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Is The Fed Surrendering To Big Brother?

Economic Viewpoint


On Apr. 19, the Federal Reserve Board yielded to Clinton Administration pressure for racial quotas in bank lending. Despite fears expressed at that day's board meeting about the Community Reinvestment Act's "potential for regulatory-driven credit allocation," the Fed agreed to changes that will permit the CRA to be used as a mechanism for racially allocating credit.

The regulatory changes, which Governor Lawrence B. Lindsey shepherded through the Federal Reserve Board, are the outcome of 21 months of negotiations involving the Fed, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the Federal Deposit Insurance Corp. One change repeals a color-blind regulation dating from 1976 that forbids banks collect data on race, color, gender, or national origin from its loan applicants. Another new regulation requires banks to report their loans by census tract, a proxy for racial reporting.

In his presentation to the board, Governor Lindsey acknowledged that these changes will give federal regulators "the capacity to micromanage bank decision-making to an unprecedented degree." Nevertheless, Lindsey marshaled hope that regulators will "use balance and reasoned judgment" and "avoid this micromanagement." Otherwise, he warned, regulators will "undermine the functioning of the market and therefore the underpinnings of capitalism" with racially allocated credit. "As believers in democratic capitalism," Lindsey said, "we are therefore extremely perturbed about race-conscious and gender-conscious practices."

"CONTENTIOUS." With so many reservations about the potentially dire consequences of the regulatory changes, it's natural to ask why the Fed acquiesced. Governor Lindsey answers that it is no longer politic for the Fed to hold out for color-blind safeguards. "This board's position that the use of such irrelevant characteristics as race, gender, religion, and national origin has no place in decisions regarding the provision of credit" is "not as widely accepted as it once was" and has become "contentious." To avoid "the extreme requirements sought by some special interests" that would result in a harmful "extreme policy activism," Lindsey reported to his colleagues that he had struck the best compromise he could get. Americans, Lindsey said, "have long since lost the fight against Big Brother."

Perhaps hoping to constrain expansive interpretations, Lindsey emphasized that the requirement that loans be reported by census tract does not mean that loans have to be made in each tract. "The law," he says, "does not require that a bank serve every community or meet every perceived need," and CRA regs are not supposed to "adversely impact the profitability" of the banks.

Governor Lindsey is whistling in the dark. I have reported in this space (Jan. 24 and Oct. 3, 1994) instances of banks being forced into allocating credit by race prior to the new rules. Resolution Trust Corp. economist Vern McKinley found CRA regulations to be "blatant credit allocation" prior to the latest regs that make this result more likely, and the Justice Dept. has an established pattern of misusing the CRA to force banks to locate branches in minority census tracts and to issue below-market loans.

LOOKING FOR COVER. In his Apr. 19 surrender speech, Lindsey urged his Federal Reserve colleagues to be "eternally vigilant" in resisting racial lending quotas. In Washington, such exhortations are useful for covering one's behind, but they are ineffective against "the natural tendency of the bureaucratic rule-making process."

The Fed could have stood on principle and empirical evidence. Nobel prize-winners Gary S. Becker and Kenneth J. Arrow have noted that evidence of discrimination would be lower mortgage default rates among protected minorities, a sign that they were being held to higher standards. Last November, a study was released by Federal Reserve economists Glenn B. Canner and Timothy H. Hannan, Freddie Mac economist James A. Berkovec, and University of Southern California economist Stuart Gabriel that examined 220,000 Federal Housing Administration mortgage loans and found no evidence of discrimination against minorities. The study reports that blacks default at twice the rate of whites and "exhibit significantly higher default rates in both urban and suburban locations."

By compromising on principle, the Fed has opened the floodgates for regulators to inappropriately second-guess and micromanage the lending process in the name of civil rights.BY PAUL CRAIG ROBERTS

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