Moving into New Territory: Internet Banks Make DefiningCOMMUNITY Difficult

Spring 2001Federal Reserve Bank

of Boston

Art’s Economic Power in New England

Soft Second Program Celebrates Ten Years

Performance & Profitability of CRA-Related Lending

The Big $core!

Communities & Banking

2 c & b

Communities & Banking

The mission of Communities & Bankingis to enhance community and econom-ic development by exploring effectiveways for lenders to work with public,private, and nonprofit sectors towardproactive compliance with theCommunity Reinvestment Act.

EditorKristin Kanders

Editorial BoardPatricia AllouiseMarques BentonAnn EgglestonJane KatzYolanda KodrzyckiSharon LesondakJoan PoskanzerJoanna StavinsPaul Williams

The views expressed are not necessari-ly those of the Federal Reserve Bank ofBoston or the Federal Reserve System.Information about upcoming eventsand other organizations should be con-sidered strictly informational, not as anendorsement of their activities.

Articles may be reprinted on the condi-tion that the source is credited and thedisclaimer (paragraph above) is used.Please send copies to:

Kristin KandersEditor, Communities & BankingFederal Reserve Bank of BostonP.O. Box 2076Boston, MA 02106-2076(617) 973-3997kristin.kanders@bos.frb.org

For free subscriptions contact:Public and Community AffairsFederal Reserve Bank of BostonP.O. Box 2076Boston, MA 02106-20761-800-409-1333bostonfed.publications@bos.frb.org

Available on the web atwww.bos.frb.org/comaff/html/c&b.htm

this issue:

banking trends

Moving into New Territory: Internet BanksMake Defining COMMUNITY Difficult.................3The CRA was not designed to handle virtual communities. Kristin Kanders high-lights how some Internet banks are complying with the regulation and discuss-es trends being evaluated for the 2002 CRA review.

around new england

Art’s Economic Power in New England.............10The arts can play an important role in revitalizing depressed areas. Kathleen Gillexamines the economic impact of culture in three New England cities.

productive partnerships

Soft Second Program Celebrates Ten Years.....15Jim Campen and Tom Callahan overview the growth of the Soft Second Program.They also evaluate its successes and prepare for the future.

research review

Performance & Profitability of CRA-Related Lending............................................18Three Federal Reserve Board economists overview their study on a much-ques-tioned but little-researched topic. Commentary on the study is also included withthis article.

consumer focus

The Big $core!........................................................22Individuals can now purchase their credit scores. John Galligan explains how tointerpret (and improve) scores. He also gives a personal account of how he cor-rected his own credit history.

n 1977, the phone was considered thespeedy alternative to mail service and“www” looked like a typo. Today, commu-

nicating with people around the nation andworld is so easy that new associations haveformed as a result of the Internet. But whathappens when laws relying on 1977 technol-ogy and ideas about community arrive in thetwenty-first century? In at least one instance,you get a lot of bankers, regulators, andcommunity groups thinking about how tointerpret the Community Reinvestment Act.

The Community Reinvestment Act requiresbanks to provide credit access and bankingservices for all segments of their communi-ties, including low- and moderate-incomeneighborhoods, consistent with safe andsound operations. A bank’s “community” isdefined by its assessment area, a geographicregion surrounding its branches and deposit-taking automated teller machines. The needfor assessment areas arose when the practiceof redlining—literally or figuratively markingareas on maps where banks would notextend credit—came to be known andprotested. To ensure that banks would ade-quately meet the needs of their entire com-munities, the Community Reinvestment Actwas established.

by Kristin Kanders

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moving into new territory

COMMUNITY DifficultInternet Banks Make Defining

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Internet-based banks, those that donot supplement their services with atraditional branch or ATM infra-structure, present a challenge to theCRA because their “community” isnot based on geography. Becausethe deposits they gather can befrom across the nation, should theirreinvestment be across the nation?

Or is nationwide reinvestment ask-ing too much from these start-ups,most of which have small staffs rel-ative to asset size? To date, mostInternet banks have reinvested inthe community around their head-quarters. The sensitive issue,though, is that an Internet bank’sheadquarters may not be located inan area that represents its customerbase. Also, Internet bank headquar-ters may be unevenly distributedthroughout the United States—forexample, a large percentage arelocated in the Southeast.

Exit HypeFive years ago, the race was on toput traditional operations on theInternet, with the idea that theInternet would make operationsmore efficient and cost effective.Theory, however, has hit reality. Thecostly ingredients Internet bankswanted to avoid, such as branch

offices, real estate, and staffing,matter to consumers. Internet bene-fits such as home banking andhigh-interest earning accounts areattractive, but not enough to createcustomer loyalty.1 In addition,because many Internet-based insti-tutions don’t originate loans, butbuy them on the wholesale market

through third-party brokers, theystruggle with thin profit margins.The Federal Deposit InsuranceCorporation estimates that of thenearly 10,000 FDIC-insured finan-cial institutions in the UnitedStates, about one-half have a website and about one-fifth offer trans-actional Internet banking services.

Of the Internet-based banks operat-ing in 2001—various estimatesrange in the few dozen—many haveretrofitted their operations toinclude either branches, kiosks, orautomated teller machines. CynthiaBonnette, Assistant Director of theFDIC’s Bank Technology Group,says, “The large majority that start-ed a few years ago have expandedtheir delivery channels.” Brick-and-click operations, such as Salem FiveCents Savings Bank and its Internetsubsidiary directbanking.com, arehaving an easier transition thanInternet-only operations, partly

?

because they can rely on currentcustomers to sign up for theirInternet services rather than spendlarge amounts of money marketingto a new clientele.

Some Internet-based banks, though,have proved that they can sustainprofitability, and that’s why variousgroups of people are interested inthe debate over where Internet banksare responsible for reinvestment.These groups care, not only becauseInternet banks question how todefine communities in an era ofincreasing reliance on communica-tions technology, but because thestandards being set today may influ-ence the scheduled revision of theCRA in 2002.2 The Federal FinancialInstitutions Examination Council, aninteragency group representing theFederal Reserve System, FederalDeposit Insurance Corporation,Office of Thrift Supervision, Officeof the Comptroller of the Currency,and National Credit Union Admin-istration, is responsible for revisingthe CRA next year. Lynn Bedard,Community Affairs Liason for theOTS Southeast Region, thinks that“How you define an assessment areawill probably be the number oneissue in the 2002 CRA review.”

Until 2002, and possibly after aswell, Internet banks’ CRA activitieswill be evaluated on a case-by-casebasis. The regulatory agencies havenot produced guidelines for Internet-based banks to use in defining theirassessment areas because they haveno authority to do so. Tom Venables,President and Chief Executive Officerof Internet-based Lighthouse Bank,of Waltham, MA, explains his view.“It’s difficult to figure out how tocomply with the CRA because it’svery geographically based. To fit ourmodel into that world was tough.Also, the regulators can’t providemuch guidance because they arerestricted by what the law says, sountil that changes, it’s kind of a cir-cular problem.” But since Internetbanks have not been waiting aroundfor further instructions, here aresome examples of how Internetbanks and their regulators are inter-preting CRA responsibilities.

Says Lighthouse Bank’s TomVenables of the approach his insti-tution took, “What we did to meetour responsibilities with the CRAwas to create a business planshaped by CRA. As a ‘de novo’

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The regulatory agencies have not producedguidelines for Internet-based banks to usein defining their assessment areas becausethey have no authority to do so.

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institution, which is a ‘small’ insti-tution in the regulation, ourrequirement was to do the majorityof our lending in our assessmentarea, so it’s a fairly well-definedrequirement.3 We chose Waltham[as a headquarters location] forbusiness purposes and then thequestion became, ‘How big do wedraw the circle?’ We decided tofocus our marketing efforts inEastern Massachusetts and with thisapproach we came up with a logicalassessment area. We couldn’t han-dle all of Eastern Massachusetts asour assessment area so we chose a60-community area starting inBoston and moving west. So far, wehave done about 70 percent of ourlending in that assessment area.”

This approach of structuring thebank’s business model to satisfyCRA is not how all Internet banksshape their businesses, nor do theyall target marketing to a geograph-ic area. Although Lighthouse Bank,which opened for business in June2000, has not been profitable for itsbank holding company, BrooklineBancorp, and is expected to be soldto a third party or merged withBrookline’s traditional operationsby the third quarter of this year, the

method the bank followed to com-ply with the CRA is still instructive.Lighthouse Bank’s lack of prof-itability, it should be noted, is not aresult of its CRA approach, but ofthe high start-up costs associatedwith Internet banking.

Nationwide CommunityReinvestmentNetBank, which premiered in 1996and calls itself “The World’sLargest Independent InternetBank,” is an example of a prof-itable Internet-based bank that’sbeen in business for ages, at leastInternet ages. Headquartered inAlpharetta, GA, an Atlanta suburb,its lending patterns have changedas the institution has matured. In1997, NetBank’s CRA plan was forcommunity reinvestment aroundits headquarters. As a start-upoperation, NetBank was encour-aged to define its headquarters areaas its assessment area. By 1999,though, NetBank was receivingdeposits from all 50 of the UnitedStates and 20 foreign countries.

In January 2000, NetBank submit-ted a plan to the Office of ThriftSupervision, regulator of federally

and state-chartered thrift institu-tions, detailing how it could imple-ment a national CRA program. Saystheir CEO D.R. Grimes, “When westarted, we were making about 50percent of our loans in Atlanta andreceived about 25 to 30 percent ofour deposits from there. As we gotbigger our percentages shrank andit became clear that we were goingto be national. With less than 15percent of our market now inGeorgia, it would be difficult tocomply with CRA—it would be fis-cally irresponsible.” The “fiscal irre-sponsibility” Grimes is referring tois that compliance with the CRAmight suggest doing a majority ofloans in an assessment area, yetsafety and soundness regulatorswouldn’t want such a high concen-tration of loans—especially a highconcentration in low- and moder-ate-income loans—to be made in anarea that isn’t representative of itscustomer base.

