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The Deathless Financial Remora

by Stephen Spruiell
Securely affixed to the taxpayer wallet, the Left’s favorite bank lives on

The Federal Deposit Insurance Corporation has a few rules it typically follows when it takes over a failed bank. One of these prohibits the failed bank’s old investors and old management team from having anything to do with the new bank, for obvious reasons. But ShoreBank, which the FDIC seized last month, was anything but typical. Founded in the 1970s to provide financial services to low-income communities on Chicago’s South Side, it used its politically attractive mission to gain powerful friends and become the largest community-development bank in the United States, with subsidiaries in Chicago, Cleveland, and Detroit, a number of non-profit arms, and a sister bank, ShoreBank Pacific, whose mission was to finance environmental projects and green jobs. At its height, ShoreBank could count among its many political patrons Bill and Hillary Clinton, Senate majority whip Dick Durbin, and Pres. Barack Obama. It was the Left’s favorite bank, which is why the FDIC’s atypical intervention is raising eyebrows on the right.

The FDIC relieved ShoreBank of its most toxic assets but left largely intact its management team — a highly unusual move. More important, it left intact the bank’s toxic business model, which used government-insured deposits and subsidies to pursue activities best left to non-profits: Think Fannie Mae and Freddie Mac on a smaller scale. The difference is that, while even former Frannie fans have acknowledged that their business model was fundamentally flawed, support for community banks is running in the opposite direction. Democrats and some Republicans are pushing for the creation of a $30 billion fund to subsidize them and encourage them to expand rapidly into new lines of business. The rise and fall of ShoreBank shows us why that would be a terrible idea.

It should come as no surprise that Obama became such a fan of ShoreBank: If he had been a little older, he might easily have been a founding partner. Like Obama, ShoreBank’s founders hailed from the ranks of idealistic academics and community organizers from the Hyde Park neighborhood on the South Side. By the early ’70s, various social forces had transformed large parts of that area into black ghettos. Racial discrimination certainly played its role: Fierce competition for jobs between blacks and ethnic whites had been a part of Chicago’s history since the first large-scale black migrations to the city in the early 1900s. Restrictive racial covenants kept most blacks confined to neighborhoods on the near west and south sides of the city until the Supreme Court in 1948 ruled such covenants unenforceable.

Things got worse in the 1950s and ’60s with the advent of a number of anti-poverty programs that unintentionally concentrated their targets into dismal projects and created perverse incentives that kept them poor. The rot radiated east and south from a swath of high-rise projects that went up between 1955 and 1962 along the Dan Ryan Expressway, just south of Chicago’s downtown, and rising crime rates prompted middle-class residents, white and black alike, to flee the South Side for the suburbs. In 1972, a neighborhood bank called South Shore National tried to follow them, but a group of Hyde Park community activists opposed the move and successfully pressured federal regulators to deny the bank permission to relocate.

Unwilling to stay in the deteriorating community, South Shore National put itself up for sale, and the Hyde Park activists, led by a man named Ronald Grzywinski, decided to raise the money to buy it. In the late 1960s, Grzywinski had served as president of the Hyde Park Bank, where, according to Richard Taub’s history of ShoreBank, Community Capitalism, he embraced the neighborhood’s “milieu of fervid activism” and “plunged into organizational life himself.” By the time South Shore National was ready to flee, Grzywinski had already made up his mind to get more involved: He left Hyde Park Bank for the University of Chicago, where, working with like-minded activists, he came up with the idea of a “double bottom line” bank, defined as one that puts its social mission on an equal footing with its profitability.

He saw South Shore National as a chance to test whether his idea would work. Grzywinski invested $100,000, raised $700,000 in capital from such liberal standbys as the Joyce Foundation (on whose board Obama would later serve), and borrowed another $2.4 million to buy the bank, which was later renamed ShoreBank. According to Taub, the early going was bumpy, and some of the new owners’ more idealistic policies (no service charges, for instance) were among the first things to go as the bank groped toward profitability. But eventually, by sticking to neighborhoods and borrowers its officers knew well, ShoreBank found its footing and gained fame among liberals as the bank that proved you could fight “redlining” (denying financial services in certain geographic areas) and make a profit at the same time.

