The Color of Money

by Mehrsa Baradaran

  Andrew Brimmer provided the sharpest critique of black capitalism and black banking. Brimmer was born to a family of sharecroppers in Louisiana, received his Ph.D. in economics from Harvard, and was appointed by President Johnson as the first black governor of the Federal Reserve in 1966. As Federal Reserve governor, he presented a number of ideas that have been vindicated over time. For example, he suggested in 1970 that financial institutions engaged in risky activities should be forced to hold more money as reserves than typical commercial banks. The Federal Reserve chairman, Arthur Burns, rejected the idea because he believed that markets would know how to deal with the overly risky investment banks and that the Fed should not be involved. After the 2008 financial crisis, this prescient warning was resurrected and is now being seriously considered.166

  Brimmer forcefully denounced black capitalism, maintaining that “the only really promising path to equal opportunity for Negroes in business as in other aspects of economic activity lies in full participation in an integrated, national economy. It cannot be found in a backwater of separation and segregation."167 He called black capitalism a “cruel hoax" and “one of the worst digressions that has attracted attention and pulled substantial numbers of people off course."168 In 1971, Brimmer testified before the House Committee on Small Business in opposition to black capitalism, explaining that black families, who were meant to be the cornerstone of the black business market, simply did not have enough wealth or income to support a viable industry.

  He even took his argument directly to the black community in an Ebony essay in 1970, in which he denounced the “mirage" of the black community operating as a separate nation.169 He noted that blacks were 11 percent of the population, but held less than 2 percent of the nation’s assets—the black community did not have the economic strength to go it alone. As another economist, Robert S. Browne, explained, “there is no question of ‘pulling ourselves up by the bootstraps.’ We have no bootstraps."170 Brimmer played the wet blanket role that Abram Harris had played before him, standing apart from virtually every other black leader and activist. And, like Harris before him, his words of caution were drowned out by the optimistic champions of black business.

  Like Harris, Brimmer reserved his most thorough and specific criticism for black banking. He had nothing against black banks or bankers—unlike Harris, this was not the sort of criticism that labeled black bankers as exploiters or “house slaves." Black bankers, said Brimmer, “should not be encouraged in the belief that they can make a major contribution to the financing of economic development in the black community." Brimmer emphasized that the objective of these banks, of fostering economic growth in black communities, was critically important. He just did not believe that black-owned banks were up to the task. He dismissed the banks as merely “ornaments,” suitable only as “a mark of distinction or a badge of honor which provides a symbol of accomplishment.” They might be “a source of racial pride,” but they would never “become vital instruments of economic development.”171

  Research on black banks and available public data on banking in this era validate Brimmer’s position. Balance sheet analyses reveal that the specific financial hurdles these banks faced were caused by the same factors that had remained stubbornly unchanged over time, but with a few new and unexpected obstacles.

  The typical black bank was one-third the size of an average commercial bank, as measured by assets, and they were one-quarter to one-third as profitable.172 Black banks still had much higher operating costs than white banks; these costs absorbed 93 percent of operating income at black banks, compared to 78 percent at white banks. High operating costs were a result of small and volatile deposit accounts from their mostly poor clientele. Their high operating costs and low profits meant that black banks paid lower interest to their customers for their deposits than did white banks. Commercial banks paid an average interest on deposits of 4.4 percent in 1969; black banks only paid 3.1 percent. So black customers depositing at black blacks were losing an extra 1-2 percent in interest on their deposits. The banks also had to charge higher service fees to make up for their expenses, an additional cost borne by their customers. Loyal customers not driven away by this surcharge were making a financial sacrifice to support the black banks.173

  One of the most surprising reasons that black banks’ deposits were of such low value was the federal government’s deposit program. By 1971, black banks had received $44.9 million in government deposits, which made up 18 percent of their total deposit balances. In contrast, government deposits in white-owned banks were about 2 percent of their total deposits. The point of the deposits was that they would strengthen the banks and create more community-building loans. As it turned out, these deposits ended up harming black banks because they were the wrong kind of deposits—unstable accounts from government agencies. Their volatility meant that they required higher servicing costs. One study even found that such deposits were actually more costly to black banks than their regular customers’ deposits.174

  Even more problematic in their effects on operating costs was their effect on the asset side of the banks’ balance sheet. Black banks were required by law to pledge government securities for any government deposits they held over $100,000.175 An FDIC study explained that the black banks formed after 1963 invested a staggering 40 percent of their assets in government securities.176 This meant that they could make fewer loans and therefore take fewer profits, which meant that their investors made less money on their investments. In a seemingly endless cycle of problems, this meant that black banks could attract fewer capital investments, making them even weaker.177

  Adding even greater insult to injury was that government deposits, instead of bringing money into the black community, were diverting black deposits out of the community. Instead of using deposits to invest in the community through local lending, black banks were overinvested in government securities on the asset side, which, according to one economist, turned black banks into “a conduit by which local deposit funds are exported to other markets through sales of federal funds and purchases of securities."178 The black banks were taking deposits from the community and channeling them to investments in government securities that were being used to finance mortgages in other communities. “It appears," said Brimmer, “that black banks may be in the anomalous position of campaigning for U.S. government funds which they then use to finance a disproportionate share of the Federal debt."179 This was not a matter of simple racial discrimination or even an effect that was obvious, but money that was supposed to stay in the community for loans was actually being funneled outside of the community through a program meant to bolster black community enterprise.

