NEW YORK — The city of Los Angeles is putting banks it does business with on the spot.
The unanimous directive coming from the city council is that banks need to help Los Angeles slow the pace of foreclosures ravaging its neighborhoods and battle a local unemployment rate that far exceeds the national average.
If the banks don't comply, they risk getting replaced by banks that do. The price for getting tossed: Lost access to nearly $30 billion in city savings and pension funds.
"We need to challenge the financing institutions that got us into this mess," says Richard Alarcon, a Democrat who introduced the city council's motion that passed 12-0 earlier this month. "Responsible local investments are critical for our economy."
Think of what's happening as a reward system for any banks that are willing to help Los Angeles's population of 3.8 million.
Banks are going to have to offer more than just a competitive interest rate or lower fees on investments to keep the city's business. They must prove they are investing within the city's boundaries.
Los Angeles will track what kinds of loans banks do and those that are modifying mortgages. They'll look at how many new bank branches open and where, especially in poorer neighborhoods.
The goal is to get more money flowing directly into the city, where the unemployment rate is at 13.7 percent – well above the 9.7 percent rate nationally.
Everyone benefits if more people can stay in their homes, more jobs are created and businesses can thrive. That could mean a small company in the inner city that needs loans to fund its operations, or an upscale suburb where half the houses on a cul-de-sac are in foreclosure.
"All big cities are strapped for funds and dealing with big debts, and they don't want to see their money put into investment vehicles far away from home," said Dennis Santiago, chief executive at the Torrance, Calif.-based consulting firm Institutional Risk Analytics who has been following the issue. "They want their dollars coming back to them at home."
Santiago calls what Los Angeles is doing a landmark piece of legislation because it is the first municipality to go on the offensive against banks in the wake of the financial crisis and Great Recession. Los Angeles is building on a template set up by Philadelphia, which first began tracking local investments by banks it works with in 2003.
The city's new rules, which are expected to be ratified by the council next month, will go farther than what's required of banks under the federal Community Reinvestment Act. That law, enacted in 1977, requires banks to disclose their local investments but not to the extent the Los Angeles ordinance will do.
Banks in Los Angeles will be required to submit a local investment report card each year, and they'll be ranked based on their scores for community reinvestment. Preference will be given to those that rank highest, while those in the bottom 20 percent might lose their accounts with the city.
"We have a lot of power with our investments," says Alarcon, who represents part of the San Fernando Valley. "We want the banks to know that the health of the community is more important than a low interest rate."
Similar measures are being considered in Maryland, Minnesota and Massachusetts, among other places. If this tighter scrutiny on community reinvestment spreads, banks everywhere could be forced to alter how they do business.
The American Bankers Association, a trade group representing the nation's banks, doesn't oppose what is happening in Los Angeles. But it acknowledges that banks will face a "balancing situation," says Robert Rowe, the ABA's vice president and senior counsel, to stay competitive while not buckling to pressures from local governments to do things that wouldn't be economical.
"Cities want to use this as a tool of leverage," Rowe says. "But remember a bank is a business."
In Philadelphia, there is evidence the program is working. Banks working with the city made 27 percent of all loans in 2008, up from 19 percent in 2007. They also made a greater number of loans than all banks to low- and moderate income borrowers when it came to mortgages, refinance loans and home improvement loans.
Banks with business ties to the city accounted for 66 percent of the bank branches in Philadelphia in 2008, up from 62 percent in 2007.
That's progress. Let's see if it catches on.
Rachel Beck is the national business columnist for The Associated Press. Write to her at rbeck(at)ap.org