to overcome each day. economists find it useful to think about these challenges in the context of the economics of market failure. standard economic analysis tells us that when competitive conditions prevail in a market, the resulting prices induce firms and individuals to allocate resources in a manner that tends to maximize social welfare. 12 however, economists also recognize that various deviations from www. huduser. org / periodicals / ushmc. html calculations by federal reserve board staff from the federal reserve board ’ s survey of consumer finances, 1995 and 2004, www. federalreserve. gov / pubs / oss / oss2 / scfindex. html. u. s. small business administration, office of advocacy, www. sba. gov / advo / stats / sbfaq. pdf ( 91 kb pdf ). u. s. census bureau, survey of business owners, www. census. gov / csd / sbo /. u. s. small business administration, office of advocacy, www. sba. gov / advo / stats / sbfaq. pdf ( 91 kb pdf ). calculations by federal reserve staff from the federal reserve board ’ s 2003 survey of small business finances. for further information, see www. federalreserve. gov / pubs / bulletin / 2006 / smallbusiness / smallbusiness. pdf ( 178 kb pdf ). kenneth j arrow ( 1951 ), “ an extension of the basic theorems of classical welfare economics, ” in j neyman ( ed. ), proceedings of the second berkeley symposium on mathematical statistics and probability ( berkeley and los angeles : university of california press ), pp. 507 - 32. idealized market conditions, termed market failures, can inhibit the efficient allocation of resources. 13 in one type of market failure, called a neighborhood externality, the actions of one person affect the well - being or economic welfare of others in the local area, but the individual taking the action neither bears the full costs of nor reaps the full benefits from those actions. because the individual does not bear the full consequences of the actions taken, he or she may act in a way that is not in the best economic interest of the neighborhood as a whole. for example, the failure of some owners to maintain their properties can lower the value of well - maintained properties in the same neighborhood. ultimately, such spillover effects from neglected properties can lead to underinvestment in the whole

community, potentially harming all neighborhood residents and businesses. a related type of market failure studied by economists is known as an information externality. an information externality may arise when information about economic opportunities in an area has the potential to benefit many investors but is costly to gather. as a result, no single potential investor may find obtaining the data to be profitable. for example, on average, lower - income areas have fewer owner - occupied homes and record fewer home - purchase loans than higher - income areas do. 14 lower transaction activity makes accurately gauging property values and evaluating credit risks in those areas more difficult, which may inhibit the extension of credit. 15 alternatively, lower - income people may have shorter and more - irregular credit histories, making an evaluation of their individual creditworthiness more difficult and costly. because a potential investor who bears the costs of obtaining data about underserved neighborhoods may be able to obtain only a portion of the full economic benefits, these data may remain uncollected. 16 one purpose of cdfis is to help overcome these and other market failures that inhibit local economic development. for example, by facilitating larger - scale property development projects, coordinating public and private investment efforts, and working to improve amenities and services in a local area, cdfis may help to solve collective action problems and reduce neighborhood externalities. cdfis can counter information externalities by assuming the cost of learning about their local communities and developing specialized financial products and services that better fit local needs. in general, cdfis provide coordinated development activities and community - specific information that the market may not supply on its own. among other benefits, the familiarity with each community that cdfis develop can help to gauge and control risk. 17 for example, the use by cdfis of appraisers who specialize in evaluating properties in a particular community produces more - reliable estimates of the value of the loan collateral. likewise, cdfis structure loans and use public and private credit enhancements both to increase borrowers ’ ability to qualify for loans and to spread the associated credit risk among a mix of private creditors and other providers of funds. although these specialized techniques can reduce credit risk, they are labor - intensive and, consequently, expensive. most private lending institutions reduce costs by adopting processes that are highly standardized and automated. such systems are not necessarily compatible with lending to borrowers who require substantial screening, counseling, and monitoring or with acquiring specialized information about community development lending. part of the