By James L. Greer and Oscar Gonzales
The authors wish to stress that the opinions and views expressed here are theirs and theirs alone and do not reflect the position of the Department of the Treasury or the Federal government.
Money+Purpose announced the publication last month of the first comprehensive economic study of CDFIs in the context of fiscal and tax policy. James Greer and Oscar Gonzales, the authors, have agreed to provide short summaries of key parts of their analysis. The first appears below.
Community Economic Development in the United States: The CDFI Industry and America’s Distressed Communities documents the positive impact the CDFI industry has had in distressed documents the positive impact the CDFI industry has had in distressed urban and rural areas in the U.S. and examines the development and achievements of the American community development movement. It analyzes the roles of government, private philanthropies, non-profits, religious organizations, and for-profit community development agents within a framework of market failures that have led to disinvestment, credit rationing, and social unrest in economically distressed areas.
CDFIs have successfully forged bottom-up, locally-based strategies that provide affordable housing, foster business development, job creation, and provide much-needed community facilities, in highly distressed areas in inner city neighborhoods, rural communities, and also in Native-American areas. In many areas of the U.S., CDFIs represent a viable alternative to the mainstream banking industry and to high-priced loans such as payday lenders. Fiscal and tax policies are able to bring innovations such as healthy foods financing, federally qualified health centers and community clinics, community centers, manufacturing, and affordable housing to rural and urban distressed areas.
A Summary of Market Failure and thePossibilities of Community Economic Development
We begin by identifying the underlying reasons why economic development lags, sometimes severely, across America’s communities—those places and populations served by the CDFI and NMTC industries. America’s inner city neighborhoods, much of its rural areas, and not an insignificant proportion of the inner ring of suburbs in the nation’s metropolitan areas suffer from diminished economic development and investment for several reasons, each of which mirrors and magnifies the other. We identify four basic sources of what economists refer to as “market failures”.
One, the uneven development and indeed widespread obsolescence of the “built environment”—the totality of the basic infrastructural system (the streets, utility systems, rail lines, etc.), offices, manufacturing plants, warehousing facilities, and most prominently housing—contributes to the distress of many areas of the country as well as underpinning vibrant growth elsewhere.
America’s cities and rural areas have been built up over decades and as the needs of the economy and the tastes of families for housing amenities change the basic tendency in America is to build new housing and the facilities for economic activities on the fringes of the city and increasingly the metropolitan area. Over time, especially since the end of the Second World War, much of the cores of inner cities were abandoned by companies, families, and financial institutions and economic and population growth dominates outlying suburbs. Since most elements of the nation’s “built environment” are long-lasting investments and fixed in place, obsolescence takes root in the older areas of the nation’s metropolitan areas. Not only does this put such communities in the backwaters of the economy, this process leads to widespread abandonment by businesses and families in such communities. Worse still, the historical process of investment is skewed, leading to a process of systemic disinvestment across wide swaths of central cities as well as in innumerable small towns across the country and much of the rural area of America.
Since most elements of the nation’s “built environment” are long-lasting investments and fixed in place, obsolescence takes root in the older areas of the nation’s metropolitan areas.
Two, federal housing policy, especially those programs adopted in response to the unparalleled economic crisis of the Great Depression, dramatically undermined the housing markets of America’s cities and indeed almost universally in rural communities.
The Housing Act of 1934 created mortgage insurance and the Federal Housing Administration (FHA) to administer this new and untested tool to stabilize the American housing market that had been in decline since the mid-1920s and in an absolute free-fall since the stock market crash in October 1929. According to the dictates of this important Housing Act, only long-term, low-interest rate, fully amortizing mortgages where interest and principal were paid simultaneously were eligible for mortgage insurance.
There was more: the FHA developed and promulgated their Underwriting Manuals (1935, 1936, and 1938) that dictated the standards in extraordinary detail that were required for a home to be eligible for the mortgage insurance. A house, to be eligible, for instance, had to have not less than three bedrooms, a separate kitchen and living room, windows for each room, had to have full indoor plumbing and a heating system, sleeping quarters could not be in cellars or attics. Minimum construction standards had to be meticulously followed and inspected by FHA personnel. Perhaps surprisingly, a large proportion of the standing housing in the mid-1930s when these underwriting standards were being finalized could not meet these standards and were consequently not eligible for mortgage insurance. Perhaps two-thirds to three-quarters of all housing at that time were disqualified from the new mortgage insurance program.
