Gary H. Stern - President, 1985-2009
Published December 1, 2003 | December 2003 issue
Editor's note: These remarks were delivered to the 33rd Annual Membership Conference of the National Congress for Community Economic Development, in Detroit, Mich., Oct. 9, 2003.
Good afternoon. I am delighted to join you here in Detroit to participate in your annual conference for community economic development.
Promoting economic development is, in a very real sense, the Federal Reserve System's reason for being. The Fed is an institution created by Congress in 1913 to promote national economic development by ensuring the stability and efficiency of the U.S. financial system. We pursue our various specific responsibilities—monetary policy, banking supervision and regulation, payments system services and oversight, and Treasury fiscal agent services—with the perspective that they should contribute to optimal nationwide economic performance.
The Fed's core responsibilities in support of national economic development are grounded in its "community" roots. Each of the 12 Reserve banks is a separately chartered nonprofit corporation with its own regional district and a board of directors drawn from that district. This regional structure enhances the independent voice and regional perspective that the 12 Reserve bank presidents bring to the Fed's policy debates.
While part of our longstanding history, the Fed's attention to economic development at the community level ratcheted up with the passage of the Community Reinvestment Act in 1977. The CRA specifically required the Fed and the other bank regulatory agencies to examine banking institutions so as to ensure that these institutions meet the financial needs of the communities in their respective market areas. The CRA also stimulated the creation of the Reserve banks' Community Affairs function, whose mission is "to support the System's economic growth objectives by promoting community development and fair and impartial access to credit."
By officially adding the word "community" to the Fed's lexicon, the CRA brought increased attention to two broader perspectives of economic development, over and above the Act's specific regulatory provisions. First, it encouraged us to more carefully examine the distribution of economic outcomes across the diverse communities of people that comprise our nation. In particular, it directed us to evaluate how aspects of the financial system might be contributing to the problems of some communities whose economic performance lags behind overall national growth. Staffs at the Reserve banks and the Federal Reserve Board now work to provide this understanding through a combination of outreach, technical assistance and analysis.
Second, the CRA caused us to look at low-income communities not just as "in need," but also as active participants in spurring their own economic development. It encouraged us to adopt a broad perspective on how people in their neighborhoods and communities organize themselves to participate, sometimes effectively and sometimes not, in our fast-paced financial system and market-oriented economy. Participation in free markets is assisted by a host of institutions-schools, banks, government agencies, voluntary and nonprofit service organizations, even informal personal networks—whose presence, accessibility and effectiveness can vary significantly from one community to another.
For this afternoon, I want to emphasize the Fed's longstanding market-oriented approach to economic development with some tangible examples. At the same time, I readily acknowledge that we believe it is important to identify and to strengthen the national, regional and community institutions that help low- and moderate-income individuals participate more fully and successfully in the marketplace. In other words, the goal is to give the members of these communities the capacity to succeed in the marketplace, and the method is to build up the institutions that provide and maintain that capacity. Let me explain that approach further and then illustrate how it works in practice at the Minneapolis Fed. Let me also remind you that I am speaking only for myself, and not the Federal Reserve, on these matters.
Open participation in efficient markets is critical to economic development. Markets effectively promote choice, efficiency, investment and aggregate growth. Public policy helps markets promote community development by widening market participation. To be sure, markets may not address short-run distributional concerns, and these issues can be handled through tax/transfer policies determined by elected officials. And certainly, antidiscrimination and consumer financial regulations provide legal protections to ensure that markets are open to all. The Federal Reserve and the other financial regulators take seriously their responsibility to implement and enforce these market-widening regulations.
Effective market participation assumes a set of premarket skills and institutions, and supporting those institutions is at the core of the Minneapolis Fed's community economic development strategy. Neither our mission nor our resources allows us to make direct monetary grants. Instead, we use our skill base to make more indirect but, we trust, significant contributions to institutional performance. Today, I want to highlight these contributions in four areas: (a) strengthening legal underpinnings, (b) promoting financial awareness, (c) curbing predatory lending and (d) conducting research within specific local communities to achieve a deeper understanding of the institutional foundations of community economic development. During the remainder of my remarks I will provide examples of contributions in these areas.
a. Strengthening legal underpinnings
First, we try to strengthen the underpinnings that the legal system provides to the marketplace in low-income communities. On this subject, I would highlight our contributions toward a model commercial code for sovereign Indian reservations. We think this is important because a clear and consistent legal code is almost a precondition for the efficient functioning of markets in general, and especially for financial markets.
