“They Have Their Exits”: Bank Survival 1983-2010

How many formerly famous banks have disappeared in only a generation!  Of the 50 largest US bank holding companies by assets in 1983, only eight still exist as independent companies.  For those of us who have spent some time in the banking trade, reading the 1983 list is a sobering remembrance.  Only 16% of these […]

Deposit Insurance: The Forgotten Moral Hazard

Some members of Congress want to make permanent the “emergency” expansion of deposit insurance (in fact, the government guaranty of bank deposits) to $250,000 per person per bank.  Moreover, important provisions of the Senate and House regulatory expansion bills which deal with large non-bank financial companies are modeled on the FDIC.

Where do the members of Congress get the idea that the FDIC is a success?

Error vs. Fraud

From The American:

The reason I entered banking 40 years ago was that I thought, as I still think, that financial systems and their relationship to the real economy, politics, and group psychology are philosophically intriguing. In my opinion, there is no doubt that financial busts and crashes and crises are natural occurrences. However, we have to be more sophisticated than the usual ex post facto explanations, such as that bankers are stupid, greedy, fraudulent, or “fat cats”—these are uninteresting hypotheses and dull rhetoric.

Advice, Not Consent: A Case for a Systemic Risk Adviser and against a Systemic Risk Regulator

Financial crises keep happening. Could a systemic risk regulator prevent them? Not if that means it would have to predict the financial future correctly. But a “systemic risk adviser” might be useful and is worth a try–provided it is independent enough to point out the systemic risks being created by the government’s financial actions and policies, in addition to those of private financial actors.

“The [banking] failures for the current year have been numerous, many having been characterized by gross mismanagement and some by criminality. . . . The unfavorable conditions were greatly aggravated by the collapse of unwise speculation in real estate, especially in city and suburban property.”[1] This quotation comes from the report of the Comptroller of the Currency–in 1891.

In 1912, soon-to-be-president Woodrow Wilson said, “Waiting to be solved . . . lurks the great question of banking reform.”[2] Nearly a hundred years later, it still seems to be lurking.

With the creation of the Federal Reserve System, “financial or commercial crises seem to be mathematically impossible.”[3] At least, that was what the Comptroller of the Currency thought in 1914.

In 1922, then-secretary of commerce Herbert Hoover launched the government’s “Own Your Own Home” campaign. In 1927, the McFadden Act significantly liberalized the terms on which national banks could make real estate loans. By 1932, as Jesse Jones, the formidable head of the Reconstruction Finance Corporation, observed: “Strewn all over was the wreckage of the banks which had become entangled in the financing of real estate promotions and had died of exposure to optimism.”[4]

It is the professional duty of bankers and debt investors to be skeptical, not optimistic, but this seems to be forgotten in each financial cycle. As economist Abram Piatt Andrew wrote in 1908: “The American panic of 1907 . . . gave the lie directly to those who in recent years have contended that we should never again witness the experiences like those remarkable years 1837, 1857, 1873, and 1893.”[5]

Financial crises keep happening. My banking career began during the credit crunch of 1969. This was followed shortly afterward by the bankruptcy of the Penn Central railroad–clearly a “systemically important” railroad–and panic in the commercial paper market, which was bailed out by the Fed in actions that were controversial at the time, while Penn Central was nationalized.

In 1974, for the first time, unimproved land was allowed as collateral for national bank lending. In 1975-76, there was a massive real estate bust. About two-thirds of bank loans to real estate investment trusts–the enthusiasm of the day–were nonperforming. The Senate Banking Committee held hearings on what its then-chairman called an “inordinate risk to the banking system,” which was likely insolvent if it had been marked to market–but it was not marked to market.

Less than a decade later was the financial crisis of the 1980s; it reached a crescendo in 1989-91, featuring the final collapse of the savings and loan industry, another terrific commercial real estate bust, and severe insolvency problems for the highly regulated commercial banks, of which more than 1,400 failed in the decade ending in 1991. Citibank was in trouble, and it was not alone. “Banks Entering Era of Painful Change–More Bailouts, Bankruptcies, Layoffs Likely.” This headline, seemingly taken from today’s papers, was published in July 1991.[6] That same month, a Wall Street author penned this remarkable line: “Lenders are unlikely to repeat their past mistakes.”

