
Several of these studies identified race of the borrower as the key predictor determining how much interest was paid on a mortgage.
Massachusetts Congressman Joe Kennedy quipped that these results “portray an Ameri ca where credit is a privilege of race and wealth, not a function of ability to pay back a loan."112 The reality was probably far more complex than a simple matter of racial discrimination, however. There was certainly racism in lending—lenders continued to view blacks as being less creditworthy regardless of their financial statements, and they continued to offer blacks higher rate loans. However, many blacks also had fewer assets and lower incomes, which made them inherently riskier borrowers.113 The market had come looking for risky borrowers to exploit—and they used race as a blunt proxy, such that wealthy and creditworthy blacks were sold more expensive loans than they merited.
Consumer loans also came flooding into the ghetto. Where credit card issuers had been avoiding the zip codes where blacks lived, by the 1980s they joined the mortgage lenders and began looking for them. Credit cards had previously been sold to the affluent—in fact, having a credit card was considered a sign of wealth. But wealthy customers were no longer profitable for credit card companies, which were now flush with capital and looking for more yield. Wealthy customers paid no interest or fees because they paid off their balances each month—they were not “revolvers"—borrowers who paid interest to carry their balance from one month to the next. Credit card companies needed more revolvers if they wanted to make more profits.114 With the usury cap lifted and the general aversion to risk abated, lenders went looking for higher profits on high-risk borrowers. They found their ideal customers in the credit- and wealth-starved ghetto. And when they did, these revolvers, who paid interest each month, began to subsidize the credit cards of the wealthy. Academics who studied the mechanisms used by credit card companies to find revolvers discovered that credit card companies were using race to find new customers. According to their data, “the most profitable group to lend to, if a bank were maximizing finance charges, would be black Americans," because blacks were three times as likely as whites to revolve their debts.115
Credit issuers pulled on blacks to borrow so that they could profit from the attendant fees and interest. At the same time, blacks were being pushed to borrow by their low and volatile wages. Credit had become a necessity for both middle-class and low-income Americans of all races as wages and real economic growth had stagnated. Consumer debt exploded in the 1970s and kept expanding; and what was even more alarming was that the gap between what was being borrowed and what was being repaid was also growing exponentially larger.116 The economy was running on fumes—wages were stagnant, prices were increasing, and debt was being used to bridge the gap. Americans borrowed because they had to, and credit card issuers lent because there were profits to be made. The two sides made a Faustian bargain, but it was the borrowers who paid for it dearly every month—in perpetuity, with interest.
The problem for black borrowers was no longer an inadequate quantity of mortgage credit, but the inferior quality of that credit. In other words, instead of refusing to lend in black neighborhoods, subprime lenders were focusing their efforts there. Senator Donald Riegle of Michigan called it “reverse redlining." One attorney claimed, “This is a system of segregation, really. We don’t have separate water fountains, but we have separate lending institutions."117 The “market scouts" or entrepreneurs became “incentivized" to make profits in the ghetto “enterprise zones." After years of being left out of the mortgage market, black subprime borrowers were exactly what Wall Street’s hungry mortgage beast was looking for. The ultimate effect was a disproportionate wiping out of black wealth when these subprime loans blew up two decades later.
Alongside the massive changes in the credit market, and certainly spurred by it, the nature of American banks also changed. From the mid-1970s until the early 2000s, banks asked for and were granted wave after wave of deregulation that eroded the walls that the New Deal-era legislation like the Glass-Steagall Act had imposed around banks to keep them safe and simple. Banks wanted to compete in the fast-moving, highly profitable, globalized markets—even if that meant taking risks with other people’s money.118 Some of the prohibitions had indeed become outdated and overly restrictive, but after years of sta
bility and profits, bankers had also regained their appetite for risk. Free-market ideology was deeply entrenched in Washington, and there were few dissenters when the bank lobbyists pushed on regulators to leave them alone and let the market’s invisible hand regulate them. Policymakers and regulators believed, despite much historical evidence to the contrary, that banks could operate safely without any government interference. Most scholars agree that the 2008 financial crisis was caused, in part, by bank deregulation, but there is still ongoing disagreement and debate about the right balance of regulation.
What is not debated is the effect of the era of deregulation on the character of the banking sector. American banking went from an industry consisting of small community banks to one that was dominated by a few large bank holding companies operating extensive branch networks. As a result of the banking transformation enabled by deregulation, financial innovation, globalization, and new technology, the simple banking of the past half century—the 3-6-3 model of taking deposits, lending, and golf—became obsolete and unprofitable. No longer can a community bank survive by simply taking deposits and making FHA loans to the middle class. Today, a profitable bank holding company engages in deposit-taking and lending, but also trading in derivatives, stock market speculation, broker-dealer operations, insurance, and merchant banking. This increased size and complexity has led to a finance-dominated economy and unprecedented profits (and risks). It also led to cannibalization of weak banks by the strong.
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