Politics and bank regulation don’t mix

Dec 8, 2009 13:28 UTC

The Federal Deposit Insurance Corp tried to seize and sell Cleveland thrift AmTrust last January but local politicians intervened. In the end, the bank still went bust 11 months later – a delay that may have increased losses to the U.S. regulator’s funds. As Congress debates banking reform, AmTrust provides a useful warning that the regulatory apparatus needs to be kept free from politics.

Regulators had known for some time that AmTrust was troubled. AmTrust’s chief regulator turned down the bank’s request for TARP money last fall. It also hit AmTrust with a cease-and-desist order, instructing management to change lending practices and boost capital by December 31. When AmTrust missed the deadline the FDIC decided to step in.

But Ohio Congressman Steven LaTourette and Cleveland mayor Frank Jackson convinced Treasury and the White House to keep the regulators at bay. Bythe time FDIC finally seized AmTrust on Dec. 4, its tangible common equity – the capital it has to withstand loan losses – had fallen to $276 million from $943 million the year before. The cost of the bank’s failure to FDIC: $2 billion.

The price tag to the FDIC would’ve been lower had it acted sooner, according to the Wall Street Journal. This isn’t a new lesson. Congress established the Prompt Corrective Action doctrine in 1991 because the S&L crisis taught that to limit the cost of bank failures, it’s important to seize troubled institutions quickly, while they’ve still got capital.

And the importance of speedy resolution is more pronounced with larger firms, whose deterioration can infect the entire system. Remarkably, Congress is poised to erect new political barriers that may delay pre-emptive action to corral systemically dangerous firms.

An amendment offered by Rep. Paul Kanjorski to Barney Frank’ s Financial Stability Improvement Act would require Treasury to sign off on corrective actions imposed by regulators on firms with greater than $10 billion of assets. For $100 billion+ firms a White House signature would also be needed.

AmTrust was small enough that its collapse didn’t pose a systemic threat. At worst, it just compounded losses at FDIC, which may require its own taxpayer bailout before too long. With systemically dangerous firms, however, the cost of political delay will be much higher.

COMMENT

From what I understand, the Fed says it didn’t have the tools to handle the collapse of these firms. They aren’t asking for the authority to do so. But they do point out that because of a lack of any processes to unwind those companies the Fed had to keep the financial system afloat or the resulting defaults would have cause a depression on a global scale.

Mr Bernanke Pointed out that during the depression the banks were allowed to simply fail. And the resulting defaults cascaded causing a global down turn. He said that in order to prevent a repeat, some choices needed to be made to support the banks. If I understand history correctly, there was no financial social safety net in place during that time either.

I think it would have been easier and cheaper to keep the citizens afloat than it has cost us to keep the banks up. It also would have put the banks in a position of accountability to the citizens. Citizens with money can choose what sectors of the economy to support by choosing where to spend. It’s just incomprehensible to me that even though the citizenry is the engine of the economy, the engine is never given any fuel.

It’s like wanting to keep harvesting fruit from a tree that never gets watered. Eventually the tree dies and there is no fruit to be had. We are strangling our people with poverty. We are cutting off our own heads by keeping our people uneducated and sick, while expecting them to labor tirelessly. Our future slips away with each failed generation. It’s time to think about the citizens.

If banks can delay, pray

Nov 24, 2009 17:51 UTC

The “too-big-to-fail” amendment offered by Representative Paul Kanjorski has good intentions, but fatal flaws.

One I wrote about on Monday. Another is a section (see page 7) that gives systemically dangerous institutions (SDIs) the right to appeal regulatory orders in a federal district court. If they don’t like the corrective actions that regulators instruct them to take, they could delay them indefinitely.

With bank resolutions, the key issue is speed. We learned that the hard way during the savings and loan debacle. Allowing banks to deteriorate until they have no capital left is like waiting for an infection to turn gangrenous before treating it.

With most companies, that’s not a problem for anyone but shareholders and creditors. But banks aren’t like other firms. Society provides them a strong, and expensive, safety net. And that safety net has expanded significantly in the last year.

In exchange, we rightly subject them to more stringent regulations. We guarantee their liabilities, after all, so we’ve the responsibility to control their assets.

As Ed Kane of Boston College told me: “We support them the way parents support children. It’s our responsibility to discipline them.”

So that regulators have the power to act quickly against plain-vanilla banks, Congress established the Prompt Corrective Action doctrine in 1991. It gives bank regulators extraordinary power to put the screws to banks before they dig themselves too deep a hole.

Banks may consult with regulators on what needs to be done. But the only judicial review available to them is through the court of appeals, which must review the administrative record of corrective actions that regulators have already instructed banks to take. And it must do so in an expedited manner, typically 30 days.

