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Banker's Holiday: Strengthen "George Bailey's Law"

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The season of holiday specials is in full swing and one stands out as particularly poignant in these economic times. In Frank Capra's timeless fable, "It's a Wonderful Life," we learn of the importance of sacrifice and redemption, small town values and, yes, the virtues of small banks. In a critical moment in the film, the hero, George Bailey, hopes to prevent a run on his family's bank, the Bailey Building and Loan. He implores his customers, many of whom are looking to withdraw their deposits: "your money isn't here, it's in Joe's house, and Mrs. Smith's house. It's what banks do."

Yesterday, President Obama met with leaders of small banks from across the country to urge them to open the lending spigots to help jump start business development and job creation. But the small banks did not get us into the present mess. Admittedly, for some small banks, the lure of packaging mortgage loans to be sold off and securitized or ambitious commercial real estate deals was too strong, and well over one hundred such banks have had their doors closed by regulators this year. At the same time, the overwhelming majority of small banks, literally thousands of them, focused on local lending, were not blinded by ambition, and stuck to the boring business of making "plain vanilla" mortgages, offering checking and deposit accounts and making small business loans.
This principle--that banks should concern themselves with their local communities and try to meet the needs of those communities--is enshrined not only in Depression-era tales, but also a law that has served as a constant target for some since its passage in 1977: the Community Reinvestment Act (CRA).

Many attempt to blame the CRA for the financial crisis, saying that it forced banks to make risky loans in low-income communities. These risky loans, the argument goes, turned out to be the spark that led to the subprime mortgage crisis and the wider financial crisis that has followed. Unfortunately for this line of argument, it has the distinct misfortune of being gang-tackled by the facts.

The CRA, which requires only that federal bank regulators use their influence over banks covered by the law to encourage them to meet the needs of all of the communities they serve, including low- and moderate-income communities, consistent with sound lending practices. One of the key loopholes of the law is that only banks that take deposits are covered by it. This, among other gaps in the law, meant that 94% of subprime loans were not covered by the CRA during the height of the subprime frenzy. As a result, the law was irrelevant to the overwhelming majority of risky loans that helped start the crisis. In fact, numerous studies have shown that CRA lending was actually as profitable and viable as many other stable loans on banks' ledgers, and much less likely to enter into foreclosure than subprime loans.

Congress is considering strengthening the law by closing many of its loopholes and expanding its coverage to mortgage lenders that do not take deposits, insurance companies and credit unions. The core principle of the CRA--that banks must take into account the needs of their local communities--is what motivates small town bankers and what made the Bailey Building and Loan serve as a pillar of the community for the working class of the fictional Bedford Falls. Congress should resist the cries of those who mistakenly place the blame on the crisis on George Bailey's Law; they're not just wrong, they're also not in keeping with the spirit of the season.