What NetBank received OTSapproval for in March 2001 is toreinvest in three communities thatare its biggest business generators:California, Georgia, and Florida.NetBank’s strategic plan, whichoutlines its CRA goals and

No one knows yet which trackInternet banks will follow.

tion in Commerce Bank’s publicevaluation, the document each fed-eral regulator produces after exam-ining a bank for CRA compliance,states: “Commerce Bank’s assess-ment area includes some ofMetropolitan Atlanta’s most afflu-ent areas. None of the census tractsin the Fulton County portion of theassessment area are designated aseither low- or moderate-income.”Likewise, Telebank, which wasacquired by E*TRADE Bank inJanuary 2000, had an assessmentarea in Arlington, VA, which con-tained, “no low-income censustracts. . . .” Community advocatesare also wary that the affluent sub-urbs of Silicon Valley, Atlanta, andWashington, DC, where many of thebanks are located, may dispropor-tionately receive reinvestment ben-efits at the expense of lower-income neighborhoods in theUnited States.

CRA Evaluation StandardsTo foster creativity with the CRA,OTS Director Ellen Seidman hasencouraged Internet banks to pre-pare “strategic plans.” Regulatorsand Internet bankers agree thatstrategic plans are a useful tool for

complying with the CRA untilthe regulation is amended.

Lynn Bedard of the OTSbelieves that “All Internetbanks should consider thestrategic plan option fortheir CRA compliancebecause it is very difficultfor a retail lender, usingthe Internet as its primaryoutlet, to comply with the

regulation. Filing a strate-gic plan,” she adds, “enables

an institution to identify andget maximum credit for its

approach, states that should its cur-rent market demographics change,so will its CRA plan. NetBank’sstrategy of CRA lending in threeareas is a “great resolution,” saysGrimes because, while demonstrat-ing how to be creative with CRA, itroughly matches loans withdeposits and so is in keeping withthe spirit of community reinvest-ment. Lynn Bedard, who worked onbehalf of the OTS to help NetBankdevelop its strategic plan, says ofthe plan, “It probably isn’t perfect,but it’s a start.”

To some, that might be an under-statement. But even so, a strategicplan is often considered to be a bet-ter solution than having Internetbanks automatically choose theirheadquarters as their assessmentareas. Home base designations con-cern community advocates who feelthat Internet banks unfairly limittheir areas for reinvestment. Forexample, ebank, formerly under thename Commerce Bank, has itsheadquarters area as its assessmentarea. The reinvestment area descrip-

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strengths.” The strategic plan is anoption that has so far been used pri-marily by wholesale and credit cardinstitutions to guide CRA reinvest-ment. The plans allow banks to settheir own standards for how theirCRA compliance should be judged,rather than rely on the standardlending, service, and investment testmix, which values lending abouttwice as heavily as services andinvestments. The strategic planbecame part of CRA regulation in1995. Its greater flexibility worksbetter for institutions with nontradi-tional communities. To becomevalid, the plans must be submittedfor public comment and may under-go regulator-suggested revisions.

Some Internet banks do not havestrategic plans, nor do they haveCRA compliance evaluated by thestandard CRA tests for either“small” or “large” financial insti-tutions. This is because they oper-ate as wholesale, as opposed toretail, banks, which means thatthey do not originate loans direct-ly but buy them on the wholesalemarket. Regulators of wholesaleand limited-purpose banks use theCommunity Development Test toassess community developmentservices, investments, and lendingin total, rather than separately. If awholesale bank does not directlymake loans, the theory goes, it’smore difficult for it to earmarklending to an area when it doesn’tmake loans in the first place.

Telebank operated as a wholesalebank until it was bought byE*TRADE Bank. In fact, becauseInternet banks often operate inthis manner, Bank of Internet USAhas turned its retail status into amarketing tool. It emphasizes onits website, “Many so-called ‘on-line lenders’ are actually mortgagebrokers or simple lead generationweb sites. Bank of Internet USA,however, is a direct portfoliolender.” As D.R. Grimes, a direct-lending Internet banker, has spec-ulated, wholesale Internet banksmay be afraid of doing directlending nationwide because theydon’t know how to handle theCRA implications.

Strategic plans and CommunityDevelopment Tests have value inmaking CRA compliance flexiblefor different kinds of banking insti-

We need to update our concept of communi-ty to reflect today’s marketplace. . . . This isby no means a simple problem to solve. . . .there are aspects of the regulations, as weall know, that do not work particularly wellin today’s market of Internet banks, nation-wide lending, alternative delivery, anddeposit-gathering mechanisms.

Ellen Seidman, OTS DirectorOctober 2000 speech

Internet ValueBankrate.com, in a 2001survey of consumer finan-cial products, determinedthat Internet banks surpasstheir brick and mortar com-petition on the checkingaccount front. Eighteen ofthe top 20 checkingaccounts were associatedwith Internet banks.

interagency CRA question andanswer section. The specific ques-tion addresses the need for immedi-acy or direct benefit of communityreinvestment on an institution’sassessment area. The answer is thatimmediacy and direct benefit donot have to be shown as long as the“purpose, mandate, or function ofthe organization or activityincludes serving geographies orindividuals located within the insti-tution’s assessment area.”4 Thisstatement has encouraged Internetbanks, such as G & L Bank, to pur-sue compliance with the CRA inways that coordinate with theirbusiness philosophies.

Niche InternetCommunitiesG & L Bank, a $90-million-assetbank that caters to the gay and les-bian community, serves its assess-ment area by caring for the needsof its nationwide community, of

Bank of Internet USA, a $120 mil-lion asset bank that opened on theFourth of July 2000 and is lookingto be profitable by its one-yearanniversary, thinks that his bankcan meet the needs of its communi-ty by reinvesting according to thecurrent regulation. He’ll be moreconfident, of course, after the CRAreview his bank is scheduled for inJune. Says Evans of his San Diego-based bank, “We don’t think we willneed to develop a strategic plan,”but he is hoping that the CRA willbe revised to “address the realitiesof our market.”

The nationwide approaches sug-gested by First IB and NetBank,however, are only theoretical. Whilealternative approaches to fulfillingthe CRA are being debated, someInternet banks are managing to fittheir triangle of an operation intothe CRA regulation square by mod-eling CRA activities on a method ofcompliance discussed in the FFIEC’s

tutions, but community groups fearthat lending, the crux of CRA’simpact and the most heavilyweighted factor a regulator uses toassess a CRA rating for a typicalretail institution, may becomediluted—especially if Internet bank-ing becomes more powerful. TheWoodstock Institute, a Chicago-based nonprofit that promotes com-munity reinvestment, considersstrategic plans to be imperfectbecause they allow banks to set thethresholds for attaining a certainCRA rating as low or high as theywant. The Woodstock Institute sug-gests looking at market share todetermine assessment areas forInternet banks. Its position is thatfor each MSA, Internet institutionswith 0.05 percent of the marketshare of a particular product shouldhave a CRA obligation for at leastthat product in that area. For insti-tutions that don’t have 0.05 percentof the market share in any areas,then the institutions should looknationally at the ratio betweenlending to low- and middle-incomegroups and middle- and upper-income groups. “Ideally,” says theInstitute’s Katy Jacob, “the ratioshould be one or higher.”

Some Internet bankers believe thata solution to fulfilling CRA willdevelop from looking nationally—although in a different manner thanthe Woodstock Institute proposes.Bob Connors, Community AffairsOfficer of First Internet Bank ofIndiana (First IB), says, “Because weoperate with the entire country asour marketplace, we think that anyloan we can make to that targeted[LMI] market should qualify towardour CRA commitment.” First IB,which is classified as a “small insti-tution,” currently has an assessmentarea consisting of two countiesaround its Indianapolis headquar-ters. He adds, “With the Internet-business model, we don’t have geo-graphic control over our customerbase—we have the entire country—so we need to come up with somecreative solutions to measuringCRA compliance.”

D.R. Grimes of NetBank also thinksthat meeting the national LMI per-centage with the number of loansan Internet bank makes is “appro-priate; it’s a reasonable approach.”Another Internet banker, GaryLewis Evans, President and CEO of

Legislation to address how a financial institution (includ-ing Internet-only banks) should fulfill CRA requirementswas reintroduced to the House of Representatives onMarch 6, 2001, by Representatives Thomas Barrett andLuis Gutierrez.

The Community Reinvestment Modernization Act, whichhas since been referred to two subcommittees of theHouse Committee on Financial Services, has 33 cospon-sors and calls for expanding a financial institution’sassessment area to each community in which the finan-cial institution makes more than 0.5 percent of its loanvolume and each state in which it has a branch outsidethe metropolitan area.

The legislation was drafted by the National CommunityReinvestment Coalition, a community advocacy group.As in the current regulation, the assessment area wouldalso include metro areas in which the financial institutionhas one or more branches.

This legislation faces strong opposition, as it did duringthe Clinton Administration, because it calls for expand-ing CRA obligation areas and extending CRA obligationsto lending affiliates of financial institutions that are cur-rently exempt under the Gramm-Leach-Bliley Act, suchas insurance companies and mortgage banks. It is alsoopposed because it calls for increased reporting of HomeMortgage Disclosure Act data.

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Tracking CRA Policy

Reaching out to the local communi-ty through technology is also pop-ular with Internet banks, for obvi-ous reasons. Lighthouse Bank’s TomVenables believes that it is impor-tant “to expand the technology rev-olution to those behind the curve,to expand computer literacy.” To dothis they forged an alliance withthe Charles River Computer Center,a nonprofit organization that offersfree training and computer time tothe Waltham community. NetBankalso plans to focus on technology.As stated in their strategic plan, oneof their service goals is to “Form apartnership with an organization[that] serves the low- and moder-ate-income community, to providecomputers and Internet access witha goal of bridging the digital divideand providing these communitieswith more low-cost banking prod-ucts and services.” This type ofcommunity outreach, which di-verges from traditional CRA activi-ty, makes sense to Internet bankersbecause it provides them with away that they can complement (andavoid competition from) what tra-ditional banks currently do forcommunity outreach.

