Continuing our if-the-opportunity-will series of Great Posts By Others (GBPO), here are three more provocative slices of the housing finance world:

Down these mean streets a blogger like Jockin goes

2.1 Business for Development

The site Business For Development [Hat tip: Yousuf Marvi] advertises Martin H. Klein’s book, Poverty Alleviation through Sustainable Strategic Business Models, written from his doctoral thesis, which yields this AHI-resonant insight:

Conditions in the low-income context differ from those in high-income markets. These include differences in cultures, institutions, cognitions, dependence on the informal economy, economic development, living conditions, and motivation.

The per-customer revenues are minuscule, but the customers are limitless

The characteristics of the poor and the challenging circumstances in which these firms operate necessitate business model innovation to enable firms to operate successfully in low-income markets. This includes disruptive innovation in distribution, price-performance ratios, value chain management, workflows, organization, payment schemes, customer education, and human resource management. Hence, success at the BoP requires simultaneous disruptive innovation of multiple aspects of the ways in which firms do business.

To that I’d add, new financial products, such as Home Asset Finance.  Finance and governance are the DNA from which visions grow into Mission entrepreneurial entities (MEEs).  We don’t yet know how to grow them, so any insights that help are welcome:

Plenty of skills down there: DVD repair, Dharavi

Among the key features covered in the book are:

1. The first rigorous survey of pro-poor for-profit businesses. In cooperation with NGOs, development organizations and micro finance institutions, I collected a unique dataset of 143 firms operating in base-of-the-pyramid markets in a total of 105 countries. Their focal group of customers, employees, suppliers, and/or distributors have an average daily purchasing power of $2 or less.

2. Building upon this dataset, I develop a classification of the business challenges pro-poor for-profit firms face and investigate how these challenges change as firms develop and as the investment climate changes.

3. An examination and testing of the central postulate that embedding social and environmental value in a firm’s business model drives a firm’s financial performance at the base-of-the-pyramid. I find evidence that firms’ profit motive motivates firms to do well by doing good socially, and that addressing social issues is not adjacent but central to strategy at the base-of-the-pyramid.

That’s certainly correct.  If it’s not built into your DNA from the beginning, the talent updraft will always take you to more profitable, higher-income bands, and away from the BoP.

Always looking for the updraft, aren’t you?

4. A conceptual explanation of the concept of “business models” from a strategic management perspective.

5. Building upon case studies of pro-poor businesses, the book creates an understanding of why some businesses are successful at the base-of-the-pyramid whilst others fail.

6. A management support model for developing profitable pro-poor business models. I present business model qualities divided over five dimensions around which firms focused at the base-of-the-pyramid should build their business model.

The right model has to be fund asset management of social venture capital model, concepts we’re developing and putting into practice here at AHI. 

Rummaging about in Chapter 1 (available as a .pdf for free download), I found this useful listing of ‘business-school’ fallacies:

Prahalad and Hart (2002: 57) explicate six of such, often false, assumptions:

C. K. Prahalad is the doyen of BoP thinking, based on this book

1. The poor are not our target consumers because with our current cost structures, we cannot profitably compete for that market.

2. The poor cannot afford and have no use for the products and services sold in developed markets.

3. Only developed markets appreciate and will pay for new technology. The poor can use the previous generation of technology.

4. The bottom of the pyramid is not important to the long-term viability of our business. We can leave Tier 4 to governments and nonprofits.

5. Managers are not excited by business challenges that have a humanitarian dimension.

6. Intellectual excitement is in developed markets. It is hard to find talented managers who want to work at the bottom of the pyramid.

All this is incredibly thematic with AHI’s work, so we’ve ordered a copy.

2.2 Access Housing, from FinMark Trust

FinMark’s banner

Access Housing, published by South Africa’s FinMark Trust, whose housing director Kecia Rust is an AHI affiliate, puts out a fantastic periodical [Hat tip: Kecia Rust], Access Housing, whose most recent issue shines a spotlight on South Africa’s Financial Sector Charter:

Kecia Rust, FinMark Trust

The first phase of the Financial Sector Charter came to an end on 31 December 2008. By this date, it had been promised that financial institutions would lend R42 billion into the low income housing sector, with a promised growth in net book value of R32 billion.

