Digging Deeper

"Exposing the FDIC" covers alot of ground.  Is this problem political, bureaucratic, economic?  Is this a top-down problem or bottom-up?  Is this a conspiracy or incompetence?

As we hope our previous posts demonstrate, all of the above.

Yes, the economy is in shambles, in a way almost none of us has ever experienced.  But this time is different.  This time Main Street is taking the punishment for Wall Street if only because Main Street doesn't have the right resources or connections.

Politicians and their appointees are adept at shifting the blame, but their policies are the ones that created and maintain the problem.

Bureaucrats are only interested in a paycheck and pension.  Keep your head low, and let the blame keep flowing downhill.  At the bottom of that hill is community banks and the people they serve.

Research papers and news articles can only take us so far at exposing the truth.  If we really want to help community banks, we need your input.  Is your bank the victim of the economy, hurt but recovering?  Are individual examiners passing the buck or exacting revenge?  Is this systemic within the FDIC?  Do politicians have an agenda to support Too Big To Fail by feeding them the carcasses of community banks?

Contribute to the solution by pointing others towards our site.  Then tell us your story at info@fdicexposed.com.  We will never share your information - any stories we publish will have all identifying details removed.

Remember - united we stand, divided we fall.

Widespread Problem

The FDIC wants the public to think it's targeting "problem" banks, but more and more stories are cropping up where they are targeting sound, profitable community banks.  Perhaps they are going on the theory that where there's one cockroach there's alot more you don't see - but this logic is 100% false. 

The FDIC condoned the free-for-all during the housing boom.  Once they were caught with their pants down they overreacted.  They are shuttering solid community banks that took a hit from commercial loans during the housing boom, even though they were always or have returned to profitability.  This Cover Your Ass tactic may benefit the bureaucrats and politicians, but they're hiding how much damage this is doing to our communities.

Gotta wonder how many of those failed and troubled banks were caught up in this net.  Perhaps FDIC Exposer will look into that.

FDIC Rebuttal

The FDIC issued its own statement following yesterday's hearing.

In typical Washington bureaucratic fashion, the statement cites many facts and figures marginally related to the actual point.  After wading through all of these, the FDIC regurgitates from its own policy handbook.  The tenor is one of an executive in Washington who has no idea what is going on down here on Earth.  For example:

"The FDIC has a number of outlets for bankers to express their concerns when this occurs. When banks disagree or are uncomfortable with examination findings, they are advised to discuss such concerns with us."

Technically, yes, this is true.  And this is what the FDIC should strive for.  However, reality is very different.  The process is all but transparent - the FDIC's methodology is vague and undocumented, and "discussion" is not an option.  If a banker disagrees with the examiners, he can appeal the findings - to the FDIC.  He must appeal within 14 days, and that appeal goes to a group of examiners in another region, not up the chain.  They have 60 days to respond, and 99% of the time they defer to the local examiners.

Further appeals up the chain follow similar timelines - a very short time to file an appeal, followed by a long waiting period before the FDIC responds.  No one but the local examiners really know what's going on, so each successive review takes the easy way out and again defers to the original findings.

"We are aware of concerns expressed by some bankers that examinations are being conducted in an overly conservative manner during this challenging economic time. To address these perceptions, we have expanded our outreach at the national, regional, and state level to broaden our communication with both individual banks and trade associations. The FDIC welcomes feedback from the industry and relies on bankers' informed perspective as we consider refinements to our supervisory process."

They are aware of concerns, but they do not address the actual concerns.  They address "perceptions" through "outreach."  Community banks don't need outreach - they know exactly what the FDIC policies are.  What they want is for Washington to recognize that their policies are neither the problem nor the solution.  The problem is the actual workings of the FDIC - not its administration, not its public perception.  Those examiners who hold the fate of every community bank in their hands are not held accountable, and banks have no real recourse.

Community Banks on the Agenda

Congressman Lynn Westmoreland held a hearing in Newnan, GA, yesterday regarding regulators' treatment of community banks, and it got alot of attention - see the Newnan Times-Herald, the Atlanta Journal-Constitution, the New York Times, and the Associated Press).  He hits the nail on the head:

"[W]hat we are seeing is that banks that are ‘too big to fail’ are given assistance to survive, while community banks are pushed to the side and have become ‘too small to save.’"

"Some of these purchasing banks don’t know the community...  What they know is that the quicker they flush out troubled assets – even those that are performing – they better off they are.  So now we have communities that don’t have community banks.  Generational wealth has been sucked out of communities and capital has dried up.  Had some of these federal regulators thought to themselves, ‘I’ve been in Washington for 30 years and have never actually worked in a bank.  I should be talking to these local leaders and bankers to determine what would be the best way to help them out.’  Instead, they ignored problems and enforced policies, like loss-share agreements and immediate write-down of loans, that only caused more trouble for community banks.  Without these community banks – who know and understand and are invested in their community because it is their own – economic recovery has stalled and we see investment in smaller areas all but disappear."