Our 50 states have traditionally respected the model commercial codes proposed by the legal experts who draft the Uniform Commercial Code (UCC). But even when adopted in all 50 states, these codes do not necessarily facilitate lending on Indian reservations, which are sovereign from state commercial law and find it difficult, for cultural and administrative reasons, to simply adopt the state code. The lack of a common code or insufficient set of tribal codes has proven to be a significant concern and impediment to the extension of credit on the reservation by off-reservation lenders. And since many reservations are too small to support a lending institution that serves only the reservation, access to off-reservation lenders is critical.
Our work at the Fed has been directed at overcoming existing barriers through extensive education of both lenders and reservation borrowers on how to conduct business via the existing tribal laws and administrative structures. Notwithstanding the successes we have achieved under the existing legal framework, our experience has led us to also seek to improve that framework. Accordingly, in the mid-1990s, we cosponsored an initiative to draft a model tribal UCC for all Montana tribes. In 2002 the National Conference of Commissioners on Uniform State Laws created a committee to draft a version of UCC Article 9, which governs transactions secured by collateral, that could serve as a model code for reservations nationwide. The earlier initiative we had cosponsored in Montana provided a model, and we are now very involved in the national drafting effort as well. Assuming completion of the draft in 2004, we expect to remain involved in the next phase, a rollout and marketing effort to persuade tribes nationwide to adopt the model tribal UCC Article 9. I would regard this as a very significant step toward making financial markets work for Indian Country.
b. Promoting financial awareness
The second area of contribution I'd like to highlight is supporting institutions that give low-income consumers the information and knowledge they need to make sound decisions. Without that knowledge, they cannot participate effectively in the modern financial marketplace. To be sure, we have specific responsibilities as a regulator to ensure that banks comply with requirements to truthfully and conveniently disclose information about the costs and nature of the financial services they provide, and our Consumer Affairs examiners meet those responsibilities. But our experience shows that it is not enough to give consumers numbers, for they need training to know how to interpret information and to apply it to their own circumstances. The growing complexity of financial services, the greater responsibility placed on individuals to plan for their own future and the rapid increase in immigrant populations with limited formal education only deepen this need for financial training and education. And research shows that individuals with less education and less financial experience benefit the most from education on how to make financial decisions.
Partly for that reason, I have long been a supporter of education in general, and of economic and financial education in particular. Currently, I chair the board of directors of the National Council on Economic Education. Other officers of the Federal Reserve Bank of Minneapolis serve with the boards of the Minnesota and Montana councils. The councils have been good partners for us, because their train-the-teacher approach to disseminating materials such as their "Financial Fitness for Life" curriculum leverages our resources and helps us reach, albeit indirectly, thousands upon thousands of children.
Chairman Greenspan shares this commitment to financial education and, in recent public service announcements, has thrown his support behind a Federal Reserve System effort to promote financial education for everyone. My staff and I support this effort with several initiatives. We are taking leadership roles within the Native American Financial Literacy Coalition and the St. Paul Foundation's project on responsible use of credit card debt. We are also just beginning a first-of-its-kind partnership with the Minnesota Personal Finance Center, a joint effort of the Minnesota Extension Service and the Minnesota Council on Economic Education. The partnership will coordinate resources to efficiently deliver financial education to low-income adults throughout Minnesota.
c. Curbing predatory lending
Financial education and research help us strike a favorable balance as a regulator of consumer financial markets, as illustrated by our approach to curbing predatory lending. Although predatory lending is hard to define or measure precisely, we are all aware of incidents in which borrowers appear to have been taken advantage of in contracts, with high interest rates and fees or other provisions that strongly favor the creditor, often with very negative consequences for the borrower. However, we need to remember that bringing individuals with low incomes or problematic credit histories into the credit market has been a longstanding public policy objective that has been substantially achieved in recent years, mainly by means of legitimate loans with above-average rates and restrictive provisions aligned with the borrower's higher risk profile.
