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For release on delivery
October 29, 1994
8:30 a.m. EDT

More Opportunity Through Deregulation

Remarks by
Lawrence B. Lindsey
to the
Financial Institution's Joint Housing Conference
Detroit, Michigan

October 29, 1994

More Opportunity Through Deregulation

It is my pleasure to be here in Detroit to address the 1994
Financial Institution's Joint Housing Conference.

It is always

refreshing to be among creative people who are actually getting
things done and meeting people's needs.

Funny, I don't get that

feeling in Washington very much.
There are few more important tasks before the country today
than the one you will be discussing here at this conference.


need to provide homeownership opportunities to millions of
American families who do not now have them and to provide the
financial infrastructure to rehabilitate America's depressed areas
is great.

It is very important that we all work together in this

regard, and in particular, that we not get in each other's way.
We regulators have a particular responsibility to aid you in your
Back on July 15, 1993,. the President asked the four banking
regulatory agencies to revise the Community Reinvestment Act
regulations to make them more objective, more focussed on
performance and more oriented to extending loans to low and
moderate income neighborhoods.

As you know, last December we

released a proposed rule which represented our first draft of
these revised guidelines.

More than 2000 individuals and

organizations commented on those rules.

We very much took those

comments to heart and on September 2 6 issued a new proposal.
I believe that the proposal we have produced meets the


President's objectives.

Most important, we have preserved, to a

maximum extent, the strength of the current system by allowing
examiners flexibility in assessing bank performance in light of
local conditions as well as the capacity and constraints of the
institutions involved.

One size fits all types of solutions have

no place in a successful effort to increase credit to America's
inner cities.

The diversity and variety of conditions in

America's credit markets is a fact which we regulators ignore only
at our peril.

I hope that we have, in general, succeeded in

extending maximum flexibility with minimum interference, while
still conforming to the President's request for a more objective
set of criteria.
In general, we attempted to set a high standard of cost
benefit analysis, before imposing either paperwork or capital
allocation types of requirements.

I think that the standard which

we established should be more broadly applied in government.


the thrust of my comments today is on what government can do to
ease the regulatory burden which is holding back home ownership
opportunities and inner city development.
I must admit, however, that I am concerned that we may not
have, in at least part of the proposed regulation, resisted the
standard Washington temptation to write rules which sound good and
are well intentioned, but fall short in practice.

In particular,

as I made clear at the Board table, I have some concerns about the
proposed race and gender coding of small business loans at large
banking institutions.

Under this proposal, whenever a business

applies for a loan under $1 million, it will be asked to reveal,
by percentage, the racial, ethnic, and gender composition of its

Clearly this provision is intended to help promote

economic development in underserved minority communities.

On the

other hand, questions have been raised about the workability and
potential unintended consequences of this approach.

Given the

competing objectives of public policy, we in the banking agencies
are now in the process of soliciting the public's views on this
proposal, and greatly value your input.
Regardless of the outcome of CRA reform, we in the government
have a particular responsibility to evaluate our own behavior in
every area.

To many people, government problem solving follows an

all too predictable pattern.
than government is found.

First, a source of a problem other

Second, that private sector problem

source is given a new paperwork burden with severe penalties for

Third, the government bureaucracy is enlarged in

order to administer the new rule and cope with all the paperwork.
We at the Federal Reserve are estimating a compliance staff
increase of between 25 percent and 50 percent in order to meet the
demands of these and other new rules.

While I personally feel

that the proposal we have made in the CRA area is worthy of
consideration, we should not stop here in looking for ways to help
disadvantaged communities.
My experience has shown that the chief obstacle to economic
development in distressed neighborhoods is often government

In my three years at the Fed, I have toured more than 30

inner cities and talked to countless people who are actively
involved in community development about what their biggest
problems are.

Invariably their answer comes down to government

-- federal, state, and local.

So, rather than imposing yet

another paperwork burden on the private sector, maybe we should
try getting government out of the way of the private sector
Government is a source of problems in virtually every aspect
of urban redevelopment.

Local governments have zoning and tax

rules which leave wide expanses of their potentially most valuable
real estate vacant.

Labor laws such as Davis Bacon at the federal

level and similar laws at the state levels drive up housing
rehabilitation costs, as do excessively strict local building

HUD regulations make it needlessly cumbersome to become a

lender under its programs.

Let me begin with a list of proposed

rules which affect banks, which, as a banking regulator, I think
should be on any priority list to help encourage homeownership and
inner city development.
Minimum Downpavment Requirements.
Improvement Act

As part of the FDIC

(FDICIA) , the agencies were required to impose

regulatory requirements for all loans secured by real estate for
the purpose of constructing or improving buildings.


these involved minimum downpayment requirements of 2 0 percent in
the case of homes and as much as 35 percent for commercial

Had the homeownership downpayment requirement gone into

effect, as everyone in this room can well imagine, it would have

literally stopped all low and moderate income homeownership
programs in the country.