Let's continue to support Westmoreland as a key voice for community banks in Washington.

Why Regulation Will Never Prevent a Meltdown (Part 2)

All the legislation hastily passed following economic disasters in the 1980s, 1990s, and the last few years revolve around a key assumption:  bank failures are caused by crooked bankers.

Not free market competition.  Not honest errors.  Not economic cycles.  Greedy, irresponsible, negligent fat cats who don't care what happens to everyone else are villains who must be punished.  Congress has sung the same song each time a crisis comes along, and they always end up causing more harm than good:

"The legislature's haste to get the 'savings and loan crooks,' which is particularly evident in provisions granting regulators extraordinary powers to freeze or attach assets, has caused substantial social and economic costs.'*

But if failures are due to fraud, why would we have a such a rash of greedy bankers all at once?  Even if the abuse rode on the back of a bubble, surely a competent FDIC examiner would uncover these fraudsters one by one.  The only logical explanation is that the economic downturn took its toll.  For those who question whether history really does repeat itself, note that the same problems (economic, not fraudulent) leading up to the Great Recession are almost exactly mirrored by those before the 1873-1878 depression:

"The causes of the failure of the national banks were mainly injudicious banking and depreciation of securities.  In only one case was failure due to fraudulent management.  The state bank failures arose from excessive competition among the too numerous banks.  New banks were chartered freely by the state legislature during the preceding years of prosperity.  Public supervision was entirely absent....  When seven of the largest savings banks failed between August 29 and December 31, 1877, it was found that over 45 per cent of their combined assets was invested in real estate or real estate loans.  In addition the banks had lent large amounts at high rates of interest on worthless collateral to individuals speculating in land and construction enterprises."**

By the way, this was written in 1935 as a comparison to the Great Depression.  A second parallel between the Great Recession and historical depressions is the question of whether bigger is better.  Should we encourage Bank of America or Bank of the Ozarks, with their better capital and efficiency, to take over community banks to create greater stability?

"It is commonly held that small banks are much more susceptible to failure than the large and, therefore, large banking units are to be encouraged.  This study, however, shows that the failure rate of large banks is quite as great as that of small banks during the last few years.  An attempt to prevent failures by encouraging development of banks of larger size cannot in itself be expected to be particularly beneficial."**

As we've written previously in this blog, the vast majority of community banks do not fit the profile of greedy fat cats taking advantage of the rest of us.  There are crooks in any industry, but they are not as pervasive as Congress would like us to believe. 

When Congress tars all banks with the same brush, the public turns against the bankers who are "widely regarded as major culprits in the crisis because of press reports detailing reckless, and sometimes outright fraudulent, management practices."***

Being legislators, Congress responds by creating acts such as the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) as well as a host of bureaucratic regulators and regulations.  Try this one on for size:

"Until 1989, deposits in S&Ls were insured by the Federal Savings and Loan Insurance Corporation (FSLIC), and the S&Ls themselves were under the chartering, regulatory, and supervisory authority of the Federal Home Loan Bank Board (FHLBB).  In August of 1989, FIRREA, the major piece of legislation aimed at resolving the failed S&Ls and recapitalizing the S&L deposit insurance fund, became law.  FIRREA abolished the FHLBB and the then-insolvent FSLIC, transferred FHLBB's regulator powers to the Office of Thrift Supervision (OTS), established the Resolution Trust Corporation (RTC), whose function is to manage and resolve the failed S&Ls, and transferred FSLIC insurance functions to the Federal Deposit Insurance Corporation (FDIC)."***

We don't know about you, but FDIC Exposer thinks that's overkill to the nth degree and has no idea how bankers can comply with all these regulators at once.  Did any of this really contribute to the recovery?  The industry was recovering long before any of this took effect, and community banks suffered from the economic downturn and not abuse of regulations.  Not to mention that the problem arose again in the 1990s.  And again in 2007.  So is regulation the solution?  FDIC Exposer thinks not. 

And that is yet another example of why regulation will never prevent a meltdown.


*  Crawford, P. (1993). Inefficiency and abuse of process in banking regulation: Asset seizures, law firms, and the RICOization of banking law.  Virginia Law Review, 79, 205-242.
**  Thomas, R. G. (1935). Bank failures - Causes and remedies. The Journal of Business of the University of Chicago, 8, 297-318.
***  Anbari, M. M. (1992). Banking on a bailout: Directors' and officers' liability insurance policy exclusions in the context of the Savings and Loan crisis. University of Pennsylvania Law Review, 141, 547-589.

