I’m very honored to be here today to talk about the situation we find ourselves in more than 2 years into a very deep and seemingly never-ending recession, through two lenses—policy in Washington, and community banking and community development finance. And I’ll try, without being presumptuous, to bring it home to Maine.

Let me start by telling you where I’m coming from. I have spent most of my career in public service in Washington, including stints at the Transportation and Treasury Departments, the National Economic Council under President Clinton, and the Democratic staff of the House Financial Services Committee. I also worked at Fannie Mae in the early 1990s and ran the Office of Thrift Supervision, the regulator of the savings and loan industry, from 1997 to 2001. Since 2002, I’ve been at ShoreBank and its various affiliates, and since 2007 at the New America Foundation. ShoreBank, based in lower-income and minority communities in Chicago, but with wide ranging activities through its non-profit and international affiliates, is the largest of the country’s Community Development Financial Institutions or CDFIs, and one of the oldest.

Like CEI, ShoreBank believes that the combination of high-quality finance, and information, can make an enormous positive difference in the lives, health and strength of communities, businesses and individuals. We also believe there is a critically important role for specialized institutions with a mission to serve those often overlooked by larger, conventional players. But unlike CEI, ShoreBank is also a commercial bank subject to all the same rules, regulations and standards that many of those in this room deal with. 

And it is stressed, like many community banks. In our case, much of the problem stems from the spectacular fall in housing prices and increase in unemployment in the Chicago, Cleveland and Detroit neighborhoods we serve. Amazingly, bad lending—not by ShoreBank—created housing bubbles even in some of the most troubled Midwest communities. The residents of our communities have been devastated. Some estimate that equity built up by an entire generation of African American families has been lost. So that’s part of the perspective I come from.

The other half of me is a Washington policy wonk, an advocate for a financial and mortgage system that serves all people and all communities fairly and equitably. In some senses, I’d like to rewind the clock to about 1995 (a year many of us have hit upon as when we had about the right balance in housing finance between access to finance and credit quality), but I think the problem is in fact much deeper, and we need to think more broadly. Moreover, while there has been at least a temporary hiatus in some of the worst practices in mortgages—with Maine joining other forward-looking states to put on the brakes, and the Fed and Congress have stepped in on mortgages, credit cards and overdrafts, that doesn’t deal with (and in some respects may exacerbate) the ongoing need for constructive and creative credit and other financial products in all communities. 

Let’s look at some of the issues we’re facing. Making the system work fairly and equitably for consumers—and sustainably for banks and credit unions; getting credit to small businesses at a time when their cash flow and collateral are reduced; the very different challenges of the largest institutions—whose size and obvious support from the government raises the bar for what we expect of them, and of the smaller ones, whose personal touch is needed now more than ever; and the stresses of keeping all communities, including those with limited resources, economically strong.   I’ll discuss aspects of each of these and offer some thoughts about policy responses to them.

According to the FDIC, 9 million households nationwide are unbanked, and another 21 million are underbanked—they have a checking or savings account at a bank, thrift or credit union, but use non-bank providers, such as check cashers, for some (frequently a good part) of their financial needs. These consumers may be getting products that meet their short-term needs, such as immediate cash without a hold for someone living paycheck-to-paycheck, or a fast, no questions asked, emergency loan. But those products are often expensive and in some cases can trap people into a cycle of debt. At least as important, by shying away from banks, thrifts and credit unions, consumers lose the opportunity to save in an insured account and to build a long-term relationship with an institution that can work with them to manage their finances, build up savings, and grow their assets, including the business assets that are so important to many Mainers.

Maine does better than the country as a whole. Nevertheless, according to the FDIC, 14,000 Maine households are unbanked and another 99,000 are underbanked. While this group is disproportionately lower income, it also includes a substantial number of those earning at least $75,000 a year, with some college or a degree, and more than half the underbanked are homeowners. Given what’s happened since the survey was completed a year ago, the situation has probably deteriorated. The challenge for Maine’s banks and credit unions will be not only to make sure they’re on top of the needs of their current customers, but also to understand what’s missing in their outreach, products or services that keeps good potential customers out of the system. 