Ironically, ShoreBank simultaneously proved a point libertarians had been making in opposition to public policies designed to fight redlining: Absent legal barriers to entry, the market will undermine redlining  in areas where there are profitable loans to be made. Someone will find a competitive advantage by lending in redlined communities; when the profits start rolling in, his success will attract competitors. This will happen regardless of whether the initial lender has “double bottom line” motivations: Competitors will see those profits and try to take them. This happened to ShoreBank, which found condominium conversions to be very profitable until larger competitors moved in offering lower costs.

If Grzywinski saw the irony, he showed no sign of it in 1977, when he famously became the only banker in America to testify in favor of the anti-redlining Community Reinvestment Act. (ShoreBank’s website suggests that the act was actually Grzywinski’s idea.) There is a fierce debate about the extent to which the CRA, with its low-income lending mandates, contributed to the proliferation of subprime mortgages and the inflation of the housing bubble. But one thing is not in dispute: The act made it much easier for ShoreBank to raise capital, something it had always found difficult to do because of the relatively low returns it offered. Under the CRA, banks must do a certain amount of low-income lending to appease regulators, who can make life very difficult for them if they fail to meet their CRA targets. But banks can get credit for low-income lending by making capital investments in government-certified community-development banks.

The CRA didn’t really start paying dividends for ShoreBank until the ’90s, when one of the bank’s biggest supporters was elected president. But the early 1980s had been a busy time: ShoreBank became a Small Business Administration preferred lender, granting it access to explicit government guarantees on many of its riskiest loans. It formed a partnership with Bangladeshi microlender Muhammad Yunus, who would go on to win the Nobel Peace Prize for making small loans to poor individuals. And, in 1984, it finally achieved the same level of profitability as banks of a similar size. Knowing what we now know about Bill Clinton’s global philanthropic interests, this menu of activities was virtually guaranteed to get his attention.

Which of course it did. In 1984, then-governor Clinton recruited Grzywinski to launch a similar operation to make credit available to poor people living in rural Arkansas. Grzywinski agreed, and ShoreBank worked with Clinton and the Winthrop Rockefeller Foundation to create what is known today as Southern Bancorp. As a candidate for president, Clinton promised that he would push for legislation to create 100 banks on the same model, and in 1994 he followed through by signing the Community Development Banking and Financial Institutions Act, which strengthened the CRA and created a fund to support certified community-development banks. The Clintons would go on to have a long relationship with ShoreBank, installing revolving doors between their political circle and the ranks of ShoreBank’s board members and executives.

President Clinton’s efforts to boost community-development banks contributed to a substantial increase in lending in low-income markets. Between 1992 and 2000, home-ownership rates among blacks and Latinos grew far faster than the national average, and a Fed study found that community-development banks had increased their lending by 160 percent during those years. At ShoreBank, where mission creep was a constant, bank officials decided to open subsidiaries in low-income neighborhoods in Cleveland and Detroit, start small-business-lending programs in Eastern Europe, and add a third bottom line: ecological sustainability. It encouraged its partners to build with environmentally friendly materials and expand into renewable-energy ventures, culminating in the creation of ShoreBank Pacific. The move opened up new sources of government revenue: ShoreBank Pacific qualified for $35 million in tax credits in 2006 alone.

By 2000, ShoreBank’s founders had grown it from a small community lender with around $40 million in deposits into a billion-dollar business. But that was nothing compared with the expansions it would undertake during the inflation of the great credit bubble. Between 2003 and 2006, the bank doubled the size of its loan portfolio to $2 billion. Its management team had even bigger ambitions. A story in Crain’s Cleveland Business at the end of that year noted that the bank’s goal was to be making another $2 billion in loans every year by the end of 2013. Another piece in Crain’s raised the question of whether a bank “dedicated to helping the poor can get big without losing its way.” It didn’t seem to matter to bank officials, who expressed their confidence that more resources and more lines of business only meant more opportunities to “do well by doing good.” They discussed the possibility of a $100 million IPO as if it were a foregone conclusion.

Then the crisis hit. By the end of 2009, ShoreBank’s losses on bad loans tied to strip malls in Detroit, multi-family residences in Cleveland, and condos in the Logan Square neighborhood of Chicago (which is about 15 miles from the bank’s South Shore headquarters) totaled just over $100 million. The FDIC had warned the bank in July of that year that it was dangerously undercapitalized and would need to raise additional capital in order to remain solvent. Some of the managers who had presided over the heedless expansion were dismissed, but others who had backed the moves, such as CFO George Surgeon, were promoted — in Surgeon’s case, to CEO. Bank officials applied for bailout money through the Troubled Asset Relief Program, but Treasury informed them that in order to qualify, they needed to demonstrate self-sufficiency by raising $125 million in private money.