Here was a classic government approach -

- rules to solve the immediate political problem without regard to
the unintended consequences on problems not currently at center
Instead, we developed a set of general rules that did not
contain any specific down payment requirements, but did set
guidelines which included a 10 percent downpayment for owner
occupied housing with a special "basket" for exceptions.


practice, there are many cases in low income areas where even
lower downpayments may still be consistent with prudent lending.
Often, a mortgage payment on a rehabilitated property is less than
the current monthly rent payment the potential homeowner is now

But, because of the high rent, it is virtually impossible

for the family to save enough for a downpayment.
The downpayment requirement is particularly onerous for
development in low and moderate income areas.

The primary capital

shortage in the inner city is not debt financing, it is equity

This requires accumulated wealth in the form of liquid

financial assets or collateral such as property.


requirements exacerbate this problem by preventing any
substitution of debt for equity.
Appraisal Rules.

FIRREA required that banks hire certified

licensed appraisers to estimate the value of real estate property
which is to be used to collateralize any loan.

Of course, this

drives up the cost of loans for everyone, and marginal loans which

are disproportionately in distressed areas are particularly hard
hit by this requirement.
even more complicated.

But, the problem in distressed areas is

Appraisals are based on the current

condition of properties, not on their ultimate value.


property values in distressed areas seem to be systematically

The net result is to sharply depress the collateral

value of inner city properties, thereby cutting them off from
access to loanable funds.
The federal banking agencies minimized the potential damage
by first establishing a $100,000 appraisal threshold and have
since raised the threshold to $250,000.

But, getting rid of this

requirement entirely could substantially raise the equity capital
available in inner cities.
Glass Steaaall.

Ever since the 1930s banks have been

severely limited in taking equity positions in non-bank type

Yet, "equity kickers" are a natural part of higher-

risk loans.

These equity positions allow the opportunity for big

payoffs in the case of successful endeavors.

These potential

payoffs in turn allow for more affordable loan rates on the debt
portion of the financing.

It bears repeating that it is equity

capital which is in shortest supply in the inner cities, and Glass
Steagall prevents the kind of financing which would most directly
help solve this capital problem.
It is true that Bank Holding Companies can have limited
equity participation through Community Development Corporation
subsidiaries or by petitioning the Federal Reserve for approval of

certain investments under Regulation H.
cumbersome and somewhat limiting.

But these are both

Now that the interstate banking

legislation is law, consideration of Glass Steagall reform is on
the table.

Representative Leach, the ranking Republican member on

the House Banking Committee, and Representative Gonzalez, the
current Chairman, have both announced a willingness to explore
this issue next year.

This is potentially very good news.

Environmental Liability Rules.

Because of their histories,

inner cities are far more likely to harbor hidden environmental
hazards than are green field properties.

These added risks, and

the manner which Congress has prescribed for cleaning up these
properties, stand as major obstacles to inner city development.
Potential owners are naturally wary of taking on a property where
they might be liable for pollution caused by someone who owned the
property decades before.

It is even harder on a bank, which under

the deep pocket principles applied, could be stuck paying
virtually unlimited damages on a property it didn't even want to
own, but on which it needed to foreclose.

Ironically, Superfund

Reform, which would have eased this problem, was killed in the
last Congress partly by efforts to require that Davis Bacon rules
be applied to contractors on clean up sites.
Indeed, environmental rules often make rehabilitation of rundown neighborhoods prohibitively expensive for seemingly no

These environmental improvements are not usable as

collateral for bank loans.

Thus, environmental restrictions drive

up the amount of equity financing required for any project without

increasing either its likely cash flow or the property's true

For example, our clean water laws require that ground

water be brought up to standards applicable to drinking water.
Yet, it is inconceivable that anyone would consider sinking a well
in a densely populated area already served by municipal water
Inner city residents and community development organizations
often get the job done in innovative ways.

For example, in

Philadelphia, a neighborhood housing group had redeveloped an
entire block of row houses.

The problem was at the corner where

an old gas station once stood.

The risk of having to dig up and

dispose of an underground gasoline tank which probably lay beneath
the property would have been prohibitively expensive.

No one --

including the state and city governments - - would touch the

So, to avoid an eyesore on their newly rehabilitated

block, the neighbors got together, washed the windows, and painted
the exterior shell of the building to make it appear occupied.
Restrictions on the Use of Cash.

The Treasury has extensive

reporting requirements affecting the use of cash.
rules were well-intentioned.

As always, the

They were intended to inhibit money

laundering by drug dealers and others.

But, many inner city

communities have never had easy access to banking services and
have residents who may rely on income from informal or casual

Restrictions on the use of cash keep these

neighborhoods from mobilizing their saving and entering the
mainstream of economic activity.

