Congress should set up a new Federal Reserve System to fund and regulate community development banks, an economist told a panel of law-makers this week.

Dimitri B. Papadimitriou, executive director of the Levy Economic Institute at Bard College in Annandale-on-Hudson, N.Y., said the model most frequently suggested for development banks - South Shore Bank of Chicago - will not work on a national scale.

South Shore relies on socially responsible people to invest in the bank - and accept below-market returns, Mr. Papadimitriou told the House Small Business Committee's subcommittee on Regulation, Business Opportunities, and Technology.

But relying on philanthropy to support a nationwide bank system would be unrealistic, Mr. Papadimitriou said.

He also dismissed proposals to offer existing banks Community Reinvestment Act credits for investing in development banks, and proposals to federally guarantee their own developmental lending.

"Credits are inappropriate because they would not strengthen CRA lending, and federal guarantees would just establish a new welfare system," Mr. Papadimitriou said in an interview. "Community development banks should be as profit-seeking as commercial banks."

Under his proposal, Congress would earmark $1 billion for a Federal Bank for Community Development Banks. The new "Fed" would match up to $5 million in private investment in the new banks, playing the dual role of investor and regulator.

The proposal is drawing fire from all quarters.

It "will never fly in Congress," said James D. Vitarello, president of James Vitarello Development Associates in Washington.

Mr. Vitarello, who formerly ran community development programs for the Office of the Comptroller of the Currency, said "it's very dangerous to put the promoter, the funder, and the regulator under the same tent."

|Reinventing the Wheel'

Jeana Wooley, who heads the North/Northeast Development Bank Organizing Group in Portland, Ore., said a new banking superstructure would limit the flexibility of development banks. She added that development banks should operate in concert with commercial banks, "handling all the regulatory minutiae for them."

Steve Verdier, senior legislative counsel for the Independent Bankers Association of America, said Mr. Papadimitriou's proposal would mean "reinventing the wheel when everyone else is talking about working within the existing system."

According to Rep. Ron Wyden, D-Ore., who is chairman of the Small Business subcommittee, President Clinton is about to unveil his plan for community development banks. It is expected to call for a pilot effort, with $380 million earmarked for 12 to 15 new banks.

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