Five years ago, I twice spent a week with the Banking Association, helping them brainstorm ways the banks could collaborate on structure and compete on products and customers to meet the target. 

I also got a little time for game parks

They were heady days, and it appears in some small way, we contributed to pointing the banks in the right direction.

They did it!

All too often advocates find fault or quibble about success.  Nice to see Kecia giving credit where it is due.

You gotta give it, Ali G

More so even.

Unaudited figures from the Banking Association show a total value of R44,8 billion originated by the Big 4 banks (Absa, FNB, Nedbank and Standard Bank), constituting a total of 984 730 loans extended to the FSC target market between January 2004 and 31 December 2008. This is no small task and the housing sector has clearly benefited.

In a paper prepared for the FinMark Trust by Linda Sing [Scoping the Pension-backed Loans market, forthcoming on the FinMark web site – Ed.], Linda offers the following analysis:

“With the commencement of the FSC, originating banks invested aggressively in resources and significantly heightened focus on the lower income market. Through 2004 to mid-2007, this resulted in historically pent up demand for housing finance being satisfied through a frenzy of marketing initiatives, amply bolstered by a generally booming property sector. Towards the end of 2007, however, the effects of the sub-prime crisis and the shortage of housing stock finally began to take effect, and the sector’s performance was only salvaged by a few, exceptional property finance transactions. The apparent spike in unsecured housing loans is mainly due to previously unavailable data being included in the report, following upgrades to banks’ measurement systems, rather than an actual increase in the number of loans granted.”

All this shows in the charts, with steady loan numbers and a falloff in aggregate loan volume, as the banks, having picked all the low-hanging fruit, were moving down-market almost in spite of themselves.

Excellent work – thorough, quantitative, evenhanded.  Read the whole nine-page issue, and subscribe (free) to Access Housing.

2.3 Future Pundit

In the century of cities, public transportation will be essential – but let us not think public transportation a panacea, as revealed in this HIGH-VOLUME POST, Mass transit is hard on your hearing

Hard on what?

Contrary to the view in some quarters that mass transit is an unalloyed blessing, buses and subways around New York City generate harmful levels of noise.

Cities are intrinsically noisy, and city streets very noisy, as anyone knows who’s tried to hold a cell-phone conference call outdoors in a city.

Using sensitive noise dosimeters, the team of researchers, led by exposure scientist Richard Neitzel from the School of Public Health at the University of Washington and Robyn Gershon, DrPH, an environmental and occupational health scientist and faculty member at the Columbia University Mailman School of Public Health, conducted hundreds of measurements of noise levels at platforms and stations, as well as inside of vehicles on New York City subways (MTA and PATH), buses (MTA), ferries (Staten Island), commuter railways (LIRR, SIRR and Metro North), and the Roosevelt Island tramway.

Gershon descended into noisy subways so you don’t have to

The scientists found that on average, the MTA subways had the highest noise levels, at 80.4 decibels (dBA), followed by the Path trains, at 79.4 dBA, and the tram, at 77.0 dBA.

Having ridden both systems, I can attest that when it comes to noise, Boston’s subways are little better.  Nancy and I often ride the Boston subways, and she’s taken to plugging her ears when trains are squealing around

The lowest average levels measured, 74.9 dBA and 75.1 dBA, were obtained from the LIRR and Metro-North trains, respectively. The very highest levels measured in the study were found on an MTA subway platform (102.1dBA) and at a bus stop (101.6 dBA).

In contrast, the noise level of a whisper is 30 dBA, normal conversation is 60 to 70 dBA, a chainsaw is 100 dBA, and gunfire is 140 dBA.

Quieter than an MTA subway?