In Our FutureThese examples show how Internet-based banks are finding ways ofreinvesting that relate to the commu-nities they serve. They present onemethod of community reinvestmentthat Internet banks are following,and one method that regulators are

our customers and is why homemortgages for same-sex coupleshas been our strongest productoffering. Small-business ownerstoo tell us that discrimination hap-pens.” In this way, Internet banks,often thought of as threatening totraditional community reinvest-ment, may turn out to encouragecredit access for nontraditionalcommunities that sometimes feeldisenfranchised from the bankingworld—just not by income.

Other communities that may bebetter targeted by the Internet thanby a traditional bank include ethnicgroups. Bancointernet bills itself, inthree languages, as the “PersonalFinance Community for Latinos.” Itoffers products such as mortgagesfor nonresidents, internationalmoney transfers, and financialinformation that is geared towardHispanic and Brazilian communi-ties living or newly arrived in theUnited States. Bancointernet, how-ever, is a misnomer, as it does notprovide transactional banking serv-ices. VirtualBank is a bank for tech-nology professionals, and it isoffered through technology firms.Its special services include thingsthat the technology-savvy appreci-ate, such as a single database thatholds a person’s entire financialportfolio, from mortgages to check-ing accounts. These financialproviders are finding lifestyle, eth-nic, and professional niches and areredefining what it means to have abanking relationship.

which the assessment area popula-tion is a part. (Its assessment areaconsists of Pensacola, Florida, plustwo neighboring counties.) G & LBank specializes its direct commu-nity reinvestment in Pensacola bysupporting gay and lesbian com-munity groups, programs that pro-vide medicine for people with HIV,AIDS, or other diseases, and pro-grams that provide sustenance andfinancial assistance to those inneed. Primarily, though, it viewsits community impact in broadterms as a national provider ofaffordable loans and mortgages togay and lesbian individuals, cou-ples, and companies.

The G & L Bank model seems newto the financial services industrybecause its community is basedneither on geography nor onincome. Internet banks, by virtueof their reliance on computer-liter-ate and generally computer-own-ing customers, and because someof them are linked to brokeragehouses, attract higher-income cus-tomers than traditional banks. ButG & L Bank is a prime example ofhow Internet banks are illuminat-ing new communities that needaccess to credit. CRA Officer BillKnight says that G & L Bank servesa community that is not beingserved by traditional means. “Thegay couples we serve tell us thattraditional banks typically do notallow gay couples to use their jointincome to qualify for mortgages orloans. This is a major issue with

As Gary Lewis Evansof Bank of InternetUSA says, “We areconvinced this is theway of the future.”

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Comments on this article? E-mailkristin.kanders@bos.frb.org

Endnotes1. OTS Director EllenSeidman remarked in aSeptember 2000 speech that“. . . we have observed that,in most cases, Internet-onlyinstitutions are forced to payvery high rates in order toacquire customers. As soonas they lower their rates, thedeposits flow out. Thus, thesecond conclusion we havedrawn is that most Internet-only institutions attract pri-marily non-core deposits.This ‘hot money’ comes fromdepositors who are simplyseeking high interest ratesand have no loyalty towardone particular institution.”

2. Regulators expect torelease a document request-ing public commentary onCRA this June. In addition tothe topic of Internet bankcompliance, it may alsorequest comments on bankmergers, exam processes,and the investment test.

3. “Small” institutions arecharacterized as those withassets of less than $250 mil-lion or less than $1 billionin assets if it is a part of abank holding company. Tosatisfy CRA, small institu-tions are supposed to do amajority of their lendingwithin their assessmentareas. Large institutions, onthe other hand, are thosewith assets of $250 millionor more or assets of morethan $1 billion if in a hold-ing company. Large institu-tions are evaluated for CRAaccording to three tests:lending, service, and invest-ment. The lending test typi-cally weighs twice as heavi-ly as the other two tests.

4. An excerpt from theanswer reads, “Therefore, aninstitution’s activity is con-sidered a community devel-opment loan or service or aqualified investment if itsupports an organization oractivity that covers an areathat is larger than, but

assessing. Because there is no uni-form policy on how Internet banksshould fulfill CRA, many other rein-vestment examples can be found.

The FFIEC policymakers have ashort history to rely on for some bigdecisions. Only a handful ofInternet banks have been examinedfor CRA compliance to date, andmost of them have been regulatedas “small banks,” which limits theirreinvestment obligations to theirheadquarters assessment area.NetBank’s strategic plan, the firstone approved (in March 2001) foran Internet bank, has stirred debateabout its strength and weaknesses.The policymakers, who will takeinto account the positions of com-munity advocacy groups and regu-lation-averse bankers, have a toughjob ahead of them.

But the Internet banking industrytoo has encountered strife in itsyoung life. Some Internet bankshave witnessed a decline in venturecapital; others haven’t been able toturn profits, have changed theirbusiness plans to include branches,or have been bought by a tradition-al banks, brokerages, or Internetconglomerates. Some are trying toremain Internet-only. While it’s dif-ficult, there are business reasons forremaining in the field. Of thenumerous dot-com businesses outthere, Internet bankers believe thatfew are as well suited for theInternet as financial services. AsGary Evans of Bank of Internet USAsays, “We are convinced this is theway of the future.” At the end of theday, his bank is doing “basic, purebanking” without the high over-head. Yes, Internet banks may haveeradicated the need for the middle-man, along with our quaint ideas ofhow to define a community.

includes, the institution’sassessment area(s). Theinstitution’s assessmentarea need not receive animmediate or direct benefitfrom the institution’s spe-cific participation in thebroader organization oractivity, provided the pur-pose, mandate, or functionof the organization or activ-ity includes serving geogra-phies or individuals locatedwithin the institution’sassessment area. Further-more, the regulations permita wholesale or limited-pur-pose institution to considercommunity developmentloans, community develop-ment services, and qualifiedinvestments wherever theyare located, as long as theinstitution has otherwiseadequately addressed thecredit needs within itsassessment area(s).” For theentire question and answer,see section .12(i) &563e.12(h)-5 of the intera-gency CRA Q&A.

W

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Art’s Economic Power in New England

by Kathleen Gill

We must never forget that art is not a formof propaganda, it is a form of truth.

-John F. Kennedy

Art is making something out of nothing andthen selling it.

-Frank Zappa

hen TIME magazine’s “100 People WhoMade the Millennium” were named, twen-ty-five were artists. Our admiration forartistic people and places is such that oneof the measures of a community’s desir-ability is the amount of art and culturalactivities available to its citizens. Art isalso big business.

In New England, nonprofit cultural organ-izations and attractions generate $3.9 bil-lion dollars in annual revenue and support110,000 jobs, according to the NewEngland Foundation for the Arts. Further,this estimate covers only a small portion ofthe arts “industry.” An inclusive definitionof arts and culture can include movies,music, graphic design, publishing, andother businesses. Together these enterprisesmake up the “Creative Economy,” accord-ing to a June 2000 report by the NewEngland Council.

Using a broader definition of art, includingenterprises and individuals that directlyand indirectly produce cultural products,the Creative Economy supports more than245,000 jobs in the region, and 3.5 percentof New England’s job base. In dollar terms,New England attracts $6.6 billion in rev-enues from cultural tourism alone.However, this is just part of the value pro-duced by the Creative Economy. Businessesand workers are attracted to the NewEngland region and to particular commu-nities because of the quality of life.Fortunately, the New England Council proj-ects that Creative Economy jobs will grow18 percent over the next ten years.

Seeing the Path of the Wind, by Stacy Levy is a wind installationcurrently on display at Mass MoCA. Eight strategically placedfans replicate wind patterns detected from the museum’srooftop and “breeze” onto the flags.

While art has many positive eco-nomic and social effects, it also hasmany expenses that the economy atlarge is asked to subsidize. Forexample, museums on average gen-erate only a fraction of their operat-ing revenue from admission sales.According to a 1995 survey of 174member institutions of theAssociation of Art MuseumDirectors, the average cost permuseum visitor was $30, whileadmission fees per visitor averaged$1.45. To cover the revenue gap, in1995 the public sector contributed$281 million to museums and theprivate sector contributed $372 mil-lion. By this fiscal measure, muse-ums are an economic drain, not aneconomic engine. Art and culture’simpact has traditionally been meas-ured with this model, and it isviewed not as a moneymakingenterprise, but as an expense.

But the economic model of art ischanging. A more contemporary andpractical way of viewing the artseconomy is through an exampleprovided by the Federal ReserveBank of Cleveland. The Bank exam-ined the economic impact ofPlayhouse Square, a cultural enclavein downtown Cleveland. To describethe relationship of the public sectorinvestment to the enterprise, theBank used the metaphor of a skiresort. It noted that the ski lifts in aresort are a “loss leader,” designed toattract visitors to the resort. The skiresort makes its profits from the sur-rounding vacation condominiums,time-shares, restaurants, and otherretail activity that subsidize the skilifts as a business expense. In an artinvestment, the public sector acts asa ski resort, creating an enterprisethat attracts visitors, who in turngenerate sales tax dollars andincrease property values. Thismetaphor is accurate in that muse-ums attract visitors who thenpatronize a variety of businesses inthe community.

Several examples of how art and cul-ture play a role in revitalizationefforts can be found in New England.Pittsfield, Massachusetts, is incorpo-rating cultural activities into a largerdowntown revitalization strategy.North Adams, Massachusetts, is ben-efiting from the opening of a largemuseum complex and Providence,Rhode Island, is using art as a cen-terpiece for downtown renewal.

Pittsfield, MassachusettsThe Berkshires of Massachusettshave long been a cultural magnetfor the East Coast. Tanglewood, thesummer home of the BostonSymphony Orchestra, has been asummer attraction for over 70 years.Berkshire County attracts an esti-mated 2 million visitors per year,most in the summer months. Whilethe southern section of BerkshireCounty has prospered, the centraland northern regions have not beenso fortunate. Pittsfield, located incentral Berkshire County, is attempt-ing to reverse this trend with adowntown revitalization plan thatemphasizes cultural and entertain-ment activities.