While until about 10 years ago, few people focused on the concept of un- and underbanked consumers, concern about access to credit has been around far longer. It came to a head from a policy perspective in the 1970s, when a group of Chicago activists, led by a woman named Gale Cincotta, rallied others from around the country to focus on redlining and block busting. Redlining was a federally-condoned—that’s condoned, not condemned—practice of literally drawing a red line around whole neighborhoods and refusing to lend. In urban America, these were older, minority or racially mixed neighborhoods; but rural communities were also left out. Blockbusting was the practice under which white homeowners were scared into to sell their houses at cheap prices because the neighborhood was “turning”; that is, blacks were moving in. It was a disgraceful period in modern American finance, and it resulted in the two major statutes that today attempt to equalize access to mortgages and other kinds of credit—the Home Mortgage Disclosure Act or HMDA and the Community Reinvestment Act or CRA. I’m proud that Ron Grzywinski, a founder of ShoreBank, testified in favor of CRA in 1977.

Especially in Maine, with its overwhelmingly white population, it’s important to put on the table that, while HMDA and CRA had their roots in racial discrimination, they were meant to deal with access to credit for all. Gale was a formidable white woman working to get mortgage money into her working class neighborhood. But she joined with people of all races to make certain that credit was available in all low- and moderate-income neighborhoods, and to all low- and moderate-income people. 

When CRA was enacted in 1977—not coincidentally the year CEI was founded—the financial services world looked very different from today, although looking back, some things would seem very familiar. Back then, local banks took deposits locally and made loans in their local communities. In fact, the rallying cry for CRA was that the deposits being taken by the banks in Gale’s neighborhood were being used to finance houses and businesses in other places. Interstate banking hadn’t happened, and in many states, a bank could only have one office—no branches. While Fannie Mae and Freddie Mac bought some mortgages from banks and thrifts, almost all other loans a bank made stayed on that bank’s books. And if you had a bank relationship, you pretty much did all your financial transactions with that one institution. Of course, one of the problems CRA highlighted was the extent to which some peoples’ and some communities’ banking relationships were either non-existent or limited to savings accounts, with no access to credit.

Maine is blessed with a relatively large number of healthy community banks and credit unions, many of whom have the same kind of relationships with their customers and their neighborhoods that all banks had in 1977. But those banks and credit unions exist within an environment that has changed drastically. The dominant bank in Maine, TD Bank, is owned by a Canadian bank, and three other banks with major market shares—Bank of America, Key Bank and Peoples—are based outside the state. Whereas in 1994 there were 51 banks active in Maine, all based here, by June of last year, there were 33. And we know that much mortgage and credit card finance, including credit cards that finance small businesses, comes from banks and other financial institutions without any deposit presence here.

Nationally, the situation is even more extreme. Not only has the number of banks declined sharply, but the size of the industry has mushroomed and the concentration has become extreme. In 1992, bank assets totaled $4.5 trillion and the top 5 held 12%; by the end of 2005, the total was $10.8 trillion, and the top 5 had a 34% market share. The current financial crisis has only exacerbated the situation, with JP Morgan Chase acquiring Washington Mutual, Wells Fargo taking on Wachovia, and Bank of America buying Countrywide and Merrill Lynch. As of last September, the top 5 banks had 41% of the market; JP Morgan Chase alone had assets over $1.6 trillion—12% of all bank assets. No wonder there is significant concern in Washington, as around the country, about some institutions being “too big to fail.” “Too big to fail” institutions have funding advantages over everyone else, and their perceived safety no matter what makes it harder for community banks to compete for deposits. 

Let me give you a close-to-home example I noticed when I was in Maine at New Years. The limit on FDIC deposit insurance is $250,000. During the worst of the crisis, the FDIC announced that it was insuring, without additional cost to the institution, transaction accounts and low-interest NOW accounts without limit. On January 1, the FDIC extended the program through June 30, 2010, made it optional, and, began to charge banks to participate. I have accounts at both a national bank and a local Maine bank. Guess which one had a sign at the teller station announcing it had chosen not to participate. I assume they had decided they were not concerned that business customers might move their accounts to somewhere safer, because they were “too big to fail.” They are clearly saving a good deal of money by not paying the FDIC for the additional insurance—insurance the local bank continues to pay for. The large bank seems to have made a sensible business decision, but this example helps us see some of the implications of the “too big to fail” phenomenon. 