According to Dr. Gershon, of all mass transit, subways had the highest noise levels, with roughly half of the maximum levels exceeding 90 dBA. “At some of the highest noise levels we obtained (ex. 102.1 dBA on the subway platforms), as little as two minutes of exposure per day would be expected to cause hearing loss in some people with frequent ridership, based upon the International Organization for Standardization models for predicting hearing impairment from noise.”

Here’s the authors’ punchline, from their study’s abstract:

Conclusive, I think

Conclusion

Recent research has shown that many construction workers are exposed to levels of noise which are high enough to cause permanent noise-induced hearing loss.  In Washington state, construction workers represent approximately 7% of the workforce, but file 21% of accepted workers compensation hearing loss claims. Obviously construction noise exposure and the resulting hearing loss is a big problem. A number of research groups and regulatory agencies are working on ways to lower construction noise exposures and reduce hearing loss claims. While noise control efforts have the best chance at long-term success, effective hearing conservation programs will always be needed to insure that workers receive adequate training and protection from noise exposure.

Here’s the blogger’s point, one not to be lost:

Cars take you from where you want to start to where you want to end up. You can control who you ride with. You can choose a car with very good noise insulation and a quiet engine. You can choose which music to listen to and do not need ear plugs to listen to it. Granted, you have to drive and pay attention to the road. Cars come with trade-offs.

But given the advantages it is not surprising that most people choose to drive.

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The previous two parts of this post introduced us to Howard Husock’s argument in City Journal, recapitulating themes he’s sounded over years and years, that the Community Reinvestment Act is the worm in capitalism’s apple that sucked banks into making bad loans.

CRA?

It’s particularly tough because the CRA’s had gone three decades without creating a crisis.  It was enacted 31 years ago, added tough regulatory teeth (in the form of merger-approval requirements) 20 years ago, and became critical for banks a decade past.  If that is a deadly virus, its infection rate is glacial.

While opinions vary on how long the current crisis in our housing and financial markets will last, its principal causes are clear. 

Exceptionally low interest rates

High levels of available capital

The advent of mortgage securitization

combined to spur overinvestment in housing—and underinvestment in the sort of due diligence that once typified lending.  [Reformatted for clarity – Ed.]

What inconvenient drivers?

I am mightily impressed with the easy way Mr. Husock leaps over the three principal drivers, none of which have anything to do with CRA, to focus on the lesser ones.

But as with most events of such magnitude, a long chain of subsidiary causes also played a part.

Mr. Husock would hotly deny that he is a foe of affordable housing.  He argues – wholly wrongly, in my view – that any deviation from rock-ribbed underwriting will ipso facto destroy neighborhoods. 

The crucial link was the extension of CRA-type thinking and regulation to the secondary mortgage markets through the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, which buy loans from banks in order to provide liquidity.

Another bouncing leap of logic – “CRA-type thinking” isn’t CRA.  Guilt by implication and intimation?

As one former Fannie Mae official puts it: “Both HUD and many advocates in the early 2000s were anxious for the GSEs to extend credit to borrowers with blemished credit in ways that were responsible.”

If Mr. Husock can add emphasis, so can I.  Extending credit responsibly to those with blemished credit is the essence of both financial forgiveness and financial expansion.  To read into that as an endorsement for band lending is absurd.

You got a problem with how I interpreted the quote?

How were such goals to be met? Crucially, subprime loans didn’t only allow banks to meet their CRA lending requirements; sold to Fannie and Freddie, they could also help the two secondary mortgage giants meet their affordable-housing targets.  

The GSEs’ hands aren’t clean here either; for several years, instead of competing with questionable lenders, they enabled them through buying their paper.  For that casual and cynical approach they (and we) have now paid dearly.

Not all subprime loans, or even a majority of them, were made for CRA-related reasons—the combination of cheap money and imprudent borrowers clearly made for a tremendous bubble.

Here we go again with the false syllogism:

Many lenders made risky loans. 

Some lenders were motivated by CRA.

Therefore CRA is the cause of all bad loans.

My logic is so graceful you fail to notice I never ground it

Don’t try to diagram that logic sequence, folks.