Pittsfield has historically been anindustrial center in westernMassachusetts. However, in the late1980s, General Electric closed twoof its three divisions in Pittsfield. Atthe same time, General Dynamicsclosed its plant following defensespending cutbacks. As a result ofthe two closings, 8,000 workerswere displaced. Many left the areaand Pittsfield’s population has beenin decline since the plant closings.In addition, retail stores movedfrom downtown to malls on theedge of town. As a result of theseevents, the downtown stores had a30 percent vacancy rate as of threeyears ago.

To combat the blight that was tak-ing over downtown Pittsfield, agroup of business owners, known asDowntown, Inc., decided that aplan was needed. Downtown, Inc.approached the remaining largebusinesses and asked for a three-yearmonetary commitment to develop a

revitalization strategy. Armed with$50,000 per year for three years,Downtown, Inc. hired the BerkshireHousing Development Corporationfor a revitalization strategy.

Berkshire Housing’s approach waspragmatic. They proposed public/pri-vate partnerships and a combinationof rehabilitation of historic buildingsfor commercial space and culturalactivities to bring people downtown.In the past, large-scale developmentprojects were proposed, but nodevelopers could be found to take therisk a major development required.Berkshire Housing developed anincremental strategy consisting ofthree parts with a total plan cost of$25 million. The first part of the planwas to develop office space, whichwas in short supply in Pittsfield. Thesecond part was to restore some his-toric buildings and tear down non-historic abandoned buildings. Thethird part of the plan was to developa cultural action strategy forPittsfield. The cultural action strate-gy was developed by Hunter InterestsInc. and contained a set of strategicsteps aimed at utilizing existingassets more effectively, then devel-oping new facilities.

The strategic plan for Pittsfield con-sisted, first, of using the BerkshireMuseum, an art and natural historymuseum located in downtownPittsfield, as a centerpiece. The rec-ommendation was to focus funding,human resources, and regional mar-keting support on the BerkshireMuseum. Since this recommendationwas made, the Berkshire Museumhas hired a new director, revampedits exhibits, and doubled annual vis-itors from 30,000 to 60,000.

The Berkshire Museum attracts twice as manyvisitors as before Pittsfield’s revitalization plan.

Second, the strategic plan suggestedthat Pittsfield restore and reopen theColonial Theatre, a historic theatrelocated in downtown. After havingbeen closed for several decades, it isnow being used as an art supplystore. Currently, a nonprofit grouphas an option to purchase and reha-bilitate the Colonial Theatre to itsoriginal use. Part of the restorationproposal is to include a TheatreMuseum within the structure tofocus fund-raising activities andraise awareness of the project.Hillary Clinton helped to generatepublicity for the theatre when shevisited it last year as part of her tourof America’s hidden treasures.

Third, the plan called for developingthe North Street Arts Collaborative,a private venture launched by indi-viduals in Pittsfield. It offers studiospace and art classes for Pittsfieldarea residents. Other recommenda-tions in various stages of develop-ment include a new cinema com-plex, a stadium, and an arts center.

Art is a viable economic engine inPittsfield because of the city’s geo-graphic location between two majorcultural centers. To the south,Tanglewood, Jacobs Pillow, and asummer Shakespeare Company allattract seasonal art patrons fromBoston and Albany. To the north,The Massachusetts Museum ofContemporary Arts (Mass MoCA)opened two years ago. It has attract-ed visitors who make day tripsthrough Pittsfield to the NorthAdams museum. Also, Pittsfield hadbeen holding “Art Walks,” an annu-al festival in which artists set up dis-plays in the vacant storefronts of thedowntown area. The Art Walks start-

Now showing—an art supply store.Pittsfield hopes to reopen theColonial Theatre to its original use.

A decaying building in the Central Block area of Pittsfield (above) may soon look likeBerkshire Housing Development Corporation’s plan (below).

Because public monies did not fundMass MoCA in full, it began to lookelsewhere for revenue and reshapedits concept for greater economic via-bility. Instead of being designed as apure art museum, Mass MoCA hasdeveloped a performance arts compo-nent and rents one-third of its250,000 square feet to private busi-nesses. The performance arts sectionof the museum contains a 10,000square-foot black box theatre withseating capacity of 650, anothersmaller theatre, and a summer open-air cinema. Nearly 20,000 peopleannually attend one of its performingarts events. Including office space ina museum complex is unusual, but ithas provided many benefits. Forexample, several new businesses havebeen attracted to North Adams by thespace. Presently Mass MoCA’s tenantsemploy almost 350 people.Companies such as Kleiser-WalczakConstruction Company, a computeranimation company, and eZiba.com,an online gift retailer, have settled inNorth Adams, attracted by MassMoCA’s unique image.

Mass MoCA has renovated 250,000square feet of a potential 750,000square feet at a cost of about $65 persquare foot. This is a remarkableachievement because museum reno-vation is generally between 10 and

30 times as expensive. One reasonfor the low cost of renovation hasbeen the design technique practicedby Bruner/Cott & Associates, thefirm hired to redesign the space.These architects work with the exist-ing structure and design renovationsto suit the building. The technique isaptly called architecture from foundbuildings. The result in this case is a

In the late 1980s Tom Krens, whowas Director of the Williams CollegeMuseum of Art, conceived of theconcept for Mass MoCA. He wasmotivated by the observation thatmodern art was becoming larger inscale and at the same time, exhibitspace in New York was becomingmore expensive. When Krenspitched his idea to the Mayor ofNorth Adams, he originally hadanother North Adams building inmind, but the Mayor suggested theSprague buildings.

After hiring Joseph Thompson asdirector of the project, Krens left tobecome the director of the SolomonL. Guggenheim Museum in NewYork. The project was thought torequire about $35 million dollars inpublic funds from the state ofMassachusetts. Governor Dukakisenthusiastically supported the planas a way of revitalizing NorthAdams. He approved the plan andMass MoCA began to conduct itsfeasibility study.

Soon after, Governor Weld, who didnot support the plan for financialreasons, was elected. After lobbyingfrom several members of the legis-lature, including then-Senator JaneSwift, Weld agreed to consider themuseum if North Adams could

demonstrate its support by raising$1 million. The North Adams com-munity managed to raise the moneyquickly through a grassroots cam-paign, which caught the Governor’sattention. After several morerounds of negotiation, Weld agreedto a three-to-seven match of funds,for the bricks and mortar portion ofthe project.

13 c & b

ed in 1996 and raise awareness ofart and culture in this traditionallyworking-class town.

One of the concerns of the culturalrevival is that it may suffer dispro-portionately in the case of an eco-nomic downturn. While it seems log-ical that during weak economic peri-ods people will spend less on leisureactivities and vacations, Pittsfielddoes not believe it will be severelyaffected. “During the last recessionwe saw very little decline in thenumber of visitors. When times arelean, people take shorter vacationsand many choose trips to theBerkshires,” says Peter Lafayette ofBerkshire Housing. The Berkshires’economy may also be more stablebecause of the number of wealthyindividuals choosing to summer nearTanglewood, as evidenced by thenumber of expensive new homesbeing built in the area.

The results of Pittsfield’s revitaliza-tion have been excellent, so far. Thestorefronts in downtown, whichonce had a 30 percent vacancy rate,now have a 15 percent vacancy rateand falling. Investment dollars areflowing into downtown develop-ment of offices and stores. Recently,one of three major banks located intown completed a new $1 millionbuilding on the site of an aban-doned department store. Otherbuilding owners have seen theirproperty values double in the pastfive years. While the art and cultur-al aspect of the revitalization can-not take all of the credit, it has cer-tainly played an important part inbringing people downtown.

North Adams, MassachusettsIn some ways the development ofMass MoCA (Massachusetts Museumof Contemporary Arts) in NorthAdams is similar to Pittsfield’s revi-talization. The two communitiesshare similar economic histories—both suffered when major manufac-turing plants closed. In the case ofNorth Adams, Sprague Electric leftin the 1980s. Sprague had employed4,000 people in a town of 18,000.Almost every family in North Adamswas affected by the plant closure.Sprague vacated 27 brick industrialbuildings located on 13 acres indowntown, about one-third of thedowntown area. After trying unsuc-cessfully to sell the buildings,Sprague eventually donated them toNorth Adams.

Kiki Smith’s Constellation is a creation that’s not meant to be hung on thetypical gallery wall; it finds ample space at Mass MoCA.

set of large airy spaces to house eachof the large artworks. Mass MoCA isthe largest contemporary art muse-um in the United States, withexhibits including a large-scalebronze sculpture and Uberorgan,designed by Tim Hawkinson, whodescribes it as a giant self-playingreed organ.

The economic benefits of MassMoCA are just beginning to be real-ized. During its first two years ofoperation, the museum attracted100,000 visitors per year and anoth-er 20,000 visitors annually attended

the performing arts events. Inresponse to the influx of visitors,new restaurants have begun to openin North Adams. The Holiday Inn inNorth Adams has seen a 75 to 80percent increase in occupancy. Anew inn, The Porches at Mass MoCA,is scheduled to open in July. Finally,property values in North Adamshave begun to rise, after severalyears of stagnation and devaluation.In all, Mass MoCA has done what itset out to do, breathe life back intoNorth Adams. The museum has beenopen for just two years, so it willtake several more to measure itslong-term impacts.

Providence, Rhode IslandProvidence presents an interestingcounterpoint to the two industrialtowns in Massachusetts that werelooking to reshape their economies.In Providence, revitalization throughthe arts is one part of the city’s muchlarger revitalization effort. WhileNorth Adams and Pittsfield suffereddramatic downturns when powerfulemployers left, Providence sufferedfrom a long-term malaise exacerbat-ed by the early 1990s recession.Currently, the situation is quite dif-ferent. Providence is experiencing arenaissance. Like the other examples,Providence has built on its cultural

and artistic strengths and resources.The city has enjoyed a long historyof art involvement thanks to theRhode Island School of Design andBrown University, both of which arelocated in Providence.

