The Region

The Road Not Taken

The interests of lower-income families ignored in financial modernization

Malcolm Bush - President, The Woodstock Institute and Member, Federal Reserve Board's Consumer Advisory Council

Published March 1, 2000  |  March 2000 issue

The legislation's failure to extend CRA to any institution or affiliate engaging in banking services has several consequences. It establishes in the financial service regulatory structure an automatic shrinkage of the CRA umbrella as traditional banking activities are increasingly offered in nonbank institutions. So, fewer and fewer institutions that engage in banklike activities will be examined for the way in which they serve their communities, including lower-income neighborhoods. Therefore, the growing body of businesses that exploit lower-income families, such as predatory mortgage lenders, payday loan stores and car-title lenders, will have less competition from regulated lenders and will continue their growing assault on that market. The results of the growth of predatory lenders are already a disaster in some low-income neighborhoods.

The proponents of the Financial Services Modernization Act, also known as Gramm-Leach-Bliley (GLB), promise a rational consolidation of the financial services industry that will provide customers with one-stop shopping, reduce costs by increasing returns to scale and profit the industry by allowing the cross-selling of a variety of products. Moreover, American-based firms will be able to compete internationally in countries that already permit cross-industry holding companies. Consolidation has been a fact of life in the banking industry for a number of years, and the regulatory prohibitions on the merging of insurance, securities and banking activities have been fraying at the edges for years with the conscious help of the regulatory bodies.

But as the dust settles on this momentous legislation, the concerns of people who work to promote economic vitality in lower-income neighborhoods remain. During the last round of legislative debates, the community reinvestment movement faced two major challenges. On the one hand Sen. Phil Gramm, R-Texas, chair of the Senate Banking Committee, had introduced provisions in the Senate that were clearly intended to severely weaken the effectiveness of the Community Reinvestment Act (CRA). On the other hand, the legislation seemed a once-in-a-generation opportunity to extend CRA to those parts of new financial holding companies that engaged in banklike activities and provided banklike products. This rationalization of CRA would have had two major positive effects. It would have dealt with the strange lacuna in current regulations that mortgage affiliates of banks only get examined for their community reinvestment activity at the election of the bank. In addition, it would have ensured that however banking activities were organized in the new corporations, they would equally fall under the same community reinvestment mandates.

At the end of the day, the most hostile of Sen. Gramm's provisions were defeated with the help of bipartisan support for CRA in the House and the support of the Clinton administration. This support was prodded on by a nationwide, grass-roots campaign to protect legislation that has served disinvested neighborhoods so well. But the opportunity to extend the logic of CRA to the reality of the new financial services world fell victim to Sen. Gramm's intransigence and the supposedly moderate view that since the CRA had not been fatally weakened, all was well. As a result, the financial service regulatory system got modernized, but the community reinvestment structure did not. While banks complained to community organizations that CRA produced an unlevel playing field, their interest in leveling that playing field proved, as always, rhetorical and not substantive.

The new law and the regulations that are currently being written confront the community development world with a number of practical problems, only a few of which can be described in this short article.

The legislation's failure to extend CRA to any institution or affiliate engaging in banking services has several consequences. It establishes in the financial service regulatory structure an automatic shrinkage of the CRA umbrella as traditional banking activities are increasingly offered in nonbank institutions. So, fewer and fewer institutions that engage in banklike activities will be examined for the way in which they serve their communities, including lower-income neighborhoods. Therefore, the growing body of businesses that exploit lower-income families, such as predatory mortgage lenders, payday loan stores and car-title lenders, will have less competition from regulated lenders and will continue their growing assault on that market. The results of the growth of predatory lenders are already a disaster in some low-income neighborhoods.

In Chicago, for example, there is clearly a dual market in mortgage refinance lending. In 1998, 17 of the 20 lenders accounting for the most conventional refinance applications in white tracts were prime lenders. 1 Conversely, 18 of the 20 lenders reporting the most applications in African-American tracts were subprime firms, most of whom were mortgage companies. Predatory lenders are a subset of subprime lenders. However, predatory activity is not the only problem. This comparative absence of prime lenders means that African-American borrowers (and this finding holds true across income levels) do not enjoy the same market choices as their white counterparts. The failure to redraw the boundaries of CRA to recognize contemporary realities means that independent mortgage companies will not come under adequate scrutiny for predatory practices and that banks will be able to continue to conduct a substantial percentage of their mortgage activity outside CRA review.

