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For release on delivery
12:00 Noon EDT
September 14, 1995

What Do We Do For An Encore?

Remarks by
Lawrence B. Lindsey
to the
National Bankers Association
New York, New York

September 14, 1995

What Do We Do For An Encore?

Thank you. It is my pleasure to be here today at the National Banker's Association
Awards Luncheon.

During my four years at the Board I have had the pleasure of meeting

with you in many settings and under many different circumstances.
In general, our past meetings have focussed on the challenges that were before us.
To a large extent you are a microcosm of the banking industry, but one which is more
susceptible to the regulatory and economic changes of the last decade. Relative to much
larger institutions, your organizations have more difficulty affording the costs of a massive
increase in regulatory compliance or a major structural shift in our economy. And, as we
have discussed many times in the past, many regulations which are designed to target the
largest institutions in the industry have major unintended consequences for your institutions.
Frankly, we as regulators have not provided sufficient recognition of the special role
that your institutions have played in extending credit and banking services more generally to
historically underserved groups in the population. As our regulatory apparatus has become
ever more detailed, we have driven the industry increasingly toward a one-size-fits-all model.
This makes your job more difficult. You have survived, often in markets that others have
neglected, during the most challenging economic period the banking industry has faced since
the 1930s. And the regulatory and technological trends now facing the industry seem to be
favoring large institutions with undifferentiated customer bases, and not institutions with the
kinds of specialized roles that have been your mission.
To a large extent your institutions have served the role of a niche bank. Recent data
indicates, for example, that 59 percent of applications at minority owned banks were from

predominantly minority neighborhoods.

Thus, you are susceptible to competition from very

large institutions looking to get into your market.

In many cases your market may not be

well defined on a geographic basis, but includes target populations that have been historically
underserved even if they are geographically dispersed, women for example. Frequently, the
services you have provided to your communities aren't easily quantifiable, but involve taking
on the vital tasks of providing community leadership and counselling.

Therefore, the

increasingly quantitative and geographic-based CRA reforms we are implementing certainly
will create new challenges for many of you.

The Democratization of Credit
Today, as a change of pace, I would like to focus on some good news and its
potential consequences for both your industry and for regulators as the 1990s unfold. Data
from a variety of sources show that there has been a dramatic trend toward the
democratization of credit during the past few years. A trend which started in the credit card
industry has now expanded to include home loans. Individuals with relatively modest
incomes, and individuals from minority ethnic and racial backgrounds, have never had
greater access to credit than they do today. Having had such dramatic success in extending
economic opportunity, I think we as a Nation and as an industry should stop and reflect on
what we may be doing right. After all, success stories in extending economic opportunity
seem to be in relatively short supply these days. Maybe we should take a look at what the
banking industry has done to achieve this success and ask the question: "What do we do for
an encore?"

Let me begin with what I thought was the great under-reported news story of the
summer. Back in July the financial regulators released their annual report on the number of
home mortgages granted the preceding year.

Conventional home purchase loans granted to

blacks rose 54.7 percent between 1993 and 1994. The comparable rates were 42 percent for
Hispanics and 15.7 percent for whites.

In economics, a 54.7 percent increase in just about

anything is a staggering, or at least a newsworthy, economic statistic. Nor was this a one
year event, but part of a multi-year trend. For black applicants, the increase from 1991 to
1992 was 26 percent followed by a 36 percent increase from the same reporting institutions
between 1992 and 1993. In both cases, the rate of increase was significantly more than for
the population as a whole. Looking at the HMDA data makes it clear that conventional
home purchase mortgage lending has gone up at a much faster rate for black families than
for white families over the 1991-1994 period.
The explosive increases in mortgages granted to underserved populations can also be
seen in terms of income. In 1990, for example, only 14 percent of all conventional home
purchase mortgages went to individuals earning less than 80 percent of their area's median
income. By contrast, more than 63 percent of such loans went to individuals earning more
than 120 percent of their area's median income. In 1994, the proportion of mortgages going
to low and moderate income families in the population rose to 24 percent, while those going
to the upper income group fell to 49 percent.