Sensors indicate your sequence is totally illogical

If CRA were to blame, then why did the world create all that subprime not bought by banks?  Why are foreign markets (e.g. England, Ireland, China) showing the same ills?

Every one of us is a sick economy

But such loans, bundled into asset-backed securities, were purchased (according to a June 2007 HUD report) especially by Freddie Mac to help fulfill its affordable-housing goals.

As recently as April of this year, Fannie actually boasted about “mortgage products and options,” which included “reduced requirements for down payment and closing costs, choices for borrowers with less than perfect credit and flexibility to provide loans to home buyers with no traditional credit history.”

In 2005 alone, Fannie Mae purchased some 3.8 million loans that could help them achieve affordable-housing targets.

I’ll give him that; I commented on it in Who’s next?

How many of the troubled Fannie/Freddie loans were also used for CRA purposes by banks that originated them? It’s impossible to know; regulators haven’t done a rigorous assessment.  

Nor have CRA advocates pushed for any performance tracking.  

Why would they?  That’s the regulators’ job.

“Don’t torture yourself, Gomez.  That’s my job.”

But they were certainly implicated in our present situation. One chief executive of a significant New York bank recently told me that Fannie Mae “scooped up” all of the CRA loans he originated.

That means ‘bought at a favorable price,’ not ‘deliberately bought bad loans.’ 

But the CRA advocates, including the New York Times [Damned by the company they keep? – Ed.], continue to claim that CRA-qualified loans made by regulated financial institutions performed well and shouldn’t be implicated in our current troubles. They point to the results of an evaluation of CRA loans by North Carolina’s Center for Community Capital, which found that such loans performed more poorly than conventional mortgages but better than subprime loans overall.

A moment ago Mr. Husock was griping that CRA advocates were uninterested in performance tracking; now he cites a study by a group I presume favors CRA.  Which is it?

What they don’t mention is that the study evaluated only 9,000 mortgages, a drop in the bucket compared to the $4.5 trillion in CRA-eligible loans that the pro-CRA National Community Reinvestment Coalition estimates have been made since passage of the Act.

Just out of curiosity, why would one expect a North Carolina group to study loans outside of North Carolina?  A huge sample in a reasonably representative state must be meaningful, and statistically relevant in its state, even if not nationally valid.

Follow again the leaps of logic:

No national data proves my assertion.

The only available statewide data disproves my assertion.

Therefore the available data is useless.

It’s easy when you defy logical gravity!

There has been no systematic study, by either the Government Accountability Office or the Federal Reserve, of the performance of loans cited by banks in their CRA filings.

From a policy perspective, this would be very worthwhile.  It would be great if the GAO or Fed would undertake such a study. 

Many such loans weren’t even underwritten by the banks themselves, which often purchased CRA-eligible loans (advertised in such publications as American Banker) and then resold them.

Good God, advertising loans for sale.  Is nothing sacred?

Advertising?  Like, so ga-ross!

Again, the emphasis was on showing regulators that loans were being made—not how they were performing.

CRA inspectors aren’t looking at safety and soundness; other bank regulators do that.  When OSHA comes to check your factory, do they ask to see your financial statement?

Bank examiners began using federal home-loan data—broken down by neighborhood, income, and race—to rate banks on their CRA performance, standing traditional lending on its head. In sharp contrast to the old regulatory emphasis on safety and soundness, regulators now judged banks not on how their loans performed, but on how many loans they made and to whom.

Banks are subject to two sets of regulatory reviews!  One for safety/ soundness, one for CRA!

He must be trying to be obtuse, mustn’t he?

As one former vice president of Chicago’s Harris Bank once told me: “You just have to make sure you don’t turn anyone [Qualified – Ed.] down. If anyone applies for a loan, it’s better for you just to give them the money. A high denial rate [Relative to credit scores or peers -- Ed.] is what gets you in trouble.”