Providence has actively encouragedits art community through a varietyof initiatives that may have beeninspired by one organization,AS220, formed fifteen years ago.AS220 is an art community locatedin downtown Providence. The nameis derived from Alternative Spaceand the street number of the original

address. The 22,000square foot space formsthe centerpiece ofProvidence’s Arts andEntertainment District.

Almost ten years ago,a small group ofartists representingAS220 approachedMayor Cianci with theidea of renovating abuilding and creatinga live/work space forartists. Although AS220had a budget of just

around $100,000, theMayor listened and supported itseffort. Through volunteer fund-rais-ing, Community Development BlockGrants, grants from the FederalHome Loan Bank, and loans fromthree local banks, AS220 financed a$1.1 million renovation that nowhouses low-income artists and pro-vides unjuried performance andgallery space to Rhode Island artists.To support the arts, the city institut-ed a special tax relief program thatprovides sales tax relief to artistsselling their work in the ProvidenceArts District. The city also offers alower property tax rate to landlordswho redevelop space for artists.

Providence also honors contributorsto the arts with annual awards.Business Volunteers for the Arts,Rhode Island, presents a series ofawards for various accomplishments.Examples include the Encore Awardfor corporate leadership in support ofcultural initiatives, the IndividualAchievement Award for outstandingvolunteerism, and the Arts AdvocateAward for fundraising contributions.A city of only 160,000 people,Providence is considered dispropor-tionately rich in artistic talent. “Artcontributes to our sense of place.Providence wants to keep its artists,”explains Catherine Horsey of theProvidence Preservation Society.

Tim Hawkinson’s giant organ was designed with MassMoCA in mind.

14 c & b

Suggestions for FurtherReadingAndras Szanto, “The Business ofArt,” The American Prospect,February 28, 2000 v11, i8 p39.

John Bos, “Culture As Its OwnReward,” Pittsburg Post-Gazette,August 13, 2000.

John Kifner, “Museum Brings TownBack to Life,” The New York Times,May 30, 2000.

Lee Rosenbaum, “MASS MoCAOpens to an Art Hungry Public,” TheWall Street Journal, June 1, 1999.

Michael Pare, “Volunteer of the YearFinds Arts a Powerful Vehicle,”Providence Business News, January15, 2001 v15, i39, p4.

National Endowment for the Arts“American Canvas: The EvolvingCultural Landscape,” http://arts.endow.gov/pub/AmCan/Contents.html

The New England Council, “TheCreative Economy Initiative, TheRole of the Arts and Culture in NewEngland’s Economic Competitive-ness,” June 2000.

About the AuthorKathleen Gill is a Community AffairsSpecialist with the Federal ReserveBank of Boston; she is a contributingwriter to Communities & Banking.

Perhaps it is the sense of place asso-ciated with art that makes artisticexpression desirable both to resi-dents and visitors. While some areasof modern cities may look inter-changeable, the cultural institutionsand works of art make a placeunique, providing identity. Sinceartists are known for seeing thepotential beauty around us, it is notsurprising that artists are attracted toareas that need renovation. Perhapsit takes an artist’s vision to show usthe potential of neglected areas. Asan ever-growing number of NewEngland communities can attest,support for the arts is an investmentin a community’s future and can bethe first step in revitalization.

Comments on this article? E-mailkathleen.m.gill@bos.frb.org

n January 29, 1991,Florence Hagins, anAfrican-American sin-gle mother with amoderate income whohad been denied amortgage once before,

became the first person to purchase ahome with the assistance of Boston’snew Soft Second Mortgage Program.Almost exactly ten years later, inearly February 2001, she stood before350 people as co-chair, along withBoston Mayor Thomas M. Meninoand Fleet Bank President ofConsumer Banking Robert J. Higgins,of a black-tie event to celebrate theProgram’s tenth anniversary.

Between those two dates, Hagins—still the proud owner of the sametwo-family house in Boston’sDorchester neighborhood—has beenfollowed by more than 2,100 otherlower-income, first-time homebuy-ers. She has become Director ofHousing Education for theMassachusetts Affordable HousingAlliance (MAHA), the community-based organization primarilyresponsible for the Soft SecondProgram’s creation and growth.

Boston’s Soft Second Program getsits name from the fact that partici-pating homebuyers receive twomortgages rather than one: a firstmortgage for 75 percent of the pur-chase price and a second mortgagefor 20 percent (the program requiresa 5 percent down payment). Theinterest rate on both mortgages is50 basis points below the bank’stwo-point rate.1 The second mort-gage is “soft” (for the first ten years)in two ways—payments are interest-only and payments may be furtherreduced for qualifying homebuyersby public subsidies. The Massa-chusetts Housing Partnership Fund

10

15 c & b

and Boston’s Department ofNeighborhood Development alsofund loan loss reserves for eachbank equal to 10 percent of thetotal value of the second mortgagesthe bank has originated. The exis-tence of the reserve fund makes itpossible for borrowers to avoid thecost of private mortgage insurance,while the banks are still protectedfrom credit losses. Affordability isfurther increased by no payment ofpoints (even though, as noted

above, borrowers receive theirloans at 50 basis points below thetwo-point interest rate) and theprovision of down payment andclosing cost assistance.

Initially dismissed by some bankersas a “one-shot deal” when itemerged from almost two years ofconfrontation and finger-pointing,the program is regarded in Bostontoday as both unusually compre-hensive and remarkably successful.

by Jim Campen and Tom Callahan

O

Soft Second Program Celebrates Years

2000, the SSP delinquency rate was2.5 percent in Boston (and 2.9 per-cent statewide), compared to adelinquency rate of 4.0 percent forall mortgages in the state. The onlyother targeted mortgage program inMassachusetts with available delin-quency data is that of theMassachusetts Housing FinanceAgency (MHFA), which sets itsincome limit at 120 percent of the

metropolitan area median (ratherthan the limit of 80 percent adopt-ed by the SSP). Recent MHFA(statewide) delinquency rates—forexample, 5.4 percent at the end ofDecember 2000—have been wellabove those of the Soft SecondProgram. Furthermore, foreclosureson SSP loans have been rare. By theend of 2000, only five of the 2,112loans originated by the Boston SSPhad ended in foreclosure—a rate of1 in 422, or 0.24 percent.

Members of the MAHA HomebuyersUnion have currently negotiatedCommunity Reinvestment Actagreements with 14 banks for over$500 million in below-market SoftSecond loans in Boston (includingtwo banks that had not yet madetheir first loan by year-end 2000).MAHA has also worked to create alocal secondary market for SSP firstmortgage loans. This effort borefruit in 1997, when the first securi-ties backed by SSP first mortgageswere sold. Packaged by Fannie Mae,the securities offered a rate of return50 basis points below the marketlevel. Savings Bank Life Insurancecommitted itself to buying $20 mil-lion of these securities over the nextten years, and had already fulfilled40 percent of that commitment bythe end of 2000. The Life Initiative,an investment entity established byMassachusetts life insurance com-panies, became the second buyer ofSSP mortgage-backed securitieswith a $6 million investment.

Measuring SuccessFirst, an examination of the incomelevels of all SSP borrowers duringthe ten-year history of the program,shows that 32 percent of all SSPhomebuyers had incomes of$25,000 or less, 60 percent hadincomes of $30,000 or less, and 94percent had incomes of no morethan $40,000. Second, over half ofall Boston SSP loans during the

ten-year period, 1,098 loans, havegone to low-income homebuyers—those with incomes at or below 50percent of the median familyincome of the Boston metropolitanarea, as determined annually byHUD; the low-income ceiling hasrisen from $25,100 in 1991 to$32,750 in 2000.

Although affordability was theirprimary goal, MAHA’s HomebuyersUnion members have always rec-ognized that there are no real ben-efits to homebuyers—and theirneighborhoods—unless they areable to remain homeowners. Thepriority that the group hasattached to sustaining homeown-ership is evidenced by its earlydecision (reaffirmed on severaloccasions) that homebuyers mustmake a significant down payment.MAHA’s low-income membersbelieve strongly that potentialbuyers must demonstrate someability to save money in order toadequately prepare themselves forthe expense of owning and main-taining a home, especially an olderhome in an urban neighborhood.Consequently, the SSP requiresthat at least 3 percent of the total5 percent down payment comefrom the buyer’s own funds.

Delinquency rates for SSP loanshave generally been somewhatlower than the rates for allMassachusetts mortgages. Forexample, at the end of December

16 c & b

Lessons LearnedFor the last ten years, the BostonSoft Second Program has been alaboratory, of sorts, for communitygroups, banks, insurance compa-nies, and government agencies. Theexperience gained suggests severalimportant lessons that are explainedbelow. One such lesson is that suc-cess is a moving target. To keep upwith that target, it’s useful to identi-fy challenges that are likely to con-front the SSP in the near future.

Grassroots involvement is crucial.From day one, the Soft SecondProgram has benefited from anextraordinary degree of involvementfrom low- and moderate-incomemembers of MAHA. Members ofMAHA’s Homebuyers Union wereintimately involved in negotiatingthe details of the program and theywere the guiding force in challeng-ing bankers and government offi-cials to increase the affordability ofthese loans. Large community meet-ings have convinced banks thatthere remains a large, grassrootsconstituency for genuinely afford-able home mortgages.

You can’t stand still. As the financial system has changedaround the program, the SSP haschanged and evolved as well. It hasgrown from three participatingbanks in 1991 to nine in 2001. Ahomebuyer can now get a loan fromFleet Bank, the seventh largest bankin the country, or from Hyde ParkCooperative, an $82 million, two-branch bank. The program startedwith banks needing to retain bothfirst and second mortgages in theirportfolios. Today, Fannie Mae andinsurance companies provide anoutlet for the first mortgages.