That's One Way to Beat Them

More evidence that the FDIC has gone off the deep end:  a well-performing community bank surrendered its charter and sold its branches out of sheer frustration with the regulators.  This bank was committed to its community, focused on loans to small businesses, and was profitable even through the downturn.  Despite all this, the FDIC slapped them with a number of ridiculous demands that would be nit-picking even for a troubled bank.  How to fight back?

"[Main Street Bank Chairman Thomas] Depping plans to set up a new lender that will operate beyond the reach of banking regulators—and the deposit-insurance safety net. Backed by the private investment firm of Microsoft Corp. co-founder Paul Allen, the company won't be able to call itself a bank, but it will be able to do business the way Mr. Depping wants."

Main Street transferred 85% of its current loans to the new, unregulated company and will continue to focus on loans to small community businesses.

This is what it has come to.  Community banks are being frustrated out of businesses.  But at least Main Street can continue to do what it does best.

Why Regulation Will Never Prevent a Meltdown (Part 1)

FDIC Exposer is about to get all academic on you.  So far we've concentrated on reports in the media and legislation, but now we're going to present some empirical evidence to demonstrate why regulation will never prevent an economic meltdown like the one in 2007.  According to one researcher:

"Three major factors have been identified as changing the nature of bank risk:  (1) the decline in bank asset quality and in capital ratios; (2) the greater reliance on purchased funds (liability management) in an environment of rising and increasingly volatile interest rates; and (3) the continued expansion into nonbanking and off-balance sheet activities."

Point 1 and Point 2 may refer to banks investing in toxic mortgage-backed securities and real estate that later imploded.  Securities jam-packed with subprime mortgages and falsely rated as AAA and the housing bubble created huge returns for investors.  Banks spent their capital to chase these high returns.  Unfortunately these were assets of the ticking time bomb type:  when the market revealed their poor quality, the invested capital evaporated overnight.

Part 3 may be where those Wall Street banks are directly responsible.  When the repeal of the Glass-Steagall Act allowed investment firms and banking institutions to merge, they went on a feeding frenzy.  Part of the frenzy involved some creative accounting that let them keep their true exposure off the books.  For years everyone thought the banks were incredibly profitable and well-capitalized, when in actuality they were tens of billions of dollars in the hole.

The author notes that the Federal Reserve is a failing bank's lender of last resort, and holds in its hands the power to save the banking industry.  When the Fed provides an emergency loan to a viable bank, that bank can pull itself back from the brink:

"[B]ank failures can only occur if the Federal Reserve neglects to provide - either through the discount window or through open market operations - the additional reserves needed to support the sound banks of the system."  Too bad that, "typically the Fed has not extended discount window privileges to all institutions (i.e., failing and sound)."

But wait! you may say.  What about the FDIC?  Can't they come to the rescue?  Well...

"[T]he deposit insurance program cannot make 'discretionary' errors of the type attributed to the Fed during the panic periods of the 1930s....  However, it is also clear that the FDIC's insurance fund (including its currently authorized borrowing lines with the Treasury and other government agencies) is too small to cover major disturbances to the banking system such as the effect of a succession of outright defaults."

Here we have just one of many studies that identifies the cause of the crisis and provides a road map to prevent another one.  The only problem?   

This study was published in 1986*.

Since then, history repeated itself in the 1990s and again in 2007, despite legislation and regulatory reform enacted after each crisis.  And despite numerous studies.  In fact, the problem has grown worse as the banking industry is controlled by a few large (too-big-to-fail) banks:

"[I]f a bank gets big enough to be considered too big to fail, it gets implicit guarantees for all its liabilities, whether they are insured deposits or not.  The bank does not have to pay for these guarantees, since deposit insurance premiums are only assessed against deposits.  So, in essence, attaining a certain size provides a bank with some free insurance and more complete coverage than it would get otherwise."

So warned an author in 1994**.  How quickly we forget, as Glass-Steagall was repealed in 1999, leading to way-too-big-to-fail Wall Street behemoths.  And the FDIC fund, which couldn't even cover a banking crisis in the 1980s, gets wiped out to the point that it has to borrow from the banks it bailed out.

And that, my friends, is why regulation will never prevent an economic meltdown.


*  Merrick, J. J., Jr., & Saunders, A. (1986).  Bank regulation and monetary policy.  Journal of Money, Credit and Banking, 17, 691-717.
**  Boyd, J. H., & Graham, S. L. (1994). Investigating the banking consolidation trend. Federal Reserve Bank Minneapolis Quarterly Review, 2-21.