May 132011

Few Cadillacs are sold in downmarket neighborhoods

Okay, so this might seem like a trivial question with an obvious answer, although perhaps asking if the government can force General Motors to do something is a bad example; being as how these days GM translates more to ‘Government Motors’ due to the massive bailout and shareholding in GM by the federal government.  Maybe they truly can force GM to do something as crazy as to open a Cadillac dealership in a depressed downtown slum area.

We can all surely agree that any car manufacturer should be free to open dealerships wherever it chooses, and should be equally free to not open dealerships wherever it does not wish to open them, correct?  That is just common sense and part of the free market.  There is not any suggestion that car manufacturers are obliged to offer their models in all marketplaces – a Yugo dealership should not be forced to open in Beverly Hills, and a Rolls Royce dealership should not be forced to open in Watts.

Let’s try another example.  Should the government be able to control where supermarket chains open stores?  Should they be able to say ‘No, you can’t open a store there, but you must open a store here instead’?  This might be more sensitive – could they say ‘It is unfair on this section of the population not to have a huge big upmarket Whole Foods in their neighborhood’, accuse Whole Foods of discriminatory practices, and force them to open their up-market overpriced stores in poor neighborhoods?  Do people have some sort of built-in right to have expensive supermarkets in their neighborhood, even if they can’t afford to buy the goods offered for sale in them?

Hopefully you agree that supermarkets too can open and close stores as they wish.

Now, for the third one.  Should the government be able to tell banks where they must open branches?  Unless you can see some way in which banks are different to car dealerships, to supermarkets, and to just about every other sort of commercial enterprise, you’ll probably agree that government has no business interfering with the normal commercial decisions of banks and where/how they open or close branches.

But, as this article reports, the government is doing exactly this; indeed, the Justice Department has opened a new division with 20 officials to try and force banks to do things which they would not otherwise choose to do themselves, including forcing them to lend money to risky borrowers and to open branches in areas they don’t see any commercial sense in having branches.

This is justified as a way to forcibly prevent banks from ‘red lining’.  Red lining was a practice, some decades ago, where banks would automatically refuse to lend money to a person based on where they lived.  This was before computerized data bases of credit reports, and at a time when discrimination was much more prevalent, and it suited banks’ purposes to simply say “If you live in a ‘bad’ area, we don’t want to risk our money with you”.  Was this fair?  Probably not, although on the other hand, whenever the government tries to force banks to lend money that they wouldn’t otherwise lend, we seem to end up with huge bailouts at the end of the day.

But these days, no-one in any bank ‘red-lines’.  They simply call up a credit report on their computer, and within 30 seconds, have a FICO score and a series of financial ratios in front of them that indicate if the applicant should be given a loan or not, and if the applicant should be allowed a discounted interest rate due to being an excellent credit risk, or if they should be charged an increased interest rate due to being a poor credit risk.

This is the same as – well, to use the car dealership example again; you go in to a dealership with a vehicle you want to trade on a new car.  If your old car is in good condition and low miles, you’ll get a higher trade-in value than if it is in poor condition and with high miles.  And if it is a vehicle that they know they can’t sell on, they might even refuse to accept it at all, or massively low-ball you on the price.

No-one is suggesting that car dealers should give the same trade-in on all vehicles.  But the Justice Department is blathering on about how banks should adopt identical policies for all potential borrowers, and ridiculously accusing banks of red-lining when in truth all the banks are doing is making prudent commercial decisions based not on race but on financial issues.

So bank regulators are setting the banks up for another banking crisis, by forcing them to open branches in areas where they don’t want to do business, and forcing them to lend money to people who by all normal measures are unlikely to be able to pay back their loans.  Does that sound familiar to you – aren’t we currently in the middle of a multi-trillion dollar economic crisis as a result of banks being pressured to make ridiculous loans to people who obviously had no way of ever paying them off?

One of the interesting consequences of this financial melt-down is that even the people the government was trying to ‘help’ have been massively harmed as a result of their dysfunctional help.  No-one has won, except perhaps for the government itself, which has used the financial crisis it generated largely by itself as a justification to become even more involved in all parts of our nation’s economy and commercial dealings.

It is common for some people to vilify bankers as being greedy and short-sighted, but spare a thought to who is forcing them to do these clearly stupid things – our own government.  There was a time when everyone respected their local banker – what has changed?  Government regulation is what has changed.

I’ll close not with answers, but with two questions.

1.  Why should the government treat banks differently to car dealerships, supermarkets, and just about every other type of private enterprise?

2.  Why can’t the government learn from its past mistakes, rather than repeat them?

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