Major regulatory reforms and reorganization–the normal political reaction–marked the time. Notable among them were these acts of Congress: the Financial Institution Reform, Recovery and Enforcement Act of 1989; the Federal Deposit Insurance Corporation Improvement Act of 1991; and the Housing and Community Development Act of 1992. Such actions would ensure that such financial crises would happen–in then-secretary of the treasury Nicholas Brady’s words–“never again.”[7]

It Happens Again: Leveraged Real Estate

Building Loss Reserves in Good Times

March 5, 2009

The Editor

American Banker

To the Editor:

Comptroller of the Currency John Dugan forcefully proposes that we need “stronger reserves during the boom years” (“Dugan: Turmoil Shows Need for Reserve Leeway,” March 3).  Former Comptroller Gene Ludwig points out that “accounting rules caused many banks to enter this down cycle with inadequate reserves” (“Crisis Demands Flexibility on Accounting,” February 25).  Thus they both enter the jousting with the SEC and the FASB over whether during credit expansions, when current delinquencies and losses are low and everybody is feeling happy, that indeed precisely because of this happiness, greater loss reserves are necessary.  In the wake of the global bust, this has become a global debate.

To put the whole issue in perspective, just imagine the crusty old chief credit officer pronouncing to the aspiring young banker (me):  “Bad loans are made in good times.”

Reform of “Fair Value” Accounting

Testimony of Alex J. Pollock,Resident Fellow,American Enterprise Institute.

To the Subcommittee on Capital Markets, Insurance and GSEs, Committee on Financial Services,U.S. House of Representatives,March 12, 2009

Mr. Chairman, Ranking Member Bachus, and members of the Subcommittee, thank you  for the opportunity to present testimony on the immediate need to reform “fair value” accounting, which has made and continues to make the financial crisis worse than it needs to be.  I am Alex Pollock, a resident fellow at the American Enterprise Institute, and these are my personal views.  Before joining AEI in 2004, I spent 35 years in banking, including 12 years as President and CEO of the Federal Home Loan Bank of Chicago.  I am a director of three financial services companies.

Reform of the “Fair Value” Accounting Theory is Needed Immediately

“Fair value,” also called “mark to market,” is an accounting theory.  We need to understand as a fundamental point that it is a theory, not a fact.  It is a theory which has had enormously damaging real world unintended results.

TARP Accountability and Oversight

Testimony of Alex J. Pollock,Resident Fellow, American Enterprise Institute. To the Joint Economic Committee United States Congress, March 11, 2009

Madam Chairman, Ranking Member Brownback, Vice Chairman Schumer, Senior House Republican Member Brady, and members of the Committee, thank you for the opportunity to be here today.  I am Alex Pollock, a resident fellow at the American Enterprise Institute, and these are my personal views.  Before joining AEI in 2004, I spent 35 years in banking, including 12 years as President and CEO of the Federal Home Loan Bank of Chicago.  I am a director of three financial services companies.

My testimony considers the context in which to understand banking bailouts, the clear accounting for them we should demand, and relevant lessons from Jesse Jones and the Reconstruction Finance Corporation.

Bank to the Future

What’s the difference between the “Bad Bank” now being so actively discussed as the next stage of political finance and the original description of the TARP plan (call it “TARP I”), namely issuing government debt to buy distressed financial assets? No difference.

Out With the Old Banks, In With the New

Two important things are entirely missing from Treasury Secretary Timothy Geithner’s “Financial Stability Plan” (FSP), formerly known as TARP. The first is any mention of encouraging the creation of new banks to increase the availability of credit; the second is any intention to reform the “fair-value accounting” fiasco.

The Future of Fannie and Freddie

What should be done with Fannie and Freddie going forward? First, there should be a transition period during the current bust in which Fannie and Freddie change from government-sponsored enterprises to government housing banks. Second, there must eventually be a long-term restructuring that will divide Fannie and Freddie into three parts: prime mortgage securitization, mortgage portfolio investing, and government activities.

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