The failure to modernize CRA also has consequences for low-income families' access to retail banking services and consumer credit. Just as the lack of CRA pressure creates a dual market in mortgage lending, so has the lack of that same scrutiny left many lower-income neighborhoods with only check cashing outlets, rent-to-own stores, and payday and car-title lenders for checking and credit services. Most states do not regulate check cashing outlets and payday loan stores, and virtually none regulate the other lenders. The consequences of the absence of regulated lenders and the presence of predatory firms in certain neighborhoods are very serious. For example, over 10 million households still lack bank accounts, and annual percentage interest rates on payday loans often exceed 500 percent.

The Financial Services Modernization Act fails to recognize a major change in the organization of banking services, namely the growth of new institutional bases for traditional banking services. In particular, insurance and other businesses are increasingly acquiring thrift charters and offering Internet banking. These firms, along with credit card companies, are essentially exempt from CRA because the regulators have tended to define their CRA assessment areas as the community in which the companies' headquarters are located.

This policy relies on an archaic reading of the CRA regulations, which assumes that an assessment area can only be drawn around a brick-and-mortar branch. In consequence, nationwide and indeed international companies have assessment areas that are based only on the geographical accident of where their headquarters are located. American Express, which accounts for 20 percent of the small business market in the Chicago region, has an assessment area that covers two counties in Utah. The State Farm Insurance Co. thrift, which is designed to be a national organization using State Farm insurance agents and phone banking as conduits, has an assessment area that covers only the central Illinois towns of Bloomington-Normal. It is the supreme irony of GLB that while the financial services industry clamored for a law that in their terms recognized the reality of 21st century financial services, they were happy to leave the CRA assessment area in the first half of the 20th century. To be fair, it should be pointed out that the Office of Thrift Supervision has made efforts to include some sense of CRA responsibility outside of their de jure assessment area in insurance companies and others' thrift charters.

Another major omission in GLB was the failure to grasp the effects of the new financial world on customer privacy. While legislative supporters claim the law has the strongest data privacy provisions ever legislated, holding companies will be able to swap information internally about customers' retail banking activity, insurance contracts and hence health status, mutual fund holdings, etc. And institutions will be able to sell that information to other companies unless customers opt out of that information sharing. One major financial industry supporter of data sharing argued recently that while Europeans like to buy things, Americans like to be sold things and that data banks were critical to this selling process. American consumers will, with any luck, prove this amateur financial anthropologist wrong and revolt against the destruction of a key element of their privacy. Their resolve should be strengthened by a tentative agreement between Washington and the European Union that U.S. companies that collect personal information about people in Europe would have to apply the basics of Europe's rigorous privacy standards if they transmit that data back to the United States on computer networks.

Despite the objections to Sen. Gramm's initial anti-CRA provisions, several pieces of Gramm mischief survived, including the curiously named sunshine provision. This provision requires public disclosure of all written agreements made in fulfillment of the CRA involving grants by banking organizations in excess of $10,000 or loans in excess of $50,000. Its intent is clearly to discourage CRA activism by subjecting community organizations to a major paperwork burden if they comment-negatively or positively—on a bank's CRA record. Besides being an example of terrible draftsmanship—one Federal Reserve Board governor described some of the subprovisions as "ambiguous and seemingly conflicted" 2 —the provision singles out a small group of people and organizations for special scrutiny, possibly violating their First Amendment rights.

It remains to be seen whether GLB prompts financial firms to offer more products at lower prices to more consumers. What is already apparent is that Congress missed a rare opportunity to strengthen the economies of lower-income communities. That task awaits a Congress that has a keener eye for the financial struggles of ordinary people.

Malcolm Bush is president of the Woodstock Institute, located in Chicago, a 27 year-old nonprofit that promotes reinvestment and economic development in lower-income communities. He is a member of the Federal Reserve Board's Consumer Advisory Council where he chairs the bank regulation committee, the National Community Reinvestment Coalition's board and the Steering Committee of the Coalition of Community Development Financial Institutions. Before he joined Woodstock Institute he was a regular faculty member at the University of Chicago.

Endnotes

1 Daniel Immergluck and Marti Wiles, "Two Steps Back: The Dual Mortgage Market, Predatory Lending and the Undoing of Community Reinvestment," Woodstock Institute, Chicago, 1999.

2 Remarks by Governor Laurence H. Meyer, before the American Law Institute and American Bar Association, Washington, D.C., Feb. 3, 2000.

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