An Lesson In Greed, Atlanta Style

As we look for ways to prevent future financial crises, many questions should be asked. Here’s one you may not have heard: What’s the matter with Georgia? - Paul Krugman, April 12, 2010

It seems that Georgia leads the nation in bank failures, accounting for 37 of the 206 banks seized by the FDIC since the beginning of 2008. No other state has suffered as badly from banks gone bad. Georgian Bank, founded in 2001, once entertained clients on the C.E.O.’s yacht and private jet before it finally went bust. Integrity Bank, founded in 2000, played up its “faith based” business model — it was featured in a 2005 Time magazine article titled “Praying for Profits” - but it too has gone bust. Nobel-winning economist Paul Krugman addressed this crisis in a recent NY Times op-ed piece.

Not surprisingly, the bank failures resulted from the collapse of the housing bubble. The share of mortgages with delinquent payments is higher in Georgia than in California; the percentage of Georgia homeowners with negative equity is well above the national average.

To appreciate the situation, Krugman explains, you first need to realize that the housing bubble was a geographically uneven affair. Prices rose sharply in cities like Portland where zoning restrictions and other factors limited the construction of new houses. In the rest of the country, permissive zoning and/or abundant land made it easy to increase the housing supply, a situation that prevented big price increases and therefore prevented a serious bubble. Atlanta is a sprawling metropolis facing few limits on expansion, so it never saw much of a housing price surge.

So what’s the matter with Georgia? Krugman says the banks went wild in a scene reminiscent of the savings-and-loan excesses of the 1980s. High-flying bank executives aggressively expanded lending — and paid themselves lavishly — while relying heavily on “hot money” raised from outside investors rather than on their own depositors. It was fun while it lasted. But then the music stopped.

In contrast, though, the same thing didn't happen in Texas, with its similarly sprawling cities like Houston and Dallas. Surprisingly, though, Texas had strong consumer-protection regulation that made it difficult for homeowners to treat their homes as piggybanks, extracting cash by increasing the size of their mortgages. Georgia lacked any similar protections (the Bush administration blocked the state’s efforts to restrict subprime lending directly) and suffered for the difference.

What’s striking about the contrast between the Texas story and Georgia’s debacle is that it doesn’t seem to have anything to do with the issues that have dominated debates about banking reform. For example, many observers have blamed complex financial derivatives for the crisis. But Georgia banks blew themselves up with good old-fashioned loans gone bad.

And for all the concern about banks that are too big to fail, Georgia suffered, if anything, from a proliferation of small banks. Actually, the worst offenders in the lending spree tended to be relatively small start-ups that attracted customers by playing to a specific community.

So what’s the moral of this story? As Krugman sees it, it’s a caution against silver-bullet views of reform, the idea that cracking down on just one thing — in particular, breaking up big banks — will solve our problems. The case of Georgia shows that bad behavior by many small banks can do as much damage as misbehavior by a few financial giants.

And the contrast between Texas and Georgia suggests that consumer protection is an essential element of reform. By all means, we should limit the power of the big banks. But if we don’t also protect consumers from predatory lending, there are plenty of smaller players — both small banks and the nonbank “mortgage originators” responsible for many of the worst subprime abuses — that will step in and fill the gap.