Get it in writing. Written agreements for the SSPevolved from a one-page letterfrom the bank to a ten-page mem-orandum of understanding (MOU)that spells out many significantdetails. These MOUs have been use-ful for resolving questions that arisewith the passage of time andchanging bank personnel. The moreformal documents have been par-ticularly valuable in merger-relatednegotiations conducted by MAHAand other organizations.

When the agreement is signed, thework has just begun. This sage advice was offered to

Although affordability was their primary

goal, MAHA’s Homebuyers Union members

have always recognized that there are no

real benefits to homebuyers—and their

neighborhoods—unless they are able to

remain homeowners.

sion would bring about the first realtest of the sustainability of SSPhomeownership during hard times.

While these challenges are serious,the achievements—and the adapt-ability—of the Boston Soft SecondLoan Program during its first tenyears provide grounds for optimismabout its ability to meet these andother challenges that are bound toarise in its second decade.

reflects the impact of the sustainedescalation of housing prices in thecity. On the one hand, potentialhomebuyers find it increasingly dif-ficult to find a house they canafford. On the other hand, somebuyers have located houses theycould afford with the assistance ofthe SSP, but they cannot buy thembecause their prices exceed SSPmaximums. Early March 2001increases in the price ceilings, thesecond set of increases within ayear, will provide some relief fromthe latter problem but do nothing toaddress the underlying problem ofthe erosion of affordability by con-tinually rising house prices.

The most likely scenario leading tolower housing prices—an economicdownturn—is not a remedy.Potential homebuyers’ ability topurchase new homes might bereduced more by falling incomesthan it would be increased bydeclining house prices. Furthermore,the ability of SSP homeowners tocontinue to make their monthlypayments in a timely fashion couldbe seriously threatened by risingunemployment and falling house-hold incomes. The Boston SSP’s lowdelinquency and foreclosure rateshave been achieved during thelongest uninterrupted economicexpansion in U.S. history. A reces-

MAHA in 1990, and the last tenyears have borne it out. There havebeen countless hours of meetingsto implement, monitor, and renego-tiate the agreements. MAHA hasadded three new programs (home-buyer counseling, homeowner edu-cation, and foreclosure prevention)to help support the SSP. It organ-ized large community meetingsfocused on the program in 1994,1996, 1997, and 1999.

Partners are essential. Bankers have spent numerous hoursin boardrooms and communityrooms discussing details of imple-menting the SSP. The MassachusettsHousing Partnership, Boston’s De-partment of Neighborhood Devel-opment, and other governmentagencies have expended enormoustime and energy to make the pro-gram a success. Other neighbor-hood-based nonprofits have promot-ed the program through outreachand workshops. The MassachusettsCommunity & Banking Council hasbeen instrumental in monitoringdelinquencies. Public officials andprivate companies have providedfinancial support. The list could goon. The program has been inclusive,and a wide variety of public and pri-vate organizations share in the cred-it for the SSP’s achievements.

Challenges AheadBetween 1990 and 1999, the shareof Boston home-purchase loansmade by mortgage companies andother lenders not subject to CRA fortheir Boston lending has tripled,from 21.9 percent of all loans at thebeginning of the decade to 61.9 per-cent at the end. During this time,however, no mortgage company hasseriously explored the option ofjoining the Boston SSP. As barriersbetween different financial indus-tries continue to crumble, con-sumers may soon be able to getmortgages from their insuranceagents. Public comments by topofficers of Boston’s biggest bankshave raised the possibility that someinstitutions might decide to get outof the highly competitive, low-mar-gin business of making mortgageloans. Increasing, or even maintain-ing, lender commitments to the SSPin this changing institutional envi-ronment could be difficult.

The declining number of BostonSSP loans in the last three years

17 c & b

Between 1990 and

1999, the share of

Boston home-pur-

chase loans made by

mortgage companies

and other lenders not

subject to CRA . . . has

tripled . . . . During

this time, however, no

mortgage company

has seriously explored

the option of joining

the Boston SSP.

Endnote1. A bank’s two-point mortgage rate will have a lower interest ratethan a similar mortgage without points. Consumers can “pay” points,each of which is equal to 1 percent of the mortgage balance, to reducetheir interest rates, which in turn reduces monthly payments.

About the AuthorsJim Campen is Associate Professor of Economics at the University ofMassachusetts–Boston. He has served on the Federal Reserve Bank ofBoston’s Community Development Advisory Council and currentlyserves on the board of the Massachusetts Affordable HousingAlliance, of which Tom Callahan is the Executive Director. In addi-tion to his position at MAHA, Callahan is vice chair of theMassachusetts Community & Banking Council and co-chair of itsMortgage Lending Committee.

Editor’s NoteThis article is adapted from a paper presented at the Federal ReserveSystem’s Community Affairs Research Conference held April 5-6,2001. To read the full paper, which provides an in-depth analysis ofthe program’s impact in a changing financial services environment,visit www.chicagofed.org/cedric/2001/Aprilconference.cfm.

CRA statute and regulations forguidance. Banking institutions aloneare subject to the law, so we focusedon them exclusively and did notconsider credit unions or mortgagecompanies. Next, we determined thata CRA-related loan was one extend-ed to a lower-income householdanywhere in a banking institution’slocal community or to a borrower ofany income in a lower-incomeneighborhood within that communi-ty. We used a similar definition for

small business lending.Note that these defini-tions exclude about halfof all lower-incomelending done by bank-ing organizations.

The second questionproved considerably

more difficult. In principle, to assessa law or regulation’s influence onloan performance and profitability,one must measure its “marginal”effect; ideally, this would mean con-sidering only the additional loansmade because of the law. Such anassessment, however, is impossiblein practice because one cannot spec-ify the subset of loans that are madesolely because of the CRA. In theend, we chose to examine the per-formance and profitability of allloans made in conformity with theCRA; in other words, those that metour definition of a CRA-related loan.This approach, though not ideal,complied with the language of thelaw that mandated the study.

To answer the third question—whether the research already avail-able was capable of satisfying thecongressional request—Board staffreviewed the existing studies of theperformance and profitability ofCRA-related lending. We found thatsuch research as did exist was toolimited to meet our needs. Nearly allof it had focused on the performanceand profitability of home lending,and most of this concerned the rela-tively narrow group of loans madeunder affordable-home-loan pro-grams. Although they target much of

programs and have established pro-cedures to mitigate the credit riskassociated with such loans.

Although the CRA’s effects on lend-ing to lower-income populationsand neighborhoods are difficult toassess, such lending has increasedsubstantially over the past decade orso. For example, home-purchaselending to lower-income householdshas increased 86 percent since 1993(compared to about 50 percent for

higher-income households). Lendingto borrowers in lower-income neigh-borhoods also has risen sharply(nearly 80 percent) since 1993.

Despite all this experience, little sys-tematic information has been pub-licly available about performanceand profitability, either for CRA-related lending activities as a wholeor for the loans extended under CRAspecial lending programs.

CONGRESSIONAL MANDATEIn November 1999, the U.S.Congress asked the Federal ReserveBoard to do a comprehensive study

on the performance (that is, thedelinquency and default rates)and profitability of loans made inconformity with the CRA. Beforeresponding to their request, theBoard needed to address threebasic questions: What is a CRAloan? How does one measure theeffect of a law or regulation onthe profitability and performanceof lending? Is previous researchadequate to fulfill the congres-sional request?

In considering the first question—how to define a CRA loan—theReserve Board staff looked to the

In November 1999, the U.S.Congress asked the Board ofGovernors of the Federal ReserveSystem to conduct a comprehensivestudy of loans made under theCommunity Reinvestment Act of1977. The Board’s study focused onthe loans’ delinquency and defaultrates—their performance—as well astheir profitability. This article reportsthe results of the study.

Responding to the CRA, bankinginstitutions have used various meth-ods to expand lending to lower-income customers and those inlower-income neighborhoods, buttheir approaches fall into two broadtypes, both typically involving spe-cial marketing and outreach. In oneapproach, lenders have sought addi-tional CRA-related customers whowould qualify for market-pricedloans using traditional standards ofcreditworthiness. In the other,lenders have gained customers bymodifying their underwriting guide-lines or loan pricing. Many bankinginstitutions, especially the largerones, have established or participatein special programs to foster lending.

Special lending programs vary wide-ly but they often feature more flexi-ble credit-underwriting guidelinesthan those used for other products;education and counseling forprospective borrowers; enhanced,targeted marketing of credit prod-ucts; and coordination with a wide

range of third parties, both privateand public. In addition, some bank-ing institutions offer pricing incen-tives for loans made under these

18 c & b

PERFORMANCE & PROFITABILITY

OF CRA-RELATED LENDINGRESEARCH BY ROBERT B. AVERY, RAPHAEL W. BOSTIC, AND GLENN B. CANNERQUOTATIONS PROVIDED BY COMMUNITIIES & BANKING

The question we need to ask is not‘How profitable is this [CRA lend-ing], but what is the overall valueof this lending?’

–James Head, President, NationalEconomic Development and Law CenterRemarks at the Federal Reserve’s 2001

Community Affairs Conference

There is no appropriate sound bite todescribe CRA profitability.

–Robert AveryRemarks at the Federal Reserve’s 2001

Community Affairs Conference

that compromised confidentiality. Inpreparing the survey instrument, wereceived input from many sources,including banking institutions,community-based and nonprofitorganizations, and members ofCongress and their staffs.

The survey had limited goals. It isespecially important to note that itsresults do not represent a cost/bene-fit analysis of the CRA. Consistentwith the Congress’ mandate, the sur-vey focused only on the perform-ance and profitability of CRA-relat-ed lending. It did not examineinvestment and service activitiesthat banking institutions may haveundertaken because of the CRA. Itdid not address the CRA’s effects onlocal communities and included lit-tle information about its benefits toindividual institutions. The survey

collected information about activi-ties in only four loan-product cate-gories (the most significant ones formost institutions). These includedhome purchase and refinance lend-ing, home improvement lending,small business lending, and commu-nity development lending.

