Bribing Banks to Make Bad Loans
Under the Federal Community Reinvestment Act (CRA), banks are required to make special efforts to direct funds into economically stressed city areas. In case there is anyone who does not remember, it was the full bore enforcement and expansion of this law that created what has come to be known as the subprime mortgage debacle. That program, aided and abetted by Fannie Mae and Freddie Mac, resulted in trillions of dollars in "toxic assets" that very nearly brought down the global financial system and left the USA with a prolonged depression in its housing market. All told, the episode points out how dangerous it is for the government to become so invested in and committed to programs that aim to get around the market and prudent financial behavior.
Now comes a Pittsburgh Council member who wants to direct City bank deposits to institutions that go above and beyond CRA dictates and demonstrate a willingness to pour even more money into troubled areas. The plan calls for the City to rank banks according to their commitment and ideas for helping distressed areas and then move deposits to the banks that rank highest in that contest and out of banks whose "assistance" proposals are not as good.
In short, the scheme is basically telling banks that the City will put more money in the institutions that are willing to take a higher loss rate by making more loans in troubled areas. The banks will have to weigh the benefits of a few million more in deposits against an uncertain level of additional losses from uncollectible loans.
Making the program even more problematic, under the proposed legislation banks would have to submit their "assistance plans" to the City. Those plans would be evaluated by the Controller who would presumably prepare a ranking for the Mayor and Council to use in deciding which banks to "reward" with more deposits and which to "punish" by withdrawing funds. What a spectacle that promises to be. First a committee will have to be appointed to draft guidelines for the bank plan submissions. In addition, guidelines on how various aspects of assistance in the plans will be valued must be developed along with an appeal process for disgruntled banks who feel aggrieved by a low ranking of their carefully and politically correct prepared proposals. And finally, a follow up monitoring scheme will be needed to make sure that banks getting additional City deposits are actually carrying out the proposals that led to their receiving the new funds.
What will all this cost? And how much ill will does it possibly create in communities expecting more assistance that are disappointed when things don’t improve and in the banking community that feels put upon and manipulated?
And finally, how much attention will be paid to the financial viability of banks that come up with tremendous proposals under the guidelines set by the City? It is easy to imagine some smaller or less stable institutions promising far more than they can deliver in order to get City funds. How does that help anyone? If they win the ranking game but do not get more City deposits or get funds but fail to deliver on their promises, the fallout is unlikely to pleasant.
In sum, why go down this road? Why not spend more time and effort trying to improve the business climate and help the city attract business that can create jobs for City residents? That is the single best approach to long term permanent improvement in the City’s neighborhood. Prior experience with assistance programs is not promising. All they do is create dependency on government dictated assistance rather than individual, private sector initiative.