A similar doctrine to break up SDIs proactively is what many had hoped Kanjorski would propose. But the judicial review process it envisions would turn corrective actions into the SDIs’ shield, rather than the regulator’s sword.

For one thing, it would allow SDIs to challenge their regulator in a district court, not the court of appeals. A district court’s review wouldn’t be limited to the administrative record; it would likely include a trial by jury. First of all, this would involve a lengthy discovery process. And systemically dangerous institutions typically have the best, most expensive lawyers in the world. While regulators are tied up, they would have an even stronger incentive to engage in morally hazardous behavior, to shift losses to the safety net while looting whatever value is left in the institution.

Just look at the billions in bonuses that Wall Streeters paid themselves last year after their balance sheets were rescued by taxpayers.

Professor Bill Black of the University of Missouri Kansas City worries Kanjorski’s judicial review process would effectively turn the district judge and jury into the regulator, a position for which they have no expertise. Would a North Carolina jury instruct Bank of America to take corrective actions that could lead to thousands of lost jobs in their area? Probably not.

Black says Kanjorski can improve his amendment by limiting SDIs’ judicial recourse to an expedited review of the administrative record in front of the court of appeals.

Kanjorski’s head is in the right place, even if his legislation is flawed. We need a new regime that encourages regulators to break up big banks before they threaten to bring down the system.

But his amendment makes the process too difficult. Already it erects a big roadblock by telling regulators they can only take action if an SDI “poses a grave threat to the (nation’s) financial stability or economy.”

By the time regulators realize a firm poses a grave threat, it’s probably too late to do much about it. And if the firm can delay action indefinitely by going to a district court, then what’s the point?

COMMENT

“And if the firm can delay action indefinitely by going to a district court, then what’s the point?’That’s the point. Believe it or not, Jacob Viner thought that the 1933 & 1935 Banking changes were just the beginning of more changes. Deposit Insurance, which FDR opposed and the Chicago Plan economists thought was a good temporary measure, was supported by many banks because they thought it would ease the support for more change. It was a good idea, but fell short of what many people believed was needed.It’s the same deal here. Things will be better for a time, but eventually worsen. I’ve got all my Narrow/Limited/Utility Banking sources ready for the next financial crisis.

Shock and awe the TBTF

Nov 23, 2009 15:39 UTC

For all the fear that bankers have expressed about Representative Paul Kanjorski’s amendment to end “too big to fail,” the final text shows that they don’t have much to fear. While the amendment gives regulators new power, it’s unlikely they’d actually use it.

The Pennsylvania Democrat neuters his own legislation with a single line, which stipulates that for regulators to take action against a systemically dangerous institution (SDI) it must “(pose) a grave threat to the financial stability or economy of the United States.”

But if the point is to break up systemically dangerous institutions pre-emptively, then we want regulators to tear them apart before they pose a grave threat. SDIs tend to fall into that category only after they’re in trouble. By that point it’s too late.

“There’s no political constituency for bank soundness regulation until it’s too late,” says Professor Richard Carnell of Fordham. “Regulators will tend to do what’s politically expedient. During good times that means carrying on business as usual.”

I don’t suspect any regulator today would say that Goldman Sachs poses a grave threat to financial stability. Yet the complexity of its operation and its interconnectedness with the rest of the financial system means that it clearly has the potential to. That may be a fine distinction, but in practice it’s one regulators will be likely to hide behind.

Another problem with Kanjorski’s amendment is that it pollutes bank regulation with politics. The Treasury secretary would have to sign off on resolutions over $10 billion and the president on resolutions over $100 billion.

Walker Todd, a bank expert at the American Institute for Economic Research recently told me: “It’s been my experience over the last 35 years that examiners in the trenches identify the problems in banks quickly. They dutifully pass their concerns up the line, but their criticisms often get wiped away or tamped down for political reasons.”

Examiners do their job well, but politicians get in their way.

I’m torn. At a visceral level, I like the idea of using TBTF status as a hammer to shatter SDIs into pieces. But if this is the best we can hope for, then perhaps it’s better to focus on other structural reforms that will make banks safer and less complex.

Putting OTC derivatives onto exchanges, strengthening capital (the Miller-Moore amendment is a good start), splitting commercial from investment banking, establishing some sort of exposure rules so that SDIs can’t have too much exposure to any single counterparty. But that’s a wish list that will never get done. In the end, I suspect the only way we’ll rebuild a sound financial system is after the one we have blows itself up.

COMMENT

Inertia. You would think that after what has happened with us teetering over the edge (and still just a step or two away from the edge) something significant would be done. Apparently not.

Then again, let a commander-in-chief raise a war cry, as GWB did, and Congress jumps to approve with a blank check.

How strange that national security is a proven winner with military deployment but it seems to pass everyone’s understanding that the financial world and national financing pose equal, if not even more dangerous threats than any armed foe.

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