If it were easy to distinguish these legitimate, risk-based loans from truly abusive loans at the time that the borrower applies for credit, then we could easily have our cake and eat it too. In this regard, it would be ideal if we could write and enforce regulations allowing the former, and the many benefits they bring, and banning the latter. As we all know, it's not that easy. For regulated institutions we face a trade-off between strict regulations that may curb more abuses but may also deny legitimate credit to needy families, and looser regulations, which do the opposite. At any point in time, the Fed and the other regulators try to draft regulations that strike a reasonable overall balance between the two. But aggressive practitioners find loopholes in laws or migrate their activities from the regulated to the unregulated sectors, and the anecdotal evidence suggests that this is true of predatory lenders. Of course, to the extent that laws or regulations are violated, we support full legal remedies against the perpetrators.
However, if we are, over time, to have our cake (access to credit) and eat it too (no abusive lending), we need to alter the terms of this trade-off, and my staff and I support both institutions that do that now as well as research into the nature of the underlying problems (which can lead to better institutions later). The financial education efforts I have already discussed are perhaps the best long-term antidote to predatory lending and other credit market abuses. In the meantime, we participate in the multi-city "Don't Borrow Trouble" campaign that provides targeted education to help borrowers protect themselves and also assists them in seeking remedies when problems arise. We support and participate in efforts to analyze whether the professional regulatory and self-regulatory mechanisms governing the mortgage and realty industry need to be updated to reflect the many changes in those markets in recent years, such as the greatly increased role of independent mortgage brokers. We are also working with researchers at two Twin Cities colleges to assess the neighborhood distribution of foreclosures and the possible value of foreclosure data as a diagnostic for issues like predatory lending or property abandonment.
d. Community-based research
Finally, we are increasingly turning to research in our local communities to deepen our understanding of the financial and related institutions that underpin market participation and community development. This research can provide support to the institutions that serve to encourage participation in markets. An example of this research is the financial survey of the Twin Cities Hmong community that the Federal Reserve Banks of Chicago and Minneapolis sponsored a couple of years ago. This survey focused on how access to credit and financial services was affecting a lower-income minority community in the Twin Cities.
While data from CRA, Home Mortgage Disclosure Act and other sources, as well as our examinations of state member banks' compliance with financial regulations, provide a useful baseline for assessing credit availability in low-income communities, they don't provide an assessment of overall outcomes in the communities we serve. Accordingly, to gain this broader understanding, we conducted financial surveys in the Twin Cities Hmong refugee community. This study derived from earlier work by the Chicago Fed, and others, on informal financial networks in a Hispanic and an African-American neighborhood in Chicago. Besides looking at a different metro area and a different ethnic group, we added a co-located white control group and examined formal as well as informal credit access by Hmong-owned businesses as compared to white-owned businesses.
The results, summarized in our 2002 annual report, show that the Hmong- and white-owned businesses were generally comparable in their characteristics. More importantly, they were comparable in their access to and use of credit. And statistical analysis showed that the relatively small differences that did emerge were accounted for by objective credit-related factors such as the owner's age, education or attitude toward risk, leaving little if any room for ethnicity or race as an explanation for the observed borrowing patterns. To further understand the factors behind this favorable outcome, we also conducted focus group meetings with representatives of the Hmong business community and the lending community. The focus groups stressed several factors that helped the lending institutions and the Hmong businesses develop an effective relationship. These factors were as follows:
The Hmong did their part and were willing to adapt to expectations of them and committed to repayment. The Hmong study has been a success for us not only because of the specific issues it addressed but also because it significantly deepened our outreach into and knowledge of the Hmong community and its development and financial needs. Based on that success, we plan to remain involved in research on the institutional foundations of financial market participation and economic development. We are pressing on with our analysis and evaluation of foreclosure data, and we are looking into further studies of credit and financial service availability in specific lower-income communities. Over time we hope to contribute fundamental knowledge about community development and how it can be enhanced by institutions that reduce the financial barriers that limit broad-based, effective participation in the market.
In conclusion, I have stressed the view that markets are the true
engines of economic development and that we take a long-term view
of community economic development that seeks to strengthen the institutions
that facilitate broad-based, effective market participation. Partnerships
with community groups and organizations engaged in similar work are
critical to our success, for the Federal Reserve Banks on their own
are not in a position to provide the depth of community presence required,
for institution building, in the community economic development and
finance arena. We are already working with some of the members of
your Congress, and we look forward to working with additional members
in the future. We share the goals of reducing poverty and developing
healthy communities, and I would hope these comments have been informative
about our approach to achieving these goals.