Last month, Muhammad Yunus united a divided Congress. The leaders of the House and Senate just minutes after a failed compromise on gun legislation stood in the Capitol Rotunda to award the Nobel Prize winner and founder of Grameen Bank the Congressional Gold Medal.
Grameen Bank is the world's first microfinance institution a "bank for the poor" that gives small-dollar, no-collateral loans to the most destitute citizens of Bangladesh. It didn't begin as the work of a global bank or a government. It was a private project started by an economics professor, who wandered into a rural village and was appalled to see local loan sharks preying upon desperate people. It was, in other words, an experiment. But it showed, and has shown for decades, the positive power of finance and banking.
Finance has the power to lift families out of poverty, provide them education and opportunity where traditional charity has failed to take root. The global financial crisis has distracted us from this truth at the worst possible time. The housing crisis has decimated the savings of middle-class Americans, just as fiscal tightening has begun to take a toll on social spending. The impact has fallen hard along existing fault lines, like race. A recent study by the Urban Institute found that, before the recession, non-Hispanic white households were four times wealthier than black and Hispanic households. Today, they are six times wealthier.
Finance can do more than stanch the bleeding. Access to safe, fair credit can reverse the trend. But as Grameen Bank shows, finance only works when there is room for experimentation. When Yunus made his first loan, women were a bad credit risk by traditional standards. They rarely had any credit history, they controlled little wealth, and their incomes were low to nonexistent. His audacity was to show that past experience was wrong, and millions of borrowers have reaped the benefits.
Bad experiments will still lead to bad resultsand as we have seen, without sensible regulation, they can do broad and lasting damage. But when experiments in lending are properly organized and priced, they can be successful for borrowers and lenders of all income groups, even in tough times. Striking the right balance is a matter of preserving a space for well-supervised innovation, just as we did with micro-credit programs a generation ago.
The housing market, as one of the most sensitive and fast-changing since the crisis, is an ideal example. Regulators have rightly focused on the outsized risk that built up in the housing bubble, and they have introduced new regulationsstandards for qualified mortgages, even stricter standards for qualified residential mortgages, not to mention mortgage servicing, loan originator compensation and other rules. Some of these requirements, however, would undercut lending to the groups who would benefit most from it. Take, for example, the 20% down payment requirement on QRMs, which is reflected in a similar requirement for Category 1 mortgages under Basel III. These proposed requirements would disproportionately affect otherwise-creditworthy minority borrowers, whose ancestors were unable to accumulate and pass on wealth in this country until a generation ago.
Limiting borrowing for homeownership to those who can afford a 20% down payment is not just unfair, it also flies in the face of evidence that other factors can matter more, at least collectively, in safely underwriting a loan. Private mortgage insurance, credit history, job stability and, of course, income speak volumes as well. Financial institutions should be able to experiment with this information and serve the disadvantaged.
The regulatory agencies can encourage moderate experimentation as well. One possible mechanism is a "safe harbor" approach to certain lending programs, which could be pre-screened by the relevant agencies in terms of borrower criteria, performance history and overall size in a given institution. Such a "safe harbor" approach could be provided through a "no-action letter" procedure, reminiscent of those used by other federal agencies.
Finance can ultimately be an instrument for goodand in a time of fiscal strain, the role it plays is even more vital. It can be an instrument of enormous public good, if we give it the right room to grow and evolve. Congress, and its most recent Gold Medal recipient, should continue to remind us of this lesson.
Eugene A. Ludwig is a founder and the chief executive of Promontory Financial Group LLC. He was the comptroller of the currency in the Clinton administration.