The Color of Money

by Mehrsa Baradaran

  A customer base that deposits little and withdraws often creates another less obvious financial bind for banks.115 Because of the volatility of their deposits, black banks had to keep more cash on hand as reserves or invest in other more liquid assets such as government securities, which were safer than loans. They did so because they needed to make sure they always had enough cash at the bank to pay out to depositors. They also held very high capital ratios to offset this risk.116 In 1920, the mean capital ratio for white banks was 18 percent; black banks had an average capital ratio of 32.9 percent.117 This meant that the bank owners invested more of their own money and earnings in the bank to keep it secure, but this severely restricted their profitability and lending capacity.

  In order to minimize the risks presented by their small and fickle deposits, bank managers held more capital, cash reserves, and liquid assets. All of this meant that they could make fewer loans and thus were not able to fully enjoy the benefits of fractional reserve lending.118 Fewer loans meant less revenue for the banks, less credit for the community, and less wealth creation overall. A profitable bank tries to hold as few reserves as possible, have as low a capital ratio as allowed by law, and make as many loans as possible in order to maximize profits.119 Black banks were trying to stay safe, but their weak deposit structure put them in a bind. Black banks were lending with one hand tied behind their back. What weakened these banks is the paltry wealth of the communities they served, which was also the reason they were created—to provide financial services to a poor population.

  Another source of vulnerability for black banks was their assets, or loan portfolios. The fate of black banks was tied up with the fate of black businesses, and the precarious state of the latter meant that black banks lacked the healthy diversity required for sound banking. Most thriving banks prefer to hold a mix of commercial and real estate loans, because a diversified portfolio is safer and more profitable. But black banks made loans almost exclusively on residential real estate because the vast majority of black businesses were “pebbles on the seashore," small service operations with no need of bank financing.120

  The black banking market was thus created to meet one key credit demand: home loans. It was widely acknowledged that white banks did not lend to blacks for home buying, and if they did, they charged much higher interest rates.121 The portfolios of black banks were dominated by home loans, which were the balance sheet equivalent of a ticking time bomb. Home loans were inherently risky, but the key problem for black banks was not the proportion of these loans they held, but their nature.122 The problem was that the collateral for these assets—properties owned by blacks in locations where blacks could buy—diminished in value as soon as the loan was made. To understand this phenomenon, which reveals the core problem of black wealth creation and bank viability, it is important to understand how thoroughly enforced segregation was in the North and how it affected housing prices.

  The North maintained strict racial segregation through a series of tools used consecutively and simultaneously, including violence, zoning laws, and racial covenants—much of which was organized by neighborhood associations and realtors.123 The color line—the place where the black ghetto met the white community—was a highly contested space and the scene of much of the race rioting and violence.124 As the swelling ghetto pushed against the white community, the white community pushed back forcefully.125 The black middle class were usually the early settlers forging into the racial frontier by buying homes in new territory. With a 50 percent down payment required for a home purchase at the time, the only buyers of black property were the black upper class—only 2 percent of the black population in the North in the 1920s.126

  These professional-class pioneers were often the primary victims of bombings and mob violence. A famous case was that of Doctor Ossian Sweet and his wife Gladys, who bought a home outside Detroit’s Black Bottom slums in 1925. The Sweets bought their home for $18,500, which was $6,000 more than its market value. The home was shortly besieged by a white mob that surrounded the home for several days hoping to pressure the Sweets to abandon their property. When the mob began to break windows, Sweet fought back. He and several friends fired into the crowd and killed a member of the mob. Sweet was charged with murder and was defended by Clarence Darrow and Walter White, president of the NAACP. This case was an outlier, not just because Sweet was acquitted of a murder charge by an all-white jury, but because he fought back in the first place. Most black professionals were not willing to wage a violent defense of their home.127

  The reason white neighbors would threaten a black doctor was not necessarily that they did not want him in their neighborhood, but because it signaled a racial breach. Members of the black middle class moving into a neighborhood were seen as harbingers of a neighborhood being swallowed by the ghetto.128 These fears turned into self-fulfilling prophesies, because once a neighborhood “tipped” and was seen as a “black neighborhood,” whites fled and the neighborhood declined and was swallowed up by the ghetto. In 1930, a realtor turned University of Chicago economist, Homer Hoyt, created an economic model based on extensive real estate data that revealed that real estate in a neighborhood declined as soon as a few blacks purchased property there. The lower market values were a result, he explained, “due entirely to racial prejudice, which may have no reasonable basis.”129 This declining property value did not affect the home prices of most immigrant groups—only blacks and Mexicans.