Later, I would like to put these figures into

some perspective regarding the overall size of the home mortgage market.
There was, of course, no mention of this on the evening news programs. One might
have higher hopes for the print media, particularly our elite publications. But, the

Washington Post failed completely to carry the story. The New York Times buried the story
on page D-6.

Neither paper has been shy about printing negative news stories about this

issue, however.

The Role of Denial Rates
This is the fifth year for which expanded HMDA data has been made public, and,
except for this year's media silence, it has always been controversial. The first time the
data was released roughly coincided with my arrival at the Fed back in the fall of 1991, so I
remember it well. That data, which made national headlines, indicated that blacks were
more than twice as likely as whites to be turned down for a conventional home purchase
loan. Even after accounting for differences in income, very wide disparities in denial rates
remained. These disparities were widely cited as evidence of discrimination. On the other
hand, both the industry and the banking regulators maintained that denial rates, particularly
ratios of denial rates for different groups, were not good indicators of market activities.
Some took this logic further to deny that there was even a problem.
Still, it was apparent to me as a novice, that even at a minimum there was a clear
breakdown in communication between the banking industry and the minority community.
Indignant charges of intentional discrimination and racism were met by equally indignant
denials. The data, and the rhetoric it was producing, were polarizing the discussion and as
a result, inhibiting useful and much needed communication.

Significantly increased

outreach efforts were clearly needed. Thoughtful and concerned people in both the industry
and community groups began talking at the local level, ignoring the highly polarized national

debate. In individual cities across the country ties were gradually forged and case-by-case
community oriented partnerships began to take hold. This proliferation of specialized
banking programs, community outreach, and economic development partnerships began to
pay off.
Both the regulatory agencies and banking trade associations have stepped up their
resources and training in this area. The secondary market as well as the private mortgage
insurance industry have taken steps to ensure that their standards do not hamper financial
institutions' ability to serve all of its neighborhoods. Lenders have improved their delivery
of credit and have been quite creative in mitigating risk through such vehicles as second
reviews of denied applications, homebuyer education programs, credit counseling, and
lending consortia.
Interestingly, the original cause of the highly charged atmosphere — the disparities in
denial rates — turned out not to be a good indicator after all. In spite of the staggering
increase in home mortgage loans granted to minority groups in the last five years, the ratio
of denial rates in the last HMDA report was virtually unchanged. In 1994, black applicants
were denied 33.4 percent of the time compared with a 16.4 percent denial rate for whites.
In 1990, the comparable figures were 33.9 percent and 14.4 percent. In retrospect, the
reported denial rate disparities served a useful purpose in prompting useful outreach activity.
At the same time, they generated more heat than light. Some might argue that there are
times when heat is what's needed rather than light. But with the progress of the last few
years, it is clear that the use of denial rate ratios is not an analytically enlightening indicator
of lending opportunities.

Low Inflation's Positive Effect on Housing Affordabilitv
I believe the sustainability of the efforts to increase lending to minority and low and
moderate income Americans is the result of a number of factors coming together. One major
factor has to do with the affordability of homeownership. Let's do the standard math
involved in any home financing decision. In 1990, fixed 30 year mortgage rates averaged
10.01 percent. In 1994 they averaged 7.47 percent. The principal and interest payments on
a $100,000 mortgage declined from $878 to $697. If one figures on annual property tax and
insurance payments as 2.5 percent of the home's $125,000 value, this adds $260 to the
monthly payment. Thus, we have seen a decline in monthly PITI from $1138 to $957 for
this typical home between 1990 and 1994. As we know, the standard PITI to income ratio is
28 percent. Thus, the annual qualifying income for this mortgage has fallen from $48,771 to
$41,014. That $7757 decline in qualifying income comes at a very dense part of the income
distribution, particularly in the minority population. For example, the number of black
families qualifying for this mortgage rises from 1,350,000 to 1,887,000, an increase of
537,000, or 40 percent. Among Hispanic families, the increase is 359,000.
Let me use these figures to stress something that I have learned as a Federal Reserve
Governor and as someone active in promoting homeownership opportunities to low and
moderate income Americans. There is a school of thought among some politicians that
fighting inflation is bad for low and moderate income people. Frankly, I think that is
debatable as a general proposition. The increased financial sophistication of the well-to-do
makes them much more able to avoid, or even benefit from the ravages of inflation. But I
can say unequivocally that inflation is bad for providing opportunities for homeownership.