SPECIAL CHALLENGESThree of the challenges posed by thissurvey warrant particular comment.Because of statutory deadlines

the same population as the CRA,loans extended under affordable-home-loan programs often deviatefrom the definition of a CRA loan ina few important respects: They areoften extended by institutions, suchas mortgage companies, that are notsubject to the CRA; they frequentlyinclude loans made by bankinginstitutions outside their local com-munities; and they sometimes aremade to borrowers whose incomesexceed our lower-income criterion.

Our review of previous loan per-formance research showed widevariation in the experience of indi-vidual banking institutions, depend-ing on such factors as their locationand the kinds of approaches theyused to extend credit. The delin-quency rates reported are generallyhigher than those for other loans,while default rates are slightly high-er or about the same.

Two types of research on loan prof-itability have been conducted, onebased on a special survey of bankinginstitutions’ experiences and theother on statistical analysis of stan-dardized reports filed by all bankinginstitutions. The Federal ReserveBank of Kansas City’s 1995 surveyfocused on home-purchase lending;its main finding was that CRA-relat-ed lending was profitable, but some-what less so than traditional lending.Statistical analysis of Call Reportdata, merged with data on home-pur-chase lending, showedthat institutions doing rel-atively more lower-income mortgage lendingare no less profitable thanother institutions.

THE BOARD’S STUDYHaving concluded thatexisting research did notprovide adequate data tosatisfy Congress’ request,the Board decided to under-take some new research. Tothis end, the 500 largest retail bank-ing institutions were surveyed abouttheir lending experience, focusingon CRA-related loans. This focusincluded special lending programs,which are sometimes an importantaspect of institutions’ CRA-relatedlending activities. We selected the500 largest retail banking institu-tions because they account forabout 75 percent of all CRA-relatedlending. Respondents were assuredthat the data reported would not bedisclosed to the public in a manner

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imposed by the Congress, bankinginstitutions had little time to prepareresponses. In fact, we continued toaccept responses for nearly a monthbeyond the deadline. The timing ofour survey coincided with due datesfor the annual reports that institu-tions must file under the provisionsof the Home Mortgage DisclosureAct and the CRA, as well as severalother regulatory reports.

In addition, we encountered someconfusion as to the definition of aCRA loan. The definition was notwell understood by all surveyrespondents, some of whom equatedCRA loans with loans made underspecial lending programs.

Finally, the study used return onequity as a measure of profitability.To calculate it, we sought very com-prehensive data, asking respondentsto include all sources of costs andrevenues. Survey responses and fol-low-up phone calls, however, indi-cated that some lenders had consid-ered cost of capital and others hadnot. As a result, much of our analy-sis focused on a relative ranking ofprofitability for CRA and nonCRAlending within a bank. Such internalcomparisons are not affected by fail-ure to consider the cost of capital orany other factor, as long as it isreported consistently within a bank.

1. SURVEY RESULTS: CRA-RELATED LENDINGWe received responses from 143 ofthe 500 institutions to which we sentthe survey (a 28.6 percent responserate). These responses and our fol-low-up telephone contacts revealedthat banking institutions generallydo not track profitability and per-formance separately for CRA-relatedlending, so our report emphasizedqualitative results regarding prof-itability. Because fewer than half of

Our experience has been that as rates move up and down, conven-tional mortgage and small-business borrowers will refinance whilethe iron is hot; however, those receiving CRA loans might not beable to refinance because of how the assistance programs helpedto get that loan off the ground. What you end up with is CRA port-folio characteristics that are more stable than in a conventionalmortgage portfolio. While the rule of thumb says that the averageperson stays in a mortgage for seven years, for the first-timehomebuyer or low-income homebuyer, it’s often one and a half totwo times that.

–Richard Staples, CRA Officer, People’s Savings Bank of BrocktonApril 2001

In Massachusetts, the Soft SecondProgram is an exception to the generalstatement on the delinquency of speciallending programs. This program hasundertaken a large number of origina-tions with low delinquencies, resulting inhigher profitability than might be expect-ed of a CRA portfolio.

–Richard Staples

the respondents answered quantita-tive questions on performance, onemust be cautious when using theseresponses to draw qualitative infer-ences comparing the performance ofCRA-related and other lending.

The results varied by loan product.Home purchase and refinance lend-ing has the largest origination vol-ume by far ($570 bil-lion, of which about10 percent is CRA-related). Responsesindicated that over-all as well as CRA-related home pur-chase and refinancelending is profitableor marginally profitable for mostinstitutions. On a dollar-weightedbasis, about 85 percent of surveyrespondents said that their CRA-related lending as a whole was atleast marginally profitable. However,CRA-related home purchase andrefinance lending was reported to beless profitable and to have similar orhigher delinquency rates than otherhome purchase and refinance lend-ing. Concerning this product, about63 percent of respondents said thattheir CRA-related lending was lessprofitable than their overall lending.Differences are less dramatic whenmeasured on a per-institution basis.

One of the strongest relationshipsrevealed by the survey concerns thecorrelation between an institution’s

size and the profitability and per-formance of its CRA-related lend-ing. Large banks were less likelythan small banks to report thatCRA-related lending is profitable,and much more likely to say that itis less profitable than their overalllending. A large proportion ofrespondents in all bank-size cate-gories reported that CRA-related

and other home purchase and refi-nance loans have very similar orig-ination and servicing costs, creditlosses, and pricing on a per-institu-tion basis. However, the respon-dents who did report differencesmost often said they had lowerprices or higher costs or credit loss-es for CRA-related home purchaseand refinance loans than for others.

HOME IMPROVEMENT AND REFI-NANCE LENDINGThe results for home improvementlending ($12 billion in originations,of which about 18 percent is CRA-related) are similar to those forhome purchase and refinance lend-ing, although fewer differencesbetween CRA-related and other

home improvementlending were reported.The vast majority ofrespondents in all sizecategories said thatorigination and servic-ing costs, credit losses,and prices for homeimprovement lendingwere about the samefor CRA-related loansas for others.

SMALL BUSINESSLENDINGNearly all respondentsreported that smallbusiness lending over-all ($117 billion inoriginations) and CRA-related small businesslending are both prof-itable. They reportedfew differences in per-formance and prof-itability between CRA-related and other small

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business lending. The same was trueof origination and servicing costs,credit losses, and pricing. Theseresults may reflect the relativelylarge proportion (about 50 percent)of all small business loans that areCRA-related.

COMMUNITY DEVELOPMENTLENDINGVirtually all respondents reportedthat community development lend-ing ($13 billion in originations) isat least marginally profitable.Comparative questions were notasked for this category of loansbecause it was unlikely that wewould be able to construct validcomparison groups from bankinginstitutions’ loan portfolios.

2. SURVEY RESULTS: CRASPECIAL LENDING PROGRAMSEvidence suggests that CRA speciallending programs ($11 billion inoriginations across all loan-productcategories) are relatively small andaccount for a small proportion of theloans extended by most bankinginstitutions. Only 1 percent ofrespondents reported that theyestablished these programs solely toobtain a “satisfactory” or “outstand-ing” CRA rating. A large share saidthey established their programs tomeet the local community’s creditneeds and to promote its growth andstability. Programs have a widerange of characteristics but theycommonly feature altered under-writing standards. About three-quar-ters of all programs involve thirdparties, such as government entities,nonprofits and lending consortia,which are often a source of subsidiesand provide many services such asscreening of prospective borrowers.In addition, third parties often sharethe credit risk of a loan with thelender. A majority of CRA speciallending programs were reported tobe profitable or marginally prof-itable. About 25 percent of themwere described as unprofitable ormarginally unprofitable.

Here we mention an interestingdebate about interpreting results fromthe CRA special lending programs.One side maintains that these pro-grams represent the marginal impactof the CRA—“the bite of the law”—andtherefore are the appropriate focus foranalyses of the CRA’s effects. Theother side maintains that these pro-grams exist for several different rea-

On how the 1995 CRA influences profitability:

But because of the regulation’s emphasison performance . . . in some markets thereis extreme competition for ‘CRA loans.’Competition is so stiff that profit marginsare under significant pressure, scaringaway smaller community banks. . . . Andsome institutions feel compelled perhapsto make loans for the sake of getting themon their books—maybe with loan termsthat are too flexible, or to borrowers whoare only marginally credit-worthy. Thesetrends, if they continue, threaten to playinto the hands of those who argue thatCRA lending is an unprofitable business.Our goal must be CRA regulations that fos-ter sustainable community reinvestment.

–Ellen Seidman, OTS Director, National Association of Affordable Housing

Lenders speech, October 5, 2000

We have also found that pre- and post-pur-chase counseling have a very important rolein the profitability of CRA loans.

–Richard Staples

response rate was 28.6percent, the institutionsthat responded are esti-mated to account forbetween 45 and 50 per-cent of all the CRA-related lending in eachloan-product category.Furthermore, statisticaltests indicate that sur-vey respondents resem-ble nonrespondentsalong several dimen-sions, including overallprofitability and CRAperformance ratings.

The survey data are primari-ly reflections of the experiences oflarger banking institutions in a par-ticularly healthy economic environ-ment. Experiences may differ forsmall institutions or under differenteconomic conditions. Our currentresearch efforts are focused on afuller assessment of the section ofthe survey that concerns speciallending programs.

sons, only one of which is to respondto the CRA, and do not necessarilymeasure the bite of the law.

CONCLUDING COMMENTSThe report does not characterize theoverall performance and profitabili-ty of banking institutions’ CRA-related lending because it does notcover all the activities of a givenbank. However, the performance andprofitability of most institutions’CRA-related home purchase andrefinance and small business lendingprovide a good indication of the per-formance and profitability of theirCRA-related lending as a whole,because these two categories are themost important ones for the majori-ty of banks. The relatively lowresponse rate to the survey does notnecessarily imply that its results areidiosyncratic. In particular, we foundno evidence that the survey’s resultsare not broadly representative of theexperiences of the 500 institutionsconsidered together. Although the

ABOUT THE AUTHORSGlenn B. Canner is a senior advisorin the Division of Research andStatistics at the Board of Governorsof the Federal Reserve System.Robert B. Avery and Raphael W.Bostic are senior economists there.