Currency exchanges spring up to


help meet the payment needs of these areas and charge exorbitant
Probably the most difficult question ever posed to me was by
a lady in Denver who had accumulated a large cash downpayment for
a house in an area which had not had banking services.

When she

brought the money in, the bank had enormous trouble accepting it
because of these well intentioned laws.

She asked me, "You people

think we're all drug dealers, don't you?"
I think we should admit that these rules, though well
intended, have had some serious unintended consequences.

At the

very least we should carefully assess the benefit of these rules
and reconsider whether they are worth the cost.
Davis Bacon Reform.

Present federal law requires that

workers at most federally financed or assisted construction sites
be paid "prevailing wages".
union wage.

By and large these are the local

An estimated $60 billion in construction falls under

Davis Bacon annually.

These restrictions impede inner city

development in two ways: they drive up the cost of construction
and they tend to deprive local residents of job opportunities.
Last week I spoke in Baltimore at a conference very similar
to this one.

There, the estimate of the so-called Davis-Bacon tax

on inner city construction was between 5 and 10 percent.


10 percent to the cost of a housing unit is the equivalent of
adding a full percentage point to an 8 percent 30 year mortgage.
In short, the Davis-Bacon requirement effectively wipes out much
of the good those of you who are bankers do when you lend to such


projects at concessionary rates.
Improve the Mechanism for Clearing Title on Abandoned

The problems of government are not just federal,
Local government creates its share of obstacles.


who has been on a tour of an inner city neighborhood can easily
see the effects of abandoned properties on living conditions in
the neighborhood.

Their very presence creates an eyesore and a

haven for drug dealers which devalue all of the existing housing
in the area.

This makes the task of rehabilitating neighborhoods

ever more difficult.
this one.

Government and only government can solve

The exorbitant delays nationwide on the rapid transfer

of title on abandoned properties in inner city areas is a national
What is often missed is the human tragedy that these delays

A few weeks ago I was touring the West Humboldt area of


A real dynamo of a lady, Mrs. Magdalena Martinez, took

us down the block where she lives and described the efforts she
had made in evicting drug dealers from one property, getting the
absentee landowner in another property to fix up his building,

Then we came to a vacant lot.

She described how two years

ago the city of Chicago had promised that her daughter would be
able to acquire the property and build her home there.
Politicians and press came out for the requisite photo

Today, the property is still vacant and Mrs.

Martinez had tears in her eyes as she asked us when the city would
let her daughter acquire the land and build her house.


Property Taxes.

One of the greatest challenges facing many

blighted urban areas is overcoming long-standing state and city
policies regarding the payment of back property taxes.

In my

view, no place typifies this problem better than Pittsburgh.
There, with a spectacular view and within walking distance of
downtown, sits the Hill.

This depressed area experienced a

tremendous amount of abandonment after riots there in 1968.


eyeball estimate would suggest that one third to one half of the
land there is vacant.

In any normally functioning market, this

would be prime real estate.

But, any for-profit developer seeking

to acquire the land would have to pay back taxes dating back to
1968, with interest.

Needless to say, the prospect of paying a

quarter century of back taxes makes even the most promising real
estate unattractive.

So there sits the vacant land on the Hill,

not paying any taxes, and dragging down the property values of the
entire neighborhood.

Where is the cost benefit analysis here?

Or again, consider Chicago.

Title clearing and property

taxes were the major obstacles confronting a very innovative group
on the North Side named People's Housing.

They had a project to

convert an abandoned property into a cooperative housing unit for
low income elderly residents.

It took two years to get approval

to go Co-op from the city, but no property tax abatement was

As a result, the property taxes consume much of the

rental cash flow, which is necessarily low because of the income
of the tenants.

Debt service at anything approaching market rates

becomes impossible, thus preventing the duplication of this

successful model.

What kind of cost benefit analysis produces

this kind of policy result?
We are all very familiar with the senselessness of many
government regulations.

However, it is not generally recognized

that residents of our most distressed regions suffer from


intentioned government even more than do most people.
Furthermore, they can least afford the costs government imposes.
Faced with these problems, I believe that we need a new
approach to policy making.

Rather than just doing something

because it sounds good, let's actually think it through to make
sure it will do good.

I disagree with those who think that

government and politicians are evil.

They aren't.

are generally filled with the noblest of intentions.

In fact, they
The problem

is that they let intentions stand in the way of solutions.
Eliminating Davis-Bacon requirements, or systematically
reviewing and modifying the banking regulations I discussed would,
in my view, do far more to promote inner city development than
would our entire CRA reform effort, as important as it is.

I am

proud of the effort we have made as regulators in trying to craft
workable CRA guidelines.

But whenever we consider new policies,

we should always remember to ask ourselves:

Are we in government

really solving anything, or are we just papering over the problem?