Perhaps surprisingly, a large proportion of the standing housing in the mid-1930s when these underwriting standards were being finalized could not meet these standards and were consequently not eligible for mortgage insurance.
Furthermore, these FHA Underwriting Manuals were dictatorial regarding the social characteristics of the neighborhood as well leading to the agency’s well-documented record of racial discrimination. With the critical importance of mortgage insurance, especially in the 1950s and 1960s where to purchase a home other than with cash (a rare occurrence), the FHA was both successful in facilitating the massive expansion and upgrading of the nation’s housing stock (albeit for white Americans only) but at the same time rendered most of the homes that had been constructed before the Depression ineligible for mortgage insurance. This had the effect of initiating a systemic disinvestment process across most central city neighborhoods and nearly all of rural housing.
Three, public investment strategies (and concentrations of tax expenditures) exacerbate and reinforce existing patterns of uneven economic development.
As economists and geographers have recognized for decades there is a paradox regarding the financing and provision of public goods such as parks, streets, libraries, and police and fire services. Because of the unique characteristics of public goods—i.e., once provided, no one individual or business can be precluded from using them, and the cost to all will be the same whether or not a consumer chooses to use these goods—it is irrational for an economically rational actor to pay for these goods (even if the cost is negligible) and as a consequence such public goods tend to be underprovided.
Indeed, only if a coercive actor (government) intervenes and requires everyone to pay for such facilities are they in fact provided. However, recognizing that American metropolitan areas especially are highly fragmented into literally hundreds of municipalities that vary notably in terms of social class, housing price, and economic future, social scientists and urban historians have recognized that these many individual localities have neither the ability or will to provide public goods and services equally or equitably. Predictably, wealthy suburban localities have the capacity to provide very high-quality schools, parks, and public services while poor and moderate income suburban municipalities have a significantly diminished tax base and therefore have simply less ability to provide similar quality public goods and services.
Additionally, even within large central cities geographers especially have documented and assessed the unequal provision of public goods across the neighborhoods of the city. In all, both across the American metropolis and within its cities, there is an uneven distribution of public spending on goods and services that matches and amplifies the patterning of economic development—viz., unevenly and unequally.
In all, both across the American metropolis and within its cities, there is an uneven distribution of public spending on goods and services that matches and amplifies the patterning of economic development—viz., unevenly and unequally.
Four and perhaps most fundamentally, private investment is uneven, concentrating in what are perceived as the safe havens of private investments—viz., higher income communities where the local housing market is vibrant, employment high paying and plentiful, and where there is an ample supply of public goods—and avoid areas and communities that are seen as a threat to the repayment of loans.
Mortgage lending, we have already noted, has been historically skewed towards newly developing housing markets, and as a result, set the stage for continuing economic health of high and middle-income localities. In part, banks and all lenders are guided by the regulatory dictates of government where the safety and soundness of a lending portfolio is essential and in part they are guided by the dictates of a private market of lending where return on investment is critical.
However, as many economists have observed, banks and other financial institutions make lending decisions increasingly on the basis of credit scores and an array of information about individuals and businesses and such information is striking in that it is starkly unevenly available—in areas where there are extensive and vibrant economic and lending activities nearly all individuals and businesses have a substantial credit history. For such individuals and businesses who apply for loans, it is relatively easy to determine both their need and ability to repay a loan.
In less well to do communities, where historically there has been a much-diminished level of lending activities there is literally little information upon which banks or other financial institutions can make lending decisions. There might be significant demand and need for loans in poorer communities, but without credit histories and other pertinent financial information on individuals, families, and businesses, private lenders tend to avoid such areas.
The community development movement in the United States has stepped into this breach where economic and social disadvantage co-exist. While this is an abbreviated discussion of the sources of market failure and the possibilities of community economic development in subsequent chapters we provide an account of the history of community development in the United States.
We highlight several critical decisions that formed and shaped the trajectory of community development in the U.S.: first the creation of the Community Development Corporation (CDC) model of development by national philanthropies, the ill-considered adoption of the CDC model by the Great Society’s War on Poverty, the subsequent long hiatus from most sources of federal and state funding, and finally the creation of the CDFI Fund as a font for funding CDFIs (and later CDEs in the New Markets program) in the early years of the Clinton administration.
One of the major objectives of our monograph was to examine the differences between the lending activities of mainstream financial institutions and that of the CDFI (and NMTC) industry.
We will present an outline of our basic findings in our second installment on this blog.