EDITOR’S NOTEThe complete study can be found atwww.federalreserve.gov/boarddocs/surveys/craloansurvey/

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Participation by banking institu-tions in the Federal Reserve Board’sSurvey of the Performance andProfitability of CRA-RelatedLending was voluntary. On January21, 2000, each prospective respon-dent was mailed a questionnaireaccompanied by a cover letter fromFederal Reserve Board ChairmanAlan Greenspan explaining thepurpose of the survey and seekingvoluntary cooperation in the study.The sample of institutions selectedto participate in the survey consist-ed of roughly the largest 500 retailbanking institutions-400 commer-

The study, which was released today,indicates that the great majority of CRA-related home and small business lendingis profitable. This study is consistentwith an earlier study conducted in 1997by two Federal Reserve Board economistsfinding that banks offering a high num-ber of loans to low- and moderate-income borrowers are slightly more prof-itable than banks that make few loans tothese populations.

–National Community Reinvestment Coalition,press release, July 17, 2000

The results of the study are clear and consistent: CRA lendingis significantly less profitable than ordinary lending, and themost unprofitable CRA loans are those that are made throughspecial lending deals with CRA specialists and other third par-ties. I am astounded by the data that shows every third dollarlent through these special deals is lent at a loss. The results ofthe Federal Reserve’s study undermine the often-heard claimthat CRA lending is good business that, prior to the CRA law,banks had ignored.

–Senator Phil Gramm, Chairman, Senate Banking Committee,press release, July 17, 2000

cial banks and 100 savings associa-tions. The sample was limited to thelargest banking institutionsbecause they account for the vastmajority (estimated at more than 70percent) of CRA-related lendingnationwide. Survey responses werereceived from 143 banking institu-tions—114 commercial banks and29 savings associations. Despitetheir relatively small number, the143 survey respondents accountedfor about one-half of the assets ofthe more than 10,000 U.S. bankinginstitutions in existence as ofDecember 31, 1999.

PARTICIPATION IN THE SURVEY

Response rates varied markedly bythe asset size of the institution.More than 80 percent of the largestsurveyed banking institutions(assets of $30 billion or more as ofDecember 31, 1999) returned a sur-vey (27 out of 33 sampled institu-tions in this asset category). In con-trast, only about 19 percent ( 72 outof 363) of the smallest surveyedbanking institutions (assets ofbetween $0.950 billion and $4.999billion) responded. Institutions withassets of between $5 billion and$29.999 billion had a response rateof about 40 percent.

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business loan, or buying a car or a house, a credit score loomslarge. It may influence both the likelihood of your getting theloan and the interest rate you will be charged. This release ofinformation comes after the United States Congress startedthinking about making credit scores public to consumersapplying for credit.

Consumers often sit in auto dealerships or mortgage bankers’offices and wonder (or agonize) about whether they will qual-ify for a loan. Now that consumers are able to know theircredit scores, their agonizing should abate. However, it willnow be incumbent upon consumers to understand how theygot their credit scores and how to keep them as high as possi-ble. The release of credit scores is also beneficial to consumerswho may not know that they have good credit and, therefore,are eligible for low-interest loans through traditional lenders.

First of all, it’s important to know the source of the creditscore and who has access to it. The most frequently used cred-it score in the mortgage industry is called a FICO® score,named after the company that devised it, Fair, Isaac andCompany Inc. Fair, Isaac derives the score based on financialinformation from your creditors, such as your history of pay-ing bills on time. The score acts like an amalgam of financialinformation about you. In return, mortgage lenders, financecompanies, and landlords can access your FICO score whenmaking decisions about extending credit to you. The creditscore is used as a measure of how risky a credit consumer youare, based on your patterns of financial behavior. Keep inmind that factors other than your credit score, such as youremployment history and income, also influence creditors’evaluation of your creditworthiness.

The Five Factors

Having covered the basics, the following is a listing of five fac-tors that contribute to your credit score, with a brief explana-tion of what each factor means, how to improve it, and its rel-ative importance in the overall score. The results of these fivefactors added together compose a score ranging from roughly300 to 850, with an inverse relationship between your creditscore and the predicted level of risk you pose to the creditor. Ahigh credit score (700-850) means that you are a relatively lowcredit risk, and a low credit score (300-500) means that you area relatively high credit risk.

Track Record

Your history of paying bills on timefigures prominently in determiningyour credit score. Your recent trackrecord counts more than your datedtrack record. While a 30-day latepayment won’t affect your score asnegatively as a 90-day late pay-ment, the bottom line is to makeyour best effort to pay your bills ontime because this factor has thegreatest single influence on yourcredit score. It is important to knowthat timely payment of bills such asthose for phone and electricity serv-ice will not influence your score.Only credit accounts are followed byFair, Isaac, unless one of youraccounts, such as your electricitybill, gets sent to collection.Percentage of your total credit score:35 percent

Amounts Owed

If you have high balances on a num-ber of credit cards and installmentloans, this situation is hurting yourcredit score. Even if you havenumerous credit cards that don’thave high balances, your creditscore could be impaired. Numerouscredit cards heighten the “potential”for accumulating high balances thatcould jeopardize your ability torepay your creditors at any giventime. Optimally, own one creditcard, use it judiciously, and pay itoff monthly. It is also best to keepinstallment loans, if you have them,at manageable levels. Percentage ofyour total credit score: 30 percent

Length of CreditHistory

The longer you have had a credit his-tory, the more likely you are to scorebetter in this category. If you are rel-atively new with credit, however,you can still score well on this factorif the rest of your factors score well.To determine your length of credithistory, Fair, Isaac looks at the age ofyour oldest credit account and aver-ages the ages of all your creditaccounts. This is why new credit,mentioned below, can be detrimentalto your score. Percentage of yourtotal credit score: 15 percent

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by John Galligan

The Big $core!

Finally, there will be no more talkingbehind your back, financially speaking. As ofMarch 2001, every consumer can know whatbankers, creditors, and loan officers couldaccess about their applicants—their creditscores. Lifting the veil on credit scores is a bigdeal. When it comes to getting a credit card or

FICO scores are only as good as the information they arebased on, which is why it’s important that the threenational credit bureaus, Equifax, Experian, andTransUnion, have the correct information about you.Each of these credit bureaus can produce FICO scoresbased on the information they maintain about you. Andas I found out, they may be inaccurately representingyour current financial position.

In anticipation of securing a loan with the best rate pos-sible to buy a vacation property on Cape Cod, I checkedinto my credit reports to certify that everything was ingood order. To get started, I ordered reports online fromthe three national credit bureaus, Equifax, Experian, andTrans Union, paying $8.50 for each. (Massachusetts andVermont are two of the six states that have enacted leg-islation requiring the three major credit bureaus to pro-vide consumers with one free credit report per year. Inaddition, you are entitled to one free credit report everyyear if you: believe your report is inaccurate due to fraud,have been denied credit within the past 60 days, are onwelfare, or are unemployed and plan to seek employmentwithin 60 days.)

Reading through the reports was disturbing because theyshowed accounts as “open” that I was confident had beenclosed years ago, showed accounts as “open” that werewith stores that had gone out of business years ago, andshowed a mortgage as “active” that had been paid offthrough a refinancing completed two years ago. In all, Iidentified a dozen errors among the three reports. It’simportant to note that simply closing accounts does not

erase them from your credit report, and they may stillinfluence your credit score.

I went to work to correct these errors. I wrote to eachcredit reporting bureau explaining the items in question,and invested a substantial amount of time and effort inthe process. As required, each bureau mailed me correct-ed versions of the reports within 30 days.

Leaving nothing to chance, I then ordered my credit scorefrom www.myfico.com. I paid $12.95 for the information,and received the report online the next day showing thatmy score was in the high 700s—enough to qualify for thebest rates possible, according to the analysis providedwith the score. Armed with this information, I am readyto scour the market, confident that I am a consumer withthe power to shop around for the most competitive offer-ings. You might say that I should be given credit for mydue diligence!

5Type of Credit inUse

This factor reflects whether you havea “healthy” mix of credit. Here’swhat an “unhealthy” mix of creditwould look like: numerous creditcards with outstanding balances,plus large mortgage and auto loans.Doing well with this factor meansnot overextending yourself withcredit. A “healthy” mix of creditwould entail managing a reasonablenumber of credit card accounts andother loans with timely payments. Itdoes not mean having one of eachtype of credit account. Using creditcards responsibly, rather than nothaving them at all, is a boost to yourscore. Percentage of your total creditscore: 10 percent

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New Credit

If you have applied for or haveobtained new credit cards recently,you are reducing your credit score.Again, the potential for getting intotrouble with multiple cards is at playhere. Low introductory rate offersswell the mail and numerous retail-ers offer discounts with the openingof an account. Yet with these offersyou are also getting another listingon your credit report that couldcount against you. Retail store cred-it, in addition, is often provided byfinance companies, and a number ofthese accounts may reduce yourcredit score. It is best to open newcredit lines only when necessary.Percentage of your total credit score:10 percent

About the Author

John Galligan is Director of Electronic Banking Services atthe United States Treasury. He recently completed a five-week internship with the Federal Reserve Bank of Bostonas part of Treasury’s Senior Executive Service CandidacyDevelopment Program. At the Boston Fed, Galliganworked to develop a financial literacy publication.

Cleaning Up My Credit History

For Further Information

www.myfico.comwww.advantagecredit.com

Credit Reporting Agencies:Experian

1-888-397-3742www.experian.com

Equifax1-800-685-1111

www.equifax.com

Trans Union1-800-916-8800

www.tuc.com

Also, the Spring 2000 and Winter2001 issues of Communities &Banking feature in-depth articlesabout credit scoring.