  This is why whites were so vigilant in keeping blacks out of their neighborhoods. They were motivated not only by outright prejudice, but also by fears of asset depreciation (which was, of course, a correlated result of racism). Otherwise, why go through the trouble of organizing associations, making contracts, and planting bombs? Whites on the edges of the black community were protecting their financial investments by keeping blacks out. This racial cartel not only reinforced white advantage; it created a negative feedback loop for black wealth creation. Because black homes were not increasing in value, black homeowners were excluded from the clearest path to wealth creation available to the middle class. On the flip side, through racial violence, whites retained the racial purity of their neighborhoods, and their home values increased precisely because they were not in black neighborhoods. The ability to retain property value—even through violence—was a uniquely white privilege.

  Data also revealed what was already obvious to the black middle class: that the first blacks to own a home in a formerly white neighborhood paid a premium to buy the home to break the color barrier. So values rose slightly, and then, as more blacks entered the neighborhood, home values suffered a drastic decline.130 In other words, blacks paid much more for properties, which came to be worth much less the second they were purchased by blacks. This sluggish real estate market contrasted sharply with the inflated rental market within the ghetto. In the densely packed black ghetto, the low supply of tenant housing coupled with high demand meant that rents skyrocketed by 50 percent or more in comparison to rental properties outside the ghetto.131 Tenants were paying very high prices for increasingly dilapidated housing, and black homeowners paid too much for homes that then lost value. Both sides of the black income scale lost wealth due to segregation. This situation seemingly defies the economic laws of supply and demand, but those laws have never been fully able to account for the intensity of white racism. It is difficult to overestimate the damaging effects of housing segregation on the creation of black wealth or the viability of black banking.

  For banks, these mortgages created severe balance sheet problems, because loans often went “underwater" as soon as they were issued.132 Not only were black banks losing the value of their own investments as their mortgaged properties declined in value, but these loans also created a liquidity bind for black banks because they could not sell them quickly. Black banks had highly illiquid assets, which were essentially stuck on their balance sheets—there was no ready market for black mortgages.133 When Binga needed liquidity, he selected his be
st mortgages on “choice pieces of real estate" and offered them for sale to a few white banks in Chicago. The banks refused to purchase even these loans because they were “unable to market mortgages on Southside properties."134 This was likely due to the twin forces of direct racism and the plummeting house values that racism had indirectly wrought. When the Binga Bank failed, it held $800,000 in mortgages in Southside properties.135

  The raison d’etre of these banks—making loans on black property—was also a principal cause of their failure. The rigid lines of segregation had created a robust black banking sector, but the same forces of segregation infected their balance sheets, making it impossible for them to lend at a profit. Black banks might have been able to survive the low incomes of their customers and their focus on home loans—after all, credit unions and building and loans were flourishing during this era by pooling the resources of their low-income customers to buy real estate. The crucial difference, one that would perpetually prove insurmountable, was that black banks’ assets, loans on black properties, were not appreciating in value. And this was not a problem the credit unions or building and loans had to deal with, for once the building and loan or credit union helped a member buy a home, that property either retained or increased its value.

  Though minutes from NNBL meetings reveal that the black bankers understood their balance sheets to be more vulnerable and risky than their counterparts’, there is no evidence that the bankers suspected that these loans would perpetually diminish in value. Even Arnett Lindsay, who observed firsthand that these banks were not profitable, did not think residential loans were a problem and focused his lament on the lack of business loans. The bankers seemed to believe that these loans, if they could be held long enough, would eventually increase in value for the banks and the homeowners.136

  The hopeful premise on which the entire enterprise was based was that either black communities would eventually acquire enough wealth and buy enough properties to stabilize their prices—or that perhaps whites would stop fleeing black middle-class homeowners. Neither hope has yet to fully materialize. In fact, after the Great Depression, segregation continued to undermine black property values and wealth accumulation. In some ways, it became even harder in the coming decades. Yet to realistically confront and prepare for the obstacles these bankers were facing would have required too bleak a vision—that the U.S. economy would sink into a dramatic decline, that segregation would increase in resiliency, and that racism would continue unabated.

  The most crucial structural problem black banks faced was their inability to multiply money due to segregation. Banks create money and wealth through fractional reserve lending. By lending customer deposits, banks create new money; they “multiply" existing money in a process called “the money multiplier effect." A bank customer, Alice, deposits her money in Bank A. Her bank holds a fraction of that money as “reserves" at the bank and lends out the majority of it to another customer, Betty. Betty uses that money to buy a home from

  Celia, who deposits that money into her own bank, Bank C. That is new money created from the loan. Alice’s bank deposit slip shows that she still has her money at Bank A, but now Celia also has a deposit at Bank C—money that was not there before. In this process, if Alice’s initial deposit was $100 and it was lent out ten times, with each bank holding 10 percent for reserves, it would have created $900 of new money.137 The money supply increases from $100 to $1,000. This is the “magic” of fractional reserve lending. Every time a loan is made, a deposit is created. To repeat, banks create money, or bank deposits, by making new loans. This money multiplier effect is what makes banks the engines at the center of the economy— the new money is “created literally out of thin air.”138 This is what Alexander Hamilton meant when he said that banks allow capital to “acquire life” and become productive—banks increase the overall wealth of a community by simply taking deposits and lending them out.