My experience as a bank regulator strongly suggests that institutions too big to fail may also be too big to manage well or to regulate effectively. I believe this is the key issue we must face in dealing with systemic risk. If the institutions are allowed to retain the size and complexity they have acquired—often at the urging of the government—three keys to reducing future risk will be: far greater transparency (to management and boards, regulators and the markets), financial disincentives to both excessive size and excessive risk in the form of significantly higher insurance premiums and more complete capital and loss reserve requirements, and better trained and less conflicted supervision. I also think the public should expect these institutions to devote a portion of the benefit they gain from their status to the creative, positive support—at scale—of the communities they serve. In their various previous incarnations, most of the banks have shown they can do that. We need more of it, and the non-banks and new banks (the ones that used to be just investment banks or insurance companies) need to be held to the same standards.

Maine consumers, businesses and communities face a host of other financial services issues. The subprime foreclosure crisis has hit certain Maine communities particularly hard, although the good news is that foreclosure filings in Maine seem to be trending down. Legislation the state has recently passed, together with the Administration’s Home Affordable Mortgage Program and the actions of individual lenders, will definitely provide some relief, but the underlying problems of bad loans, the decline in real estate prices, and rising unemployment will continue to take their toll. For example, in the third quarter of 2009, prime mortgage delinquencies topped 6% in Maine—up from 3% as recently as the first quarter of 2008—and subprime delinquencies topped 25%. 

Small businesses are also suffering. Recent data on small business lending is not readily available by state, but we know that nationally, notwithstanding significant enhancements in SBA programs, championed by both Senator Snowe and SBA Administrator Mills, bank small business lending is down by 2% over the last year. Community banks, like so many Maine institutions, do a disproportionately large share of small business lending. Whether the problem is weak demand for loans by credit-worthy borrowers, tougher definitions of credit-worthy, regulatory capital pressures, or reduced supply of funds is unclear, but the result is likely putting additional pressure on job creation and retention in the state. 

Finally, many financial intermediaries around the country that like CEI are certified Community Development Financial Institutions and are focused on service to lower income, minority and rural communities, are finding themselves squeezed between more demand for their services, slower loan repayments, higher delinquencies, fewer bank funding sources, and tighter foundation and government budgets. 

How are these issues playing out in Washington?

Let’s start with consumer protection. Whatever the other causes of the current economic crisis, the proliferation of over-priced, badly-structured, badly-underwritten mortgages, as well as a general willingness to allow consumers (and some businesses) to overextend themselves with credit, played a significant role. Clearly, there was some fraud. As clearly, there were consumers who bought the story so many far more sophisticated economists and pundits did too—that real estate prices would continue to rise and thus they would always be able to get out of debt by further mortgaging or selling their house. Both fraud and speculative asset bubbles have been with us for centuries; they’re not going away. 

A seemingly equally intractable problem is that over the last decade, real incomes for most Americans have been stagnant while the costs of housing, education and health care have continued their inexorable climb. This last is not a financial problem, and cannot be solved by financial engineering or more credit—it’s a structural problem in our economy, and correcting it requires more political will than we seem to have been able to muster. 

But there are things we can correct. They fall in three categories: better underwriting, better products, and better understanding. In theory, better underwriting should be the easiest. This is what bank regulation is all about: not letting institutions do things that are so systematically stupid they put the institution at risk. That consumers would also be protected is almost beside the point. There are many reasons regulators didn’t demand better underwriting. Here are a few: the deregulatory philosophy pervading the Federal Reserve; the reluctance of many states, most notably California, to risk pricking the real estate bubble by using their powers to stop the worst of the non-bank lenders and regulate mortgage brokers; over-vigorous preemption by federal regulators; the way mortgage and credit card portfolios are examined, especially at large banks; and the pull of the securities market including rating agency mistakes and the misaligned incentives inherent in the originate-to-sell business model. The underwriting issue requires reinvigorated and more focused supervision of banks and other financial institutions, under a set of regulations that protect consumers, financial institutions and the economy as a whole. And regulators, including banking regulators, have to be required to focus more fully on protection of consumers as well as on institutional financial health.

