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Commentary By Howard Husock

Racing To Save ShoreBank, Spawn Of CRA

The news that Goldman Sachs and a group of other leading banks may ride to the rescue of ShoreBank, by industry standards a tiny institution based on Chicago’s South Side, should add a new phrase to the justifications for bailouts. To “too big to fail,” add “too good a cause to fail.”

For ShoreBank has, since the 1970s, been exhibit A in the U.S. version of a new economic project based in the belief that a bank can serve what would be termed a “double bottom line” — operate profitably while self-consciously pursuing a social goal of serving lower-income households in so-called “underserved neighborhoods.”

Yet until Goldman, along with Bank of America, Citigroup and JP Morgan Chase, came forward as white knights potentially carrying a $125 million capital infusion, this noble institution was, after years of struggle, about to fail, according to the FDIC.

In a world of common sense about how a business actually operates and what’s actually best for the poor, that would put an end to an illusion. Instead, a ShoreBank rescue makes clear just how strong are the forces emanating from government to continue the failed experiment that has come to influence the financial system broadly.

Like the 1977 Community Reinvestment Act that its founders supported, ShoreBank was predicated on the belief that traditional financial institutions fail to recognize profit-making opportunities in poorer communities — and thus leave open a market niche that combines social goals with earnings.

It was a message that made it a darling of progressives. It branched to other Rust Belt cities, established (at then-Gov. Bill Clinton’s request) a version of itself in Arkansas and helped develop a complex tool kit of financial instruments of the sort that Nobel Prize winner Muhammad Yunnus of the micro-credit lender Grameen Bank (advised by ShoreBank when he started out) has described as a new sort of capitalism — “social business” meant to “address a social problem not to maximize profit.”

ShoreBank morphed into a “community development financial institution” channeling investments from liberal foundations into complex financial instruments, such as a non-profit affiliate established in 2007 to make $3.9 million in grants, loans and “technical assistance” to help revive Detroit. It took on international advisory roles.

That FDIC is not at its door does not, in fairness, mean there wasn’t some truth to the idea that spurred ShoreBank three decades ago. Banks in a pre-1980s regulatory era that prohibited interstate branching and effectively limited the interest-rate spread on home mortgages might, with little incentive to take on risk, have engaged in “red-lining” neighborhoods. Nor had credit scoring, which lets lenders gauge risk based on individual habits, not zip code, been invented.

But among the lessons of the burst housing bubble one must include this one: Lending on the basis of nonfinancial criteria, although it may be a defensible form of philanthropy, is not good either for poor neighborhoods or the larger financial system.

HUD and congressional pressure on Fannie Mae and Freddie Mac to meet ever-increasing “affordable housing goals” have now left American taxpayers with billions in bad debt — and neighborhoods pockmarked by foreclosures that do terrible damage to the fortunes of thrifty neighbors.

The Community Reinvestment Act, which very much reflected the ShoreBank model, was similarly used to push major banks to make loans on the basis of geography and income status, not ability to repay.

But the fact that Goldman Sachs would personally discuss the importance of saving ShoreBank makes it clear the lesson that traditional credit criteria and bank competition are the best way to serve the “underserved” has not been learned.

Goldman clearly views it in its interest — no doubt with an eye toward the CRA rating with which it must now be concerned as a bank holding company — to shore up ShoreBank. That Goldman CEO Lloyd Blankfein would use his “good offices,” according to one account, reflects the wave of corporatism that has made private financial (and industrial) institutions, once-saved by government, inclined to seek its favor.

Notably, President Obama, in Kenya as a senator, spoke favorably of ShoreBank’s micro-lending program. Worse still, the model of credit allocation by fiat is gaining, not losing, traction. The so-called CRA Modernization Act would extend the philosophy throughout the financial services industry — including to insurance companies.

Expect spin from ShoreBank’s devotees — that it was victimized by a recession that bad lenders caused, that loans such as those called for by the CRA don’t normally go bad. But the fact it will survive only on life-support should sober up a Congress that has never required banks to report separately on the performance of their CRA loans and serve as a reminder it’s no small feat to serve even one bottom line successfully.

This piece originally appeared in Investor's Business Daily

This piece originally appeared in Investor's Business Daily