There’s no way this unverifiable quote can mean what Mr. Husock wants it to mean – loans without qualifications, loans without underwriting.  Notice how the addition of a few implicit qualifiers [At your service – Ed.] defangs it entirely.  Mr. Husock also drags in recent Republican bogeymen ACORN and the Neighborhood Assistance Corporation of America (NACA), whose tactics I have found deplorable, whose credit-taking I have found implausible and self-aggrandizing, and whose pugnacity I have found counterproductive – but these are only one player; they neither stand for the whole nor represent any significant fraction of the aggregate loan volume.

How could such a system not lead to problem loans and high delinquency and foreclosure rates?

It’s called “underwriting.”  It’s also called “the profit motive.” 

Both political parties are guilty. Democrats were largely responsible for the Fannie and Freddie affordable-housing goals, but the Bush administration promoted the idea of letting holders of Section 8 rental-housing vouchers—very poor households—use their housing subsidy as a down payment on a mortgage.

This is a complete non-sequitur; people who got into homeownership using Section 8 vouchers are a minuscule fraction of all households.

Let’s allow these market mechanisms to operate, rather than relying on regulatory mandates and the political risk they introduce into financial markets.

There’s only one problem with that laissez-faire approach: Slums are economically rational, and slums are unacceptable.

The South Bronx, 1975: two years before CRA

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It’s becoming fashionable, among policy journalists (and even certain ex-CEOs of Fannie Mae) to suggest that the devil made them do it, that somehow pressure to extend affordability overrode all their instinctive prudence and led them down the primrose path to America’s financial ruin.  Don’t blame me, runs the refrain, blame the Community Reinvestment Act that seduced me into making all these bad loans.

The CRA made me go down that road!

The flare of my intellectual indignation went off as soon as I read the title of a Howard Husock article in City Journal:

A generation ago, the government began forcing banks to make bad loans.

‘Forcing’?  ‘Bad loans’?  Ay, caramba!

To be explicit right up front:

It was either this or trying to find a safe Google image for ‘explicit’

Don’t blame CRA for bad loans any more than you blame the profit motive for bad loans.

To wit:

Nobody was forced to do anything.

Lenders had no incentive to make bad loans.

Just make sure someone else is holding it when it explodes

It seems clear that we have, as a matter of national policy [Or market action? – Ed.], pushed too many households toward homeownership.

There’s no question we boosted the homeownership rate too high – but was that policy, runaway financial technology such as securitization, a market drunk on risk-taking, or just bad luck?

Nothing in the CRA anywhere recommends, endorses, incentivizes, or rewards make un-creditworthy loans.  Nothing asks banks to lower their standards.  Rather, CRA wants banks to demonstrate they are applying rational credit standards evenhandedly, and uses percentage penetration (relative to deposit-taking) as the test.  If you take money from a community, the community must have enough money so you could lend or invest it back – at suitable spread.

Mr. Husock giving a social entrepreneur of the year award

What then is Mr. Husock’s case that the CRA ‘made’ lenders make ‘bad’ loans?  He tacitly equates CRA lending with a lowering of credit standards, which it is not and not what it is supposed to be.  In pursuit of CRA market share, banks may lower their profit margins on some CRA loans – they do this for normal loans. 

It’s no surprise, then, that as early as 1999, the Federal Reserve Board found that only 29% of loans in bank lending programs established especially for CRA compliance purposes could be classified as profitable.

Presumably they’re unprofitable because the spread is narrow, meaning the loans are cheap.  From my perspective, that’s a good thing; it means they’re affordable to the customers.  I’d expect that anyhow; since CRA-qualifying assets are desirable, you’d expect that desirability to be factored into the price.

Nor does low profitability worry me.  Banks do lots of things that are unprofitable, if examined solely in isolation.  Open new branches; teaser introductory credit card rates; establish private banking units; advertise.  Like anybody else, banks leaven their product offerings and price points based on an overall strategy of bank profitability.  Getting a favorable CRA rating through large low-profit activity creates merger and acquisition options of considerable value.  Lowering margin is entirely different from lowering credit standards – actually it’s the opposite, since banks normally lower margins on better credits, not worse ones.

The once-obscure Community Reinvestment Act, passed during the Carter administration, has recently—in part because of my reporting—become a bogeyman for Republicans, some of whom have proposed its repeal.  Liberal Democrats have defended it as unrelated to the meltdown. The truth lies somewhere in between.

