When FDIC Chairman Sheila Bair gave a speech last month at the American Bankers Association’s Government Relations Summit in Washington, D.C., she got into what the American Banker newspaper characterized as some “testy” exchanges with the audience while taking questions after her prepared remarks, particularly on topics like the Dodd-Frank Act and a proposed reduction in interchange fees.
Given the tone of the Q&A session, one could reasonably conclude that the state of “government relations” between bankers and the federales smells like sour milk right now. Certainly, banking regulators have been playing hardball over the last two years with institutions that are dangerously undercapitalized or have been slow to address their deteriorating asset quality. If the regulators were asleep at the switch during the real estate bubble in the mid-2000s, they probably overcorrected once the bubble burst.
To paraphrase Claude Rains in “Casablanca,” regulators were shocked – shocked! – to discover that highly leveraged banks were piling up concentrations in commercial real estate loans that turned out to be extremely dangerous.
But this is not the first time in my memory that federal banking regulators have cracked down hard on financial institutions after a period of, shall we say, benign supervision. Back in the late 1980s, after the so-called thrift crisis, Congress passed the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) that among things abolished the old Federal Home Loan Bank Board – the thrift industry’s prudential regulator – and replaced it with the Office of Thrift Supervision. FIRREA was detested nearly as much as the Dodd-Frank Act is today, and the OTS used the law’s higher capital requirements to put a lot of highly-leveraged thrifts out of business. It struck many people back then as an example of frontier justice with the OTS playing the roles of sheriff, judge and hangman.
The point is, what’s happening today isn’t new. If you watch the banking industry long enough, you’ll see everything at least twice, including things that everyone swore the first time would never happen again.
Like it or not, the regulators have a job to do. Many banks became too reliant on real estate lending during the bubble, and once it popped they needed to raise capital so they could afford to charge off their worst loans. Based on what I have heard from bankers, lawyers and investment bankers, the regulators haven’t been willing to allow marginal institutions to earn their way out of their asset quality and capitalization problems, but have been forcing the issue in many instances. As much as they dislike Dodd-Frank or the proposed limits on interchange fees, I believe that much of the tension between banks and their regulators derives from regulatory activism at the grass roots level.
It won’t always be this way. The industry’s asset quality will gradually improve as the economy strengthens, most undercapitalized banks will either figure out a way to raise capital or will sell out to a stronger competitor, and the regulators will ease up. CEOs and directors may not like this oscillation between supervision sometimes being too soft and sometimes being too tough, but it seems to be a normal phenomenon in banking.
After living through one of the worst financial crises since the Great Depression, I am sure that all of federal banking regulatory agencies have felt pressure to tighten up their supervision. And while privately they might chafe against the heightened scrutiny, smart CEOs and their boards don’t go to war with their institution’s regulators. Instead, they consult with them frequently, communicate regularly and take a proactive approach to problem solving.
Smart bankers take the long view of regulatory relations. And that certainly doesn’t include picking a public fight with the chairman of the FDIC.