Numerous politicians and banking theorists have recently tried and failed to say what a "community development bank" is supposed to be and how it's supposed to work. They ran into the following problems:
The organizations envisioned will probably not be profitable enough to attract equity capital.
If these organizations are to be banks, not welfare programs, they must engage in credit, not grants. The earnings on the loan portfolios must cover all losses and expenses if the institution is to be a sustainable entity.
Self-help is the best kind of help. But the question remains of how to combine this with productive public support.
Rediscovering Mutuality
Also, such organizations should be owned and managed by local people. Yet at the same time, the federal government is to be involved.
All these problems can be successfully addressed by the rediscovery of a very old financial idea -- mutuality. This concept was historically considered inseparable from local thrift institutions, and reflected the community ideals of cooperation and self-help.
The mutual savings and loan association, which enjoyed decades of growth and success, had key characteristics.
It was an association, not a stock corporation, and it's purpose was not maximum profits, but the mutual financial progress of its members. It was considered by contemporary supporters as part of a movement for individual and social improvement, and as "a great character-building and community-building business."
It was a local organization, often started as a neighborhood club. It was also, as one historian put it, "generally patronized by persons in what we now call low income categories."
It gathered and cared for the savings of the local community, and its mission, according to a backer, was to promote "thrift, self-denial, temperance, simple living, success and independence." These federal associations were especially to be organized in communities that lacked a local thrift institution.
Its credits were to be sound, always based on first liens on property close to the association and thus known to its management and board. It was to be a self-sustaining economic organization. A confirmation of the theory comes from a recent Office of Thrift Supervision research report, which concludes that during the 1980s, mutual institutions were significantly less risky than those in stock form.
It was a commitment of the local community to help itself Funds invested in the association were equity or "shares," not debt and not deposits (a surprising notion to us now).
Each Member a Part Owner
Savings shares were equity investment in the creditworthiness of local people. Although the idea subsequently became blurred and then lost, the historical thinking about mutuality was very clear on this point.
A classic text stated: "The building and loan association pays all the profits to its members. Each member is part owner of the business, assuming an ownership risk. In building and loan associations, the risk is negligible, it is true, but no emphasis on this fact should be allowed to cloud the issue. The building and loan member is an owner of the business."
Also, its management was local. Training and development of local management was a key requirement in the 1930s and would be again today.
Government Investment
It could be helped by the federal government investing on a matching basis by the purchase of preferred shares in an amount up to the investment raised locally. These shares had to be retired beginning five years later. Such matching preferred investments were made in sizable amounts (a total of $225 million, which is equal to about $2.3 billion today) and with notable success. After deducting the losses that inevitably occurred, in total the Treasury recovered its entire principal plus a yield of 3%.
Finally, the institution was exempt from federal taxes.
These points provide an excellent outline of a coherent design for a community development bank.
Blueprint for Success
That this design worked is amply demonstrated by history. The notorious class of savings and loans of the 1980s, which have made the very term suspicious to us of short memory, bore little or no relation to the successful social design of preceding decades. To return to the original concept, we need to return to something very like the original form of the Home Owners' Loan Act of 1933.
This law created the charter of federal savings and loan associations.
Here, in excerpts quoted from the original 1933 Act, is an attractive structure that could be used for community development banks. (To correct for the depreciation of the currency, the amounts specified should be multiplied by 10.)
* "The purpose is to provide local mutual thrift institutions in which people may invest their funds."
* "Such associations shall raise their capital only in the form of payments on such shares as are authorized in their charter. No deposits shall be accepted and no certificates of indebtedness shall be issued."
* "Such associations shall lend their funds only on the security of their shares or on the security of first liens upon homes or combination of homes and business property within 50 miles of their home office. Not more than $20,000 shall be loaned on the security of a first lien upon any one such property."
* "The board shall have full power to provide for the reorganization, consolidation, merger, or liquidation of such association, including the power to appoint a conservator or a receiver."
* "No charter shall be granted except to persons of good character and responsibility, nor unless necessity exists for such an institution in the community to be served."
* "Each such association shall become a member of the Federal Home Loan Bank of the district in which it is located."
* "The secretary of the Treasury is authorized on behalf of the United States to subscribe for preferred shares in such associations which shall be preferred as to the assets of the association and which shall be entitled to a dividend, if earned, to the same extent as other shareholders.
"Subscription to the preferred shares of any one association shall not exceed $100,000, and no such subscription shall be called for unless the funds are necessary for the encouragement of financing in the community to be served. The amount paid in by the secretary of the Treasury shall at no time exceed the amount paid in by all other shareholders.
"To enable the secretary of the Treasury to make such subscriptions there is hereby authorized to be appropriated the sum of $100 million."
* "Such associations, including their franchises, capital, reserves, and surplus, and their loans and income, shall be exempt from all taxation now or hereafter imposed by the United States."
In Current Dollars
When we adjust the amounts from 1933 to current dollars, we find that the lending limit against any individual property is $200,000; the matching preferred stock investment available from the Treasury is up to $1 million per association; and the total appropriation for such matching investments is $1 billion.
Note that this would result in enough appropriation for 1,000 associations.
A number of implications and variations on the theme, of course, need consideration. Membership in the Federal Home Loan Bank System might be voluntary, not mandatory. An appropriate regulatory design is required. Government-guaranteed loans, such as Small Business Administration loans, might be allowable assets. All detailed issues can be settled when there is a framework.
We suggest the basic framework to create what could be called "federal community development banking associations," is logically articulated in the original 1933 version of the Home Owners' Loan Act and is available to reenact, mutatis mutandis.
Mr. Pollock is president and chief executive officer of the Federal Home Loan Bank of Chicago.