That was a staggering sum for a bank that, at its zenith, had dared to dream about raising $100 million in a stock offering but was now losing that much money at an annual rate. Not to be underestimated, ShoreBank’s network of political patrons, from Illinois Democrats such as Sen. Dick Durbin and Rep. Jan Schakowsky to friends of Bill and buddies of Barack, started suggesting to the biggest players on Wall Street — names like Goldman Sachs, Morgan Stanley, and GE Capital — that they really ought to consider helping ShoreBank. And what do you know? Last May, this who’s who of bailout recipients and regulatory targets announced that they couldn’t think of a worthier cause. ShoreBank ended up raising nearly $150 million. The banks ponied up most of the money (the Ford and MacArthur Foundations kicked in their share) and placed it in an escrow account, to be invested in ShoreBank upon its receipt of TARP money.

But by then it was too late. The Federal Reserve took another look at ShoreBank’s rapidly deteriorating assets and determined that any taxpayer investment in the bank would quickly disappear, never to be paid back. The administration couldn’t afford to let the bailout be that explicit, because House Financial Services Committee ranking member Spencer Bachus (R., Ala.) had already fired off a letter demanding to know whether any administration official had played a role in the bank’s private-capital raising. That removed TARP from the administration’s tool kit, but, having coaxed nearly $150 million out of the private sector, the bank’s friends in government found another, less obvious way to save ShoreBank.

With an FDIC seizure imminent, the consortium of private investors offered to use the money to create a new bank, to be called the Urban Partnership Bank and led by the management team then in place at ShoreBank. The FDIC proceeded to seize ShoreBank and sell it to the Urban Partnership Bank at a $368 million loss to the federal deposit-insurance fund. The FDIC waived rules forbidding managers and investors from the old bank to take possession of the new one, explaining that ShoreBank had already dismissed most of the managers responsible for the bank’s distressed condition. But even if that were true (and it depends on how loosely one defines the word “responsible”), it remains the case that the FDIC has turned over the bank to a group of people who wish to run it as it was run before: following a double (triple? quadruple?) bottom line approach that ensures mission creep, maintaining access to plentiful government subsidies to feed expansion, and doing it all secure in the knowledge that, if they blow up the bank again, taxpayers will get stuck with the tab.

The involvement of the big Wall Street players in this sordid drama adds some perspective to the picture: The community-development banks aren’t the sharks in this ocean. They are the remoras, living off (and egging on) the government and the big banks, which in tandem destroyed the financial system in a frenzied debt binge. They benefit from a dysfunctional relationship between politics and the banking system that has become increasingly problematic: Rep. Maxine Waters (D., Calif.) faces an ethics trial in the House over her improper intervention in behalf of OneUnited, a minority-owned community bank. Alexi Giannoulias, who is running as a Democrat for U.S. Senate in Illinois, faces questions over politicized loans he oversaw while working at Broadway Bank, a community bank founded by his father, which the FDIC has since closed.

At times it seems like no one has learned anything from the financial crisis. As this issue of National Review went to press, leading Democrats in Congress and figures within the Obama administration were pushing for the Senate to pass a “small-business incentives bill” that would create a $30 billion fund allowing the Treasury Department to purchase preferred stock or other debt instruments from community banks and then charge them a rate of interest (or calculate a dividend) that varies depending on how aggressively they lend out the money: the more aggressively, the less they pay.

Most don’t need the encouragement — they just need the money. The community banks that are refraining from lending are doing so for sound reasons. Their regulators don’t want them making a bunch of high-risk loans that don’t make sense. More credit is not going to mend an economy that is suffering from a massive debt overhang. But other banks will look at what happened to ShoreBank and conclude that it’s better to listen to the politicians than the regulators. The ShoreBank example sends a clear message that if you play ball with the Democrats’ political agenda, Obama and his friends can get you all the capital you need. And if that doesn’t work, take comfort in the fact that the FDIC is now on record as being willing to bend the rules a little. It’s all about whom you know.

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