As we’ll see, Mr. Husock’s work is less reporting than argumentation from his intellectually entrenched position:

Howard Husock, a contributing editor of City Journal, is the Manhattan Institute’s vice president for policy research, the director of its Social Entrepreneurship Initiative, and the author of America’s Trillion-Dollar Housing Mistake.

Any doubts about his perspective?

While not entirely free from logic or evidence, it is long on assertion and anecdote, short on statistics or balance, and strewn with Crouching-Tiger leaps of logic. 

No grounding necessary!

His piece reads like a believer searching for confirmatory signs than a disinterested observer weighing the data.  Any question where Mr. Husock stands?

Indeed, the numbers he cites he must largely explain away, as we shall see.

I can explain that …

While it’s a long way from the late-seventies world of the original Act to the twenty-first century’s housing crisis, the CRA’s role was important.

At the time of the CRA’s passage, the world of banking was, as Monty Python would put it, something completely different.  Banking was largely a local industry; indeed, interstate branch banking wasn’t legal yet. Mortgage lending, moreover, was largely the province of just one sector of the banking industry—the so-called “thrift” or savings and loan institutions, which had a long-standing deal with government.

Accurate so far. Banks were local; they took deposits locally, and they lent locally … but by the 1960’s, ‘local’ meant ’statewide’ and statewide encompassed both the growing suburbs and the shrinking, imploding cities.

They would pay relatively low rates of interest to their many small depositors in exchange for charging relatively low interest rates for home loans.

He’s making a quid pro quo that I believe is unjustified.  Banks lent cheap because everybody was used to really low interest rates.  Inflation was equally low.

The limited earnings spread strongly discouraged risk and, combined with the lack of bank competition, undoubtedly limited many neighborhoods’ access to credit.  This came to be known as “redlining,” which led many advocates for the poor to conclude that only a legislative mandate could guarantee that those of modest means, living in struggling urban areas, had access to credit. (Back then, I was a crusading left-wing journalist pushing for just this kind of regulation.)

Whoa, whoa!  That’s not the red-lining I remember.

Redlining had little to do with banks charging low interest rates on their loans.  It had everything to do with a perception that banks were not making loans in black neighborhoods.  The banks said they were exercising normal credit procedures, refusing loans because values would inevitably decline. 

Philadelphia lending map, 1937: don’t lend in red, lend in blue

What the banks claimed was prudence, others saw as racism.  I think the truth was two parts economics, one part bigotry, and one part laziness.  Banks didn’t lend in these neighborhoods because ‘those people’ lived there, and I wouldn’t live there, and really, how could you make a loan like that when everybody knew the cities were doomed?  So it was easy, all too easy, to decline credit.  You might take deposits in Roxbury, but you wouldn’t make loans back into Roxbury, you’d lend in Sudbury or Duxbury, the safe white suburbs.  The net effect was a wealth-extraction machine, money taken out of a community and not put back –

You won’t be needing those deposits

–         and therefore, went the reasoning, you were accelerating the decline of neighborhoods by failing to lend back into them. 

For the record, I think that policy reasoning was sound, and is sound today.  Retail banks will take risks presented to them by people in embroidered suspenders; they shy away from risks presented by people with dirt under their fingernails.

The legislative justification for CRA was equally straightforward.  Banks operate under Federal licenses; they access a critical Federal resource (deposit insurance via FSLIC).  They used this resource to take the deposits (because people wouldn’t put money in a bank without some confidence of recovering it) which were a critical source of low-cost capital for their lending.  Since banks availed themselves of Federal largesse to collect their money, they had a duty to follow Federal desires in disbursing that money –

– Provided that the banks were allowed to exercise normal banking prudence.

Nothing in the CRA mandates bad loans. 

Nothing in the CRA incentivizes bad loans. 

In the long run, nobody ever makes money by making bad loans. 

Isn’t this obvious?

[Continued tomorrow in Part 2.]

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