In the wake of the nation’s real estate collapse, much has been written about the banks that approved supersized mortgages for consumers who could not pay them. But it turns out that the housing disaster was also fueled by subprime lenders in a lesser-known, essentially unregulated sector of the industry: finance companies specializing in developers and homebuilders turned down by traditional banks.
A groundbreaking story by the Star Tribune’s Chris Serres on Sunday revealed that the landscape of Minnesota is littered with the consequences of reckless lending by one of these companies: Lakeland Construction Finance LLC of Eagan. In communities like Cannon Falls, Dassel and Pine City, developments that city leaders hoped would become thriving new neighborhoods are now messes of weeds, buckled roads, construction debris and towering piles of dirt. In a handful of cases, families who thought they were buying their dream home now live in a vast expanse of vacant lots and empty houses. Lakeland has defaulted on more than $400 million in loans from the Bank of Scotland. Many local governments that worked with developers who had borrowed from Lakeland are stuck with virtually worthless letters of credit guaranteeing the projects’ completion.
Serres’ story should sound the alarm for growing communities in Minnesota and across the nation. City officials regularly evaluate proposals for new housing developments and decide whether to approve them. Lakeland clearly illustrates the need for more local scrutiny of developers’ financing arrangements. It’s an unfortunate but important lesson for years ahead, and a task that both regulators and organizations such as the League of Minnesota Cities should assist cities in performing.
Until now, it’s not been widely known that companies like Lakeland operated virtually unfettered by regulation across the country. Banks, because they deal directly with consumers, are tightly regulated. But Lakeland isn’t a bank, didn’t deal directly with consumers and, thus, fell into a different niche. From a regulators’ standpoint, its operations were transactions between sophisticated business interests, with each party having adequate expertise to protect itself without government watchdogs. Unfortunately, too many people assumed a government that regulates hair salons would not neglect companies that lend hundreds of millions of dollars.
Many city officials are smartly vowing to work only with regulated, traditional banks, or to require that developers put cash in an account as a guarantee that projects get done. Those are worthwhile steps to consider. The League of Minnesota Cities is also considering new educational programs to help city officials evaluate developers’ finances, or to help cities find experts to do so. The league’s initiative is welcome, and the programs it is considering are badly needed. They merit swift implementation.
Still, construction finance companies will likely continue to play a role in the industry. Andrew Winton, the University of Minnesota Carlson School of Management’s chair in banking and finance, argues that these companies shouldn’t be regulated out of existence, but instead need to make their workings more transparent. Regulators could require them to file annual and quarterly public reports of their financial health with the Federal Reserve or Securities and Exchange Commission. That’s a reasonable step to boost industry accountability. It would also help those looking to do business with these lenders or their clients — such as city officials weighing a new development — make a more informed decision.