Fifth Third’s Transformation

A few years ago, walls of black granite lined the entrance to Fifth Third Bancorp’s headquarters in downtown Cincinnati. Today, the entrance is an open atrium lined with artwork, a café and a small stage for the public to enjoy performances. Pithy reminders for employees dot the walls and elevator: “Be the bank people most value & trust,” and “Strengthen communities.”

As if to imply that the dark days at Fifth Third are behind it, a wall of windows lets light stream in. Fifth Third not only went through a physical renovation, but a financial one as well. The $205 billion bank’s performance was in the bottom half of peers eight and nine years ago. It’s now in the top quartile. It’s rebuilt its balance sheet and its reputation after the financial crisis, when its stock plummeted to about $1 per share and its ability to survive as an independent entity was in question.

Today’s Fifth Third has accomplished a vast financial comeback as well as a digital transformation executed in part by former CEO Greg Carmichael and Tim Spence, who in July became the youngest CEO among the 20 largest commercial banks in the country.

“That was the major task of the last five, six years: Return the bank to a place where it had the right to flex its muscle a little bit and go achieve great outcomes,” says Fifth Third’s Chief Strategy Officer Ben Hoffman. “Now the question for Tim is, ‘What do you do with that?’”

As if to emphasize the changes, Spence decided our interview would not take place in a conference room. He moved us to the open-office innovation studio that shares the same floor as the executive suite inside Fifth Third’s headquarters tower on Fountain Square. “Those of us who are here today get to operate on a platform that’s going to allow us to think about growth,” Spence says in hushed tones, so as not to disturb the employees working on computers around us. “How do we grow the business organically?”

To understand what happened at Fifth Third, you have to go back in time. Although the bank traces its roots back to The Bank of the Ohio Valley in 1858, it really began growing considerably in the 1980s. Its formidable former CEO, George Schaefer Jr., a West Point graduate and Vietnam War veteran, ran the bank starting in the 1990s until 2007. He created a hard-driving sales culture and had a reputation for frugality.

One reporter described his office furniture as not so much antique as shopworn. He was religious about making sure every employee wore the iconic 5/3 pin on their lapels. One former employee told me the bank was so conservative that women weren’t allowed to wear pantsuits. But it was also one of the top performing banks in the country.

Boosted by a high stock price multiple, Schaefer went on a buying spree that enlarged the bank’s footprint. In the 1990s alone, Fifth Third bought 21 other banks. By 1999, the bank had 384 banking centers in Florida, Ohio, Indiana and Kentucky, according to the company.

“Back in the 1990s, Cincinnati had two of the most highly regarded banks in the country,” says R. Scott Siefers, managing director and equity analyst at Piper Sandler & Co. “It was Fifth Third and Star Bank, which is now part of U.S. Bancorp in Minneapolis … they both had high multiples. Fifth Third might trade at 20 or 25 times earnings and would buy these companies at say, 10 or 12 times earnings. The math just worked fabulously because of the disparity. These deals were so accretive to earnings.”

But some of the deals didn’t work out so well, and investors became more cautious on the company, Siefers says. The financial crisis of 2007-08 came along, and Fifth Third was hit hard. Although the bank didn’t get into subprime lending, management was caught off guard by the sheer loss of value in the real estate industry and the collapse of the mortgage market.

Also, what regulators and the public demanded of banks changed dramatically, remembers Kevin Kabat, who was CEO from 2007 to 2015. Becoming CEO in 2007 was less than ideal. Kabat recalls that he had one good quarter before the crisis hit.

“It was stressful, to say the least,” he says. “We were probably the second most picked-on company after [National City Corp.], which went out of business.”

Congress passed the largest financial law in decades, the Dodd-Frank Act, in 2010.

“[The crisis] broadened in a much bigger way the definition of success,” Kabat says. “In [earlier] days, there was only one thing that mattered; it was earnings per share, period. There was not a lot of conversation about much else … I think what really changed from that perspective was the definition of success. The regulators had a stronger opinion about success. Your customers had a strong opinion of success. Your politicians and community leaders had a much different perspective of what success meant. It created a three-dimensional viewpoint of success, where we were pretty one-dimensional before that.”

Kabat recapitalized the business, with then-Chief Operating Officer Carmichael, and focused on changing the culture and de-risking the balance sheet. “When I joined the company, it was clear that the sales orientation, the sales focus was the No. 1 focus,” Kabat says. “We changed it from a sales focus to a customer focus. It’s not just what the next product is; it’s how the customer feels. How do they judge us? What’s their loyalty? And we began to measure all those things.”

There’s at least one entity that doesn’t believe Fifth Third totally changed: the Consumer Financial Protection Bureau. As of press time, the bureau continues to litigate its 2020 lawsuit against Fifth Third that accuses the bank of imposing sales goals on employees that resulted in unauthorized account openings for several years following the financial crisis, similar to practices at Wells Fargo & Co. that gained attention in 2016. The CFPB accuses Fifth Third of failing to take adequate steps to detect and stop the practices, or remediate harmed consumers.

Fifth Third countered in public statements that those accounts involved less than $30,000 in improper charges that were waived or reimbursed years ago. The company currently does not have sales quotas or product-specific targets for retail employees, nor does it reward them for opening unauthorized accounts. “Starting in 2011 and 2012 and 2013, the measures we took since that point in time ensured we had a culture that put the customer at the center,” Spence says, adding that the company doesn’t comment on pending litigation.

It wasn’t just Fifth Third’s sales culture that was under the microscope. When Greg Carmichael arrived in 2015, the bank was in better shape, but it was trading at book value. Profitability was stoked by ownership of a payments business called Vantiv, but lots of investors discounted that value. Carmichael asked investors what they liked about Fifth Third and what they thought its issues or challenges were. Then, he and his management team studied banks that performed well through economic cycles, looking for their similarities. “Listen, it wasn’t rocket science,” says the matter-of-fact Carmichael, who is now executive chairman of the board. “You need a balance sheet that’s going to perform well when the credit cycle turns. You need a balance sheet that’s going to throw off strong returns, so you need to make sure you’re banking the right clients, and you have the full relationship. You need your fee businesses to be a larger portion of your business to offset low-rate environments.”

The management team committed to becoming a bank that would perform well through various interest rate environments and through the inevitable downturns. Carmichael and his team began to build larger fee income businesses, such as mortgages, capital markets and private banking. He committed the bank to quantifiable financial goals, such as return on tangible common equity and return on assets. “We communicated that strategy with financial targets, and we told our investors to hold us accountable, told our board to hold us accountable. And we also asked our employees to hold us accountable, hold themselves accountable for executing to this strategy. That was critical,” he says.

Still, investors weren’t always pleased. After Fifth Third announced the acquisition in 2018 of one of the larger banks in Chicago, MB Financial, for 2.8 times tangible book value, the stock price fell and didn’t recover fully until the end of 2019. “What they didn’t like is we paid a lot for it,” Carmichael says, “We proved them wrong … I would do that deal in a heartbeat at the same price again, and I wouldn’t bat an eye.”

The other thing Carmichael did was start building the bank’s portfolio of high-quality commercial and industrial loans in Texas and California, even in regions that didn’t have Fifth Third retail branches, says Christopher Marinac, director of research for Janney Montgomery Scott, who follows the company. The management team has been focused particularly on expanding the bank and its branches into growth markets in the Southeast.

The focus has paid off so far. Fifth Third placed No. 5 among the 33