  On the asset side, not only did black banks make fewer loans than white banks; the loans they did make suffered higher losses because the ghetto had always been a risky place to do business. Brimmer explained that there was an “inherent risk of doing business in the urban ghetto"; specifically, “the high unemployment rates, low family incomes, the high failure rates among small businesses (compounded by high crime) make the ghetto an extremely risky place for small banks to lend money." Cut off from the rest of the community, ghetto businesses could not take advantage of economies of scale or the robust infrastructure of the outside community. And the few profitable industries in low-income markets were captured by nonblack banks outside the ghetto.180

  Thus, black bank loans, concentrated in the ghetto, lost more money due to default than those of white banks. Their losses were so heavy that the black banks’ net income was less than one-half what it could have been without the defaults. Moreover, because of the high risk and high default rate of their loans, the banks held on to more cash and other liquid assets, which meant that more of their money sat dormant at the bank instead of yielding profits through fractional reserve lending. The average set-aside for loan losses at white banks was 11.4 percent of income. The difference was striking for black banks, which set aside an astounding 137 percent of their income to
cover loan losses.181 Not only did they hold on to more cash, but they hedged against the risk of high loan defaults by overinvesting in government securities, furthering the slow leak of funds out of the ghetto. These securities may have offered predictable and solid returns, but it was no way to grow a bank or a community. It was evidence, however, that these banks were making every effort to operate as safely as possible.

  In trying to protect themselves against the hazards of lending in the ghetto, black bankers were inadvertently using the incomes of their customers to undercut the ghetto economy by investing in the outside community.182 In other words, black banks were not able to use fractional reserve lending to multiply or even to keep the black dollar within the ghetto. For the most part, they either held the black dollar dormant in a bank vault or they invested it in a white community through government securities. In any case, they were not able to control the black dollar or multiply it in the ghetto, which was their raison d’etre and the reason they were supported and celebrated by both white and black leaders as the key to growing a separate economy.

  Despite the stark economic reality of these banks, there still were more cheerleaders for black capitalism than naysayers. Edward Irons, the founding dean of the Howard Business School and executive director of the NBA, conducted a study of black banks. He conceded that they were performing poorly and stuck in a trap, but he remained optimistic about the prospects of black enterprise.183 He encouraged federal, state, and local governments to place deposits in black banks, but urged major corporations to follow suit as well. Irons underscored the idea that black banks were an important source of racial pride and community building.

  This benefit was enough for some. Economist Rawle Farley extolled black banks, calling them “one of the key determinants of the course and character of black economic development.” To Farley, “the psychological impact of their emergence cannot be ignored in that they make the seemingly impossible a practical and attainable area of reality.” He explained that to the black community, banking had always seemed an impossibility and, just as Jesse Owens had broken barriers in track and field, black bankers’ success in the field of banking could serve as important role models. Black banks were thus closing the racial gap, even if only psychologically. They offered an “ethnic psychic pleasure” for the black community who kept account of the “economic achievements of their brothers,” and this pleasure would spur further development.

  More than racial pride however, many observers believed that there was no other choice. Farley himself joined with other black scholars in viewing the ghetto as a permanently separate economic environment and an isolated economy. In this framework, black entrepreneurship was necessary and unavoidable, because mainstream banks would never lend there. Farley believed that American businessmen avoiding taking risks in the ghetto was akin to “nonnative” corporations avoiding investing in the unknown jungles of Brazil. Black banks had to take risks that were “greater than the traditional risks” because they were acting as development banks. Economist William K. Tabb, a specialist in globalization and international development, believed that “the economic relations of the ghetto to white America closely parallel those between third world nations and the industrially advanced countries.”184

  Black nationalists had also envisioned the ghetto as a colony and had fought for decolonization and full sovereignty. With full sovereignty, control of land and resources, including the ability to block “foreign” competition in the ghetto, black banking could have been viable. Segregation and discrimination had operated like a tariff wall between the black and white economies, raising the price of goods and services crossing the barrier and creating two different economies—one subservient to the other. This situation, which economist Lester Thurow called “the monopoly power of whites," could be overcome through full sovereignty in the ghetto, which meant monopoly power over its resources.185 But the majority of the black population did not want this; nor would white policymakers ever consider such a proposal. Yet black banking continued to be supported and endorsed with the unfounded belief that control of banks was akin to control of capital and resources. Banking does not beget control and power; rather, control and power beget sound banking.

  In order to have a healthy banking system with the ability to increase wealth, the choice was either full sovereignty or complete integration. Black banks would be unnecessary with full integration, but would be essential in an independent black territory. But the banks themselves could not create either condition. Black capitalism and black banking constituted a frustratingly futile halfway position.

