Essays on the Community Reinvestment Act, information externalities and credit rationing

Date of Completion

January 2005


Economics, General|Economics, Finance




The access to credit and financial services play a critical role in fostering economic growth and maintaining economic stability. The ability to obtain credit at a fair price and terms has remained one of the most powerful determinants of economic opportunity, income generation, wealth creation and, therefore, upward mobility for individuals and for communities. However, the role of government in promoting the access to credit had been a controversial topic. While the community groups and advocates argue for increased intervention to enhance to the flow of credit to underserved communities, the proponent of free markets argue that credit market intervention only distorts competitive flow of credit. ^ In addition to government regulations to rectify credit market failure in certain underserved communities, researchers show that the lack of lending information and asymmetric nature of the information is associated with the flow of credit across communities and risk-groups. This dissertation aims to better understand the economics of the access to credit of underserved communities. In order to achieve this aim, this study sheds light on one of most controversial banking legislations in recent history, the Community Reinvestment Act (CRA) of 1977, and one of the principal market failure arguments associated with this act. Specifically, the essays in the dissertation can be summarized as follows: (1) The first essay takes a historical approach to understand the evolution the Community Reinvestment Act. The essay analyzes the economic implications of the legislative reforms and revision relating to the act and addresses some of the future research trends concerning the act. (2) The second essay investigates the role market activities in mortgage lending by utilizing lenders' branch office location and employing a fixed effect model with two-stage Instrumental Variable (IV) estimation. After controlling for neighborhood omitted variable bias and removing the enodogeneity bias, the study finds no evidence supporting information externalities in mortgage lending in Connecticut. (3) The third essay combines a credit-rationing model similar to that of Stiglitz and Weiss [1983] with the information externality model of Lang and Nakamura [1993] and examines the equilibrium properties of mortgage markets characterized by both adverse selection and information externalities. ^