Therefore the reduction in inflation during the 1980s, and the continuation of that policy
during the 1990s, has done more for homeownership opportunities among the lower income
groups than any program administered by the government.
It is important to stress the differential impact on inflation between those who already
have their homes and those who are seeking to buy. Our system of long term fixed interest
rates and the home mortgage interest deduction makes increasing inflation highly profitable to
those who already have financed their homes. That is why we all grew up being taught that
homes were a great inflation hedge. Part of our monthly payment goes to servicing that
inflation risk, but we get a tax deduction for it. So well-to-do homeowners pay only a
portion of the increased selling price of their homes in their mortgage payment.
If, however, you are simply in the market for physical shelter, and not a tax-shelter
or inflation-shelter, high inflation, and consequently higher long term interest rates, price you
out of qualifying for a home. Furthermore, if your income is fairly moderate, you may not
even qualify for the home mortgage interest deduction. Thus, a low inflation environment is
a key to maintaining homeownership opportunities.

Credit Availability in a Broader Context
But, the large increases in homeownership possibilities are not the only evidence of
widescale increases in the extension of credit to traditionally underserved markets. While we
do not directly collect racial and ethnic data on non-housing extensions of credit, evidence
from the Federal Reserve's Survey of Consumer Finances gives good reason to believe that
the penetration of underserved markets in the credit card business was as dramatic, and

preceded the large scale increases in mortgage credit. The Survey is taken every three years,
including 1995. The preceding two surveys, in 1989 and 1992, showed that the proportion
of white families with outstanding credit card debt was virtually unchanged — 42.5 percent in
1989 and 43.8 percent in 1992. But, the growth in credit card use as a source of finance
among non-whites was substantial. The proportion of non-white families having outstanding
credit card balances rose from 34.1 percent in 1989 to 41.9 percent in 1992. Of course, the
numbers of people actually having credit cards is much higher. This suggests that a
potentially debilitating economic burden has been lifted from a significant share of the
population who can now meet economic emergencies and time their purchases with greater
These increases in credit availability raise an interesting question. What level of
credit extension signals that all ethnic groups are being appropriately served? The real
answer is that we cannot know for sure. Just as we could not tell from the rejection rate
ratio whether or not discrimination was occurring, we cannot tell for certain what the "right"
number of home mortgages given in a particular year should be. But, even some simple
adjustments for income and demographic factors suggest that the 1994 numbers show little
race or ethnic-based discrepancies.
For example, if one takes the market for conventional, non-government-assisted loans
as being families earning $50,000 or more, then the proportion of such families getting
mortgages in 1994 was 10.6 percent for whites, 9.7 percent for blacks, and 13.0 percent for
Hispanics. Including all mortgages, conventional and government-assisted, and dropping the
income threshold to $25,000 shows that 6.8 percent of whites, 6.4 percent of blacks, and 7.2

percent of Hispanics got mortgages in 1994. This is, of course, an inexact method of
estimating the size of the market and obviously families below those thresholds also qualified
for mortgages.
There are many factors that help determine differences in demand. For example,
married couples are more likely to be in the market for home mortgages than are unmarried
individuals. Combining marriage and income as defining the base, then 7.7 percent of white
married households, 9.1 percent of black married households, and 9.5 percent of Hispanic
married households earning at least $25,000 got mortgages in 1994.

While far from

definitive, such statistics do indicate that significant race-based shortfalls in meeting demand
in the aggregate were not present in 1994.

The Success of Community-Based Partnerships
The second factor in achieving our success has been the forging of partnerships at the
local level. Traditionally underserved markets are often times examples of market failures,
most often associated with what we economists call a classic public goods problem.
Individual economic players rarely find it in their interest to enter a particular market
because the value of a single agent's investments would be adversely affected by the absence
of investment by others. This is why locally based partnerships between financial
institutions, non-profit community organizations, local governments, and neighborhood
residents that sprang up to bridge the communications gap at the national level in the 1990s
have been so successful.