  The catch is that they can only do so insofar as the creditors and debtors are operating in the same system. Now let’s see what happens when a black bank attempts fractional reserve lending. Anton deposits his money at black-owned Bank A. Bank A makes a loan to Bella, who is black. Bella uses that money to buy a home. For the money multiplier to work in a segregated economy, Bella’s money must be recycled in the black economy. Theoretically, black banks would circulate and multiply this money and hum along with white banks doing the same thing—both multiplying money in their own segregated economies. However, this was not possible. During this era, practically without exception, the sellers of the real estate were white and the buyers were black, placing them in separate banking systems. The sale proceeds usually landed in a white bank, while the loan was held at the black bank. Because blacks did not own property, their banks would constantly be stuck in an inferior position and their loans would be swallowed into the white system.

  As soon as the black bank loan was deposited into the seller’s bank, it had already escaped the black community and would continue to multiply in the white community. Even assuming that the first seller was black, she would have had to deposit her proceeds from the sale back into the black banking sector. Only if both the buyer and seller were black and each deposited their money at black banks could the money multiplier work. Every seller down the line would have to do that for the black banking system to be able to “control the black dollar" and multiply money in the black community. In reality, there would eventually be a white seller in the chain and the money would escape the black community. In the days of strict segregation, when white banks did not lend to blacks and white customers did not deposit money into black banks, the resulting “new" money always went into the white banking sector.139 Money could not be multiplied in two different segregated banking systems when one did not have much capital to begin with. In other words, the banks themselves could not help the black community hold and multiply capital without changing the structure of property ownership first.

  White banks had the advantage of circulating and growing money, and black bank loans just fed into that circulatory system. Not only were black banks not multiplying money in the black community, they were multiplying money in the dominant (white) banking system. Put another way, not only were the white banks multiplying white money, they were multiplying black money as well. If the whole point of black banking was to control the black dollar and put it to work in the black community, black banks simply could not do this.

  Not only could black banks not “control the money of the community"; they actually acted like a sieve through which money drained into the mainstream white banks and the mainstream, exclusionary economy. Instead of multiplying money, black banking effected a slow trickle-up of wealth into the white banking system. The profits were being skimmed off the top by the robust mainstream economy, leaving the ghetto economy with the scraps. Eventually, government credit markets would replace the simple apparatus of the money multiplier by providing new sources of loans. But even then, black money continued to leak out of the black economy. Because the dominant economy was taking place outside of the ghetto, its pull could not be resisted. Once in the banking system, money flows toward more money.

  Just as the money multiplier circulated white advantage, the ghetto money trap also circulated disadvantage. Because blacks were not home sellers, black banks did not have access to the large deposits received in home sales. This led back to the problem on the liability side, which is that the small deposits in black banks were too costly and had to be offset by fewer loans, which ultimately meant lower profits.

  The money multiplier was not broken just for small black banks, but also for large banks like Binga’s and the Douglass National Bank.140 This meant that no matter how much money black leaders, bankers, and the press could convince blacks to put into black-owned banks, the “power of the black dollar" would not push forward the black economy in a significant way. The truth was that segregated communities could not segregate their money. The irony is that black banks, whic
h were created to control the black dollar, were the very mechanism through which black money flowed out of the community. Through deposit-taking and lending, black money would always end up in the white banking industry despite the best efforts and highest skills of black bankers. Black banks could not participate in the wealth-producing process around which the entire banking industry is built, precisely because black banks operated on the fringes of a white banking system.

  This is not to say that a truly segregated black economy like the one Garvey imagined was not possible. If blacks could have accumulated all black resources into an all-black economy with control of large businesses and ownership of property, their money would not have easily escaped the borders. Blacks would need to be completely independent of whites and buy from, lend to, and employ only blacks. Though some whites and some blacks would have welcomed this outcome, such a world was out of reach because the black community did not accumulate enough property to sustain itself. The underlying problem for blacks was that whites started with all the property and blacks with none of it. This basic economic reality created a positive feedback loop for whites and a negative one for blacks, cycles that continue to have profound effects to the present day. Black banks’ segregated assets, volatile liabilities, and broken money-multiplying apparatus were causing a slow bleed of money and resources in the sector even before the Great Depression dealt the fatal blow.