Which brings us to products and understanding. This requires several strategies, many of which financial institutions can, and should, implement themselves. Others require direction and support from the government. On the product front, there are some products that are either so toxic in their inception (such as those that involve equity stripping up-front fees), or so unlikely to be understood or their implications appreciated (double cycle billing, cascading overdraft fees, perpetual penalty rates) that they should simply be banned. And the ban has to be nationwide, binding on all institutions, and effectively enforced as to banks and non-banks alike. But notwithstanding the difficulty almost all of us have with both math and uncertainty—which are at the heart of many loan and investment products—I think banning products is a tool that should be used sparingly.

An alternative is “default products.” The concept, in the context of financial services and consumer protection, is that the initial product a consumer is offered is one that is easy to understand and unlikely to create problems for the consumer—even if financial engineers could design one that is economically more beneficial. Other products would not be prohibited, but the days of mortgage brokers refusing to offer 30 year fixed rate loans would be over. Default products are an important concept, because for most consumers, financial products are sold, not bought. The products are inherently difficult to understand and consumers (at all income and education levels) routinely underestimate future spending and overestimate future income. This doesn’t mean defining default products will be easy. For example, the standard transaction product for middle-income consumers with a steady income from employment—the “free” checking account—may be far from optimal for people with lower and more intermittent incomes. They may well be better off paying a small monthly fee for an account that gives them instant liquidity, tolerates very low balances, and allows ATM and point of sale withdrawal without allowing overdrafts. But I think we need to try to define the default products and give them preferential treatment.

Better financial literacy, starting young, is essential. But classic “financial education,” either in the form of a high school course or an adult seminar, has consistently disappointed in terms of demonstrable effects on behavior. Newer ways to build financial capability, including “just-in-time” messages, far greater access to quality financial planning for large purchases and life-time asset building, and higher standards for those who advise consumers on financial transactions—Maine’s system of buyer’s brokers is an example—are more promising.

Given the current state of play in Washington, I’m not going to say that an independent Consumer Financial Protection Agency, as proposed by the Administration, is the only way this can be accomplished. But I do believe we need a separate financial services regulator dedicated to both protecting consumers—across the country, no matter who they’re dealing with—and helping all parts of the industry develop better products, better consumer understanding of those products, and better disclosures. I also think this is a good opportunity to broaden the duty to serve consumers in all communities beyond the banking industry.

Let me turn now to small business lending. Small businesses have traditionally been a major source of growth and jobs, especially in Maine. For example, from 2005 to 2006, Maine added over 9300 net new jobs; almost half came from firms with 1-4 employees. But between the third quarter of 2008 and the third quarter of 2009, every employment category in Maine other than education and health services showed a substantial decline; while Maine’s unemployment rate of 8.3% as of December was lower than the US average of 10%, it is far higher than the 5.4% rate for 2008, and the unemployment rate in many Maine communities is in double digits.  

Again, there are plenty of culprits, but the good news is that we’re starting to see some new life in the sector, no doubt spurred in part by the funds and program modifications provided by the SBA. For example, there’s been a slight decrease in the percentage of small business loans overdue 180 days or more and the SBA’s flagship 7(a) program backed 36% more loans in the last quarter of 2009 than the year before. 

Nevertheless, we need to use all tools available—and press for more—to enable the small businesses in the country and the state to both survive this recession and get ready to grow and prosper as we come out of the bad times. Much small business financing is real-estate based, and with collateral values down, refinancing will be difficult as those loans come due, even for a business that is cash-flowing. The Administration has proposed an increase in the SBA’s ability to support refinancing of those loans, as well as extension of Recovery Act programs that eliminate fees and raise guarantees, and increases in the maximum loan size that the SBA will guarantee. At least as important are the programs that actually create jobs, like weatherization and infrastructure support.