Financial services industry and community organizations have learned that they each
have skill sets that the other doesn't possess. Let me give you a couple of examples.


Goodyear, Chairman of BankAmerica Illinois said at a Capitol Hill symposium this past
May, "We are a bank. We know finance. The groups we partner with have the contacts and
the sensitivity to the local neighborhood issues and challenges that we don't." One of the
most successful partnerships they have had is with Peoples Housing, a Chicago community
development corporation. Here in New York City, Neighborhood Housing Services (NHS),
headed by Fran Justa, partners with no less than 180 financial institutions in the city of New
York. The banks sign on because these community based non-profits have a proven record
of success in the business of community .development. Through strategic investment, the
NHS of New York has strengthened entire neighborhoods, laying the groundwork for
additional private investment thereby creating a viable market in the neighborhood once
again. I have had the opportunity to witness first hand literally dozens of these partnerships
during my tenure at the Board.
The story of local success through partnership may also be a reason to think that
heavy-handed government regulation may actually prove counterproductive. While banks
and community groups were organizing and partnering locally, we at the national level were
ensconced in a two year effort to rewrite the regulations which implement the Community
Reinvestment Act.

During the two years I spent working on the CRA reform, I frequently

heard criticisms from locally based economic development activists that our regulatory efforts
were making their jobs harder because we were changing the rules of the game just at the
time everyone was starting to play. While I take some pride in having worked through some

of the very vexing detailed issues involved in rewriting a regulation wholesale, I sometimes
wonder if it was all worth it. After all, the enormous improvement shown in the mortgage
data was taking place throughout the nation while I was cloistered with my colleagues in
Washington. All of this improvement in the data occurred before we ever issued our new

What is Next?
What Do We Do For an Encore? Frankly, I think that our country should be proud
of its accomplishments in this area.

The banking industry began to look for answers to

difficult and long standing problems. It now appears to have found them, or at the very least
be on the right track.

Of course, we need to maintain vigilance and an unflagging

commitment to fair lending in order to maintain this success. But, as the lack of press
attention to our achievements thus far attests, the opinion leaders of this country seem
unwilling to give the country credit for having made progress at all. As a result, I think
that we are about to enter a pernicious debate which may ill serve both the country and the
target populations we all care about.
I have often gone on the record as saying that the public does not benefit from periods
of extreme policy activism followed by periods of neglect — hot, then cold regulation if you
will. Public policy should be temperate, consistent and predictable. Although there are
hundreds of temperate people involved in successful partnership projects outside the Beltway,
inside the Beltway there aren't a lot of temperate people around. The same two groups seem
to be dominating public discourse — the extreme policy activists, the HOTS if you will, and

the advocates of benign neglect, the COLDS. In the case of credit availability and mortgage
lending in particular, we must proceed very carefully. We have achieved impressive results
in increasing access to credit for all Americans and continuing on this path should be our

The HOTS and the COLDS both have the wrong approach.
The HOTS are citing the rise in mortgages to minority groups as evidence of the

success of government enforcement of anti-discrimination rules and urge further aggressive
enforcement of them and of CRA as the way to keep the industry's "feet to the fire".
Actually, the evidence suggests that there has been plenty of press, but relatively little formal
litigation in the fair lending area. No cases have gone to court. None of the legal theories
in this area have been tested.

As a result, we do not know where the law stands in this area

- particularly with respect to disparate impact issues. And, as I mentioned before, if CRA
is to be credited, it is the old set of CRA regulations which were in effect during this period,
not our new more "performance-based" set.
This is not helpful to either banks or to the target communities in which we are trying
to increase access to loans. The prevailing legal and regulatory cloudiness becomes a
dangerous fog for the industry as statistics alone increasingly form the basis for enforcement
actions and CRA evaluations. Our ability to crunch numbers often far exceeds the quality of
the data that are analyzed, with the result in some situations, that a statistical analysis gives a
patina of correctness to theories that cannot be corroborated with live testimony or real world
experience. Thus, the zeal to address a problem that, as a systemic matter, we all agree
must be addressed may be misdirected in individual cases by statistics and untested legal