  It was clear that Nixon did not understand the segregation trap for black banks when he promised that black capitalism would “[open] the full range of business opportunity to all by removing the inherited and institutional barriers to entry."186 But the intellectual founder of black capitalism, Theodore Cross, understood that black banking had become a diversion. He wrote in 1971 that black banks were still just “toy banks" or “specks of gold dust in the $1 trillion private capital and credit markets of America." Yet they had become magnets for government money and press, for, as he explained, “when the heat is on the temptations are great to build a few monuments to black affluence."187 Shining a spotlight on a few successful black banks obscured the true problems of the wealth gap and the ghetto economic trap. At best, black capitalism was being used as state paternalism, but at heart it was deployed as a decoy instead of an honest account of a systemic problem.

  Blacks had been excluded from full participation in American capitalism. Just as the civil rights laws were finally aligning the American creed with its deeds, black capitalism could be seen as a late-term remedy for systemic exclusion. The American economy was built on the theory of free-market capitalism, which meant open markets for all participants, with no government intervention, only the invisible hand of the market. In The Wealth of Nations, Adam Smith had explained that excluding any group from free market participation was antithetical to capitalism.188 The foundational premise of capitalism was that it did not discriminate; rather, it provided equal opportunity to trade and prosper based on one’s skill and ability to produce marketable goods. Smith railed against any artificial exclusions to entry into a profession or trade. In The Philosophy of Money, Georg Simmel claimed that money was a “democratic leveling social form that excludes any specific individual relationships."189 For a market economy to thrive, any person’s money should be as good as any other’s. Even Karl Marx recognized that capitalism would do away with “ancient and venerable prejudices" because it left “no other nexus between man and man than naked self-interest, than callous ‘cash payment.’ "190

  Yet blacks had been excluded from the main avenues of free trade and forced into an economic detour. Their property was not protected by law. They were banned from occupations, schools, neighborhoods, and trades. Not only that, but government intrusions into free markets had favored whites at their expense. The mixed economy of the progressive reforms that began in earnest with the Wilson administration, and had been the guiding principle through the Johnson administration, had almost completely excluded blacks from governmental infusions of credit and wealth into housing markets.191 The result was a situation in which blacks paid more for everything—where their money was not as good as any other’s. The black community was demanding that it either be allowed full entry into the system or be given monopoly state power over their own separate economy.

  However, this demand for economic redress by the black movement came at the same moment that capitalism itself seemed to be under siege by revolutionary communist regimes abroad. In the fog of domestic and foreign war and an existential Cold War, it was hard to draw lines. Identifying enemies at home turned out to be just as confusing as finding them in the jungles of Vietnam. The Panthers, the Vietcong, the Russians, student protesters, domestic terrorists— all challenged the status quo and led to paralyzing fear. Nixon’s gift to the American public was his ability to dr
aw crisp lines between “real Americans" and ne’er-do-wells; hippies, draft dodgers, and black activists were the latter. Black protesters were often labeled communists, including Martin Luther King, who was wiretapped and blackmailed by Hoover’s FBI as a domestic enemy.192 King felt compelled to respond: “You don’t have to go to Karl Marx to learn how to be a revolutionary. I didn’t get my inspiration from Karl Marx; I got it from a man named Jesus."193

  King was not a communist, but many principals of the black power movement were communist or communist sympathizers who associated with Cuba, China, and other revolutionary regimes. The ninety-three-year-old W. E. B. Du Bois, living in Ghana, joined the Communist Party in the 1960s before his death, lamenting that capitalism could not save itself.194 In a 1967 speech in Havana, Cuba, Stokely Carmichael explained his opposition to the U.S. political and economic system: “The ‘civil rights movement’ did not actively involve the masses, because it did not speak to the needs of the masses. . . . [Civil rights] laws did not speak to our problems. Our problems were an inherent part of the capitalist system and therefore could not be alleviated within that system."195

  Aside from the radical margins, the majority of black activists were essentially claiming that they had been left out of capitalism, or that it had not worked for them. Black nationalist Reverend Albert Cleague explained his aversion to capitalism as being about exclusion: “as far as the black community is concerned, the capitalistic economy doesn’t work for us because we don’t have any stake in it. It just happens that when we got to a place where we were able to do something, we were outside and the concentration of wealth in the white capitalistic set up is so complete now that you can’t break into that . . . we are frozen outside of it."196 Black separatist Harold Cruse remarked that blacks had been “prevented" from participation in American capitalism: “It is not that the Negro suffers so much from capitalism in America, but from a lack of capitalistic development.”197 This sentiment was a common theme among black leaders. Daniel Watts, editor of the most prominent black militant publication, The Liberator, posed the question in 1968 “whether black people [should] accept capitalism." His answer was realistic: “whether you like it or not, the basic fact of life is that the capitalistic system in America does produce. There is no question about it, the system works, it produces." He urged blacks to adopt capitali st principles and make it work for them.198 Many of the black nationalist and radical movements’ demands centered around meaningful inclusion in capitalism. The demand for reparations was a demand for capital in order to remedy past exclusion that had left the community bereft of that capital.