But let’s face it, not all small businesses are bankable, even with SBA guarantees, some because they are not of a type easily financed under SBA programs; some because they need substantial help with business plans, accounting and other basics; some because their cash flow and longevity doesn’t yet support a bank loan—at least not without someone else taking part of the risk and doing some of the hand-holding. That’s where Community Development Financial Institutions, or CDFIs, like CEI come into play. CEI can take a business from initial business counseling through sophisticated real estate deals. Most of CEI’s activities are in the smaller cities and towns outside the southern part of the state. Some of the most exciting work, whether lending or equity investing through CEI’s venture capital subsidiaries, has been in finding those “on the cusp” small businesses that are ready to make a major leap into long-term sustainability and growth, and—frequently with bank partners—providing the kind of financing they need and the mentoring they deserve. 

At the start of this talk, I spoke about the Community Reinvestment Act, and I want to end there also. When CRA was enacted in 1977, the immediate catalyst was redlining on individual mortgages. But the statute is far broader, and over the years it has been interpreted to mean that banks and thrifts should engage in all the functions that are part of banking—lending, services and investments, including community development lending, services and investments—in all the communities they serve. The assertions by some that CRA caused the crisis are false for a host of reasons, such as the fact that only 6% of higher-priced loans made even in the boom year of 2006 were loans that would have counted for CRA purposes made by institutions subject to CRA. But well beyond that point, is the fact that CRA is not just about making single-family mortgages.

For many years, CRA has been a critically important catalyst for economic development in the underserved communities—including rural communities—of this nation. Not only have banks and thrifts put billions of dollars into communities directly, they have also been major supporters of CDFIs who make loans banks cannot. And while some of the investments involved have generated substantial financial returns, the government’s directive that all communities must be served, together with public evaluations of how well an institution is doing, have generated activities and investments that institutions would not have undertaken without this extra push.

 Some may ask “why should private entities be told by the government what to do?” Aside from the fact that every bank’s charter says it is supposed to meet the “convenience and needs” of its community, the events of the last 2 years have erased any argument that banks and other financial institutions exist in a pure free market. They exist in a market defined and supported by the government. But for the government’s support of the industry, some of the most important players probably wouldn’t be around today. And even the community banks and credit unions that have not received direct support exist within a system that enables them to operate with a level of leverage and opacity that would be denied to an unregulated entity. That the government asks them to serve all communities within their market area, “consistent with safe and sound operation” is not too much to ask, of banks or of other financial institutions.

It has been 15 years since the last revision of CRA regulations for large banks went into effect. These have been the years of spectacular increase in concentration in the banking industry, the rise of both virtual banks and banks with nationwide presence, the rise (and collapse) of a non-bank financial services industry that took substantial market share from those subject to CRA, and, for most of the past decade, little regulatory interest in CRA enforcement. There are many consequences of these changes. Two with the most impact are the reduced importance of support for community development—affordable rental housing, community facilities, economic development in underserved places—in the CRA exams and a significant diminution in the CRA obligation of, in particular, the larger banks, in the secondary or tertiary markets in which they operate. Ironically, the connection within CRA between community banks and community development has actually been strengthened during this period.

What needs to happen? Most broadly—and it’s hard in the face of the current economic and financial situation, but it’s also a part of the recovery—regulators need to elevate CRA to the status it had in the 1990s. We need a new mechanism to encourage greater community investment, a mechanism that focuses on meeting the actual needs of the community, not just counting dollars invested.   As a corollary, we also need to elevate the importance of the hard work of community development—the multi-layer affordable housing development, the difficult-to-pull-together economic development project—within CRA. Banks with huge footprints need to be held accountable to serve all communities within which they operate. And we need to broaden the statute’s reach beyond banks.

The American financial system has apparently survived a near-death experience, but remains under severe strain, as does the economy as a whole. This is a particularly difficult time for those who were challenged before, whether it’s the community whose major employer or livelihood has left and has been facing double digit unemployment for years or the family burdened by underemployment or health problems. We need to build a new financial system that is more sustainable not only for financial institutions, but more importantly for consumers, businesses, and communities in Maine and across the nation. Maine’s community banks, credit unions and community development financial institutions are showing the way. The nation can learn from them.

Click here for a PDF copy of these remarks.