I would also urge the HOTS to heed some of the warning signs now coming from
recent lending experience. Statistical studies conducted by Freddie Mac and the PMI
industry are suggesting that mortgage loans with low downpayments to individuals with
questionable credit histories are showing high default rates. A more careful examination of
the data indicates that the screening and homebuyer education programs which those
borrowers went through were probably inadequate. It is important to remember that all
parties to a mortgage, particularly the homebuyer, lose when a mortgage goes into default.
During my four years at the Board dealing with CRA issues, I have frequently noted
that the real shortage in community development activities isn't money, but qualified
professionals with the appropriate skills and patience to make a program successful. The
statistical studies I cite above indicate that those people are still in short supply. They do not
indicate that low downpayment loans can't be made or that people with questionable loan
histories can't become responsible borrowers. The numbers do suggest that those
transformations will not happen overnight or happen costlessly. We have made a fundamental
mistake in thinking that results-based analysis, such as counting "dollars out the door" is the
best or the only way to look at our success in this area. Aggressive lending just to achieve
some numerical targets may create the kind of lending results which do not provide a solid
foundation for long term and sustained community development efforts.
Just as the HOTS have it wrong, so do the COLDS. Some are already interpreting
the adverse delinquency data as proof positive that such loans cannot, and should not, be
made. That is as false a conclusion as those who believe in ever more aggressive
enforcement. From the outset, many of the efforts at creating more flexible underwriting

criteria have been experimental, and billed as such. We do need to know which lending
criteria are effective at sorting out the quality of credit risks and which are merely acting as
obstacles to homeownership opportunity. We also need to know which types of remedial
efforts are successful and which are not.
Those who would propose that we simply do away with CRA and other types of
programs, and who do not come up with a constructive alternative are doing a disservice to
the country. On balance, I believe that CRA has been instrumental in helping to meet the
credit needs of many underserved areas and among historically underserved groups including
minorities and low and moderate income Americans.

Billions of dollars have been invested

in communities across the nation as a result. Literally thousands of Americans have achieved
their dream of home ownership because financial institutions responded to their CRA
obligations. Bank branches are opening in neighborhoods where financial services have not
been available for over twenty years. These are positive developments. Spreading
opportunity widely benefits all of us with a stake in our democratic capitalist system.
Those with a zeal to deregulate should instead seek to incorporate a workable CRA
package into an overall urban development strategy based on deregulation.

There is no

shortage of deregulatory actions which would enormously benefit community-based economic
programs. These include regulations affecting banking and financial markets, labor
regulations which inexcusably drive up the cost of low and moderate income housing and
urban redevelopment programs, cost-ineffective HUD requirements and mandates, and EPA
rules which make sensible uses of abandoned urban real estate non-economic.

An urban

policy that increases the flexibility and creativity allowable under CRA and recognizes the

wide variety of financial services needed and the enormous diversity of the markets involved
could be a powerful tool to those in the business of community development.
Of greatest concern to me is the reluctance of some of the politicians active in this
area to sit down and compromise on CRA. For example, the CRA provisions in the
Regulatory Relief bill have been used by opponents of the bill as a political football, helping
to bring movement on this issue to a grinding halt. Indeed, some of the leading opponents of
reform are refusing to negotiate the issue, saying that they will oppose any and all changes in
CRA provisions. Surely this cannot be the best strategy for the long term success of CRA
and for community development activities. Unfortunately, some politicians have seized
upon it as a red flag designed to rally the political troops, rather than as an effective weapon
for change.
So, I am left extremely troubled with the seriousness with which our country is
willing to face up to what is probably our most serious social problem — the deterioration of
our inner cities and economic opportunity for the individuals who live in them. It seems that
neither our national media nor our politicians seem aware of success when it stares them in
the face. And, not recognizing success is a virtual guarantee that we will not select policies
which will lead to success in the future. I began this discussion wondering what we should
do for an encore. Maybe I should be worried instead about why so many of the politicians
and so much of the media snuck out of the show at intermission.