CRA two point zero

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Tax Credit Advisor, August 2010: Completion of the mammoth financial-reform legislation sets the stage for a 2011 debate about restructuring the federal Community Reinvestment Act. This is long overdue – today’s financial world would have been unimaginable back in 1977, when CRA was born – and it should therefore be no surprise that CRA two point zero should be a ground-up reinvention from first principles, not a grab-bag of twiddles and tweaks.

What’s the Same as 1977, and What’s Different

Banks and financial institutions exist under and are protected by a regulatory umbrella which allows them to profit by taking money from the public (deposits) at cheap rates and lending or investing it at market rates. Banks therefore have a duty to redeploy their capital back into the segments from whence they got it – on a commercially viable basis, with government absorbing non-commercial risk. CRA sought to compel banks to explore how deploying capital in poor areas could actually pay. These core premises are every bit as important today as at CRA’s enactment in 1977.

Almost everything else is different. Geographic footprint, the cornerstone of CRA assessment areas, is anachronistic in a world of internet banking and global capital markets, where money has no location. Complex capital forms have mutated far beyond CRA’s simple typology of debt, equity, and community service. These new, sophisticated, interdependent value chains have spawned whole new species of participants that transact with financial institutions by converting capital resources into desirable social outcomes. Demographic and socioeconomic information is now available with real-time high-resolution granularity. 

A third of a century’s ossification of procedures against an obsolete legislative schema means that CRA now restricts and oversimplifies capital flows. In the low-income housing tax credit, as I wrote in March, today’s CRA can act precisely contrary to its statutory intent, a capital tourniquet that keeps money out of many markets instead of flowing it in to some markets. 

New Design Principles for CRA Two Point Zero

In light of that, where do we start? Try a principle of inclusivity – when in doubt, more things are in, more things count, and more is focused on the target income level than the geography.

  1. More institutions encompassed. All major financial institutions – not just banks – should be subject to CRA. Any major entity that plays in the U.S. financial markets and has explicit or systemically implicit federal backing – that is, insurance companies, investment banks, commercial banks, to name the obvious clusters – should have a CRA obligation.
  2. More capital forms recognized. Rather than a bright-line division into debt and equity, think in terms of Spends made and Risks accepted. Guarantees, swaps, securitized strips, credit enhancement – every fragmented capital slice that has a commercial purpose should be eligible for inclusion as a CRA-qualifying deployment. 
  3. More alignment with economic distress, less with geography as its proxy. Instead of a zip code definition of service area, aim at socioeconomic need. With the information now available, one could develop a synthesized Need Index incorporating quantitative publicly-available data – say, income relative to median, percentage of poor households, unemployment rate, economic growth rate.  Deploying capital into higher Need Index areas could get more points, as could higher weighting for capital put into deep income-targeted properties.
  4. More innovation credited. In addition to broadening the eligibility of Spends and Risks for CRA credit, give bonus points for Innovation – introduction of new Spend and Risk forms that deliver capital and credit to challenged populations or real estate asset classes (e.g., affordable housing). True, this has to be balanced with capital-innovation prudence – we’ve seen too many Sorcerer’s Apprentices – but that can be handled through capital-adequacy regulation and not separately specified in CRA.
  5. Eliminate the churning incentive. CRA in LIHTC is like the prize in a box of Cracker Jacks: To get the prize (CRA credit), you have to buy the whole box (ten years of LIHTC), and you get no prize for eating anything more than the first few bites (three years’ assessment horizon). Why not allow Holds – a long-term investment that is still owned many years later – to count as a CRA refresh (say, every five years) on the theory that to hold something is equivalent to buying it from yourself?
  6. Uniform examination. Only one part of our antiquated 1977 banking system remains unchanged – the multiplicity of regulators and CRA examining bodies. This must be standardized, preferably under a single administrative agency.

We’ll never get the CRA we need unless we’re clear about the CRA we want. Let’s get the debate into open space where we return to what CRA is for, not what it currently does. The more we circulate bold ideas, the better our chances.

David A. Smith is Chairman of Recap Real Estate Advisors, a Boston-based firm that optimizes the value of clients’ financial assets in multifamily residential properties, particularly affordable housing.  He also writes Recap’s free monthly essay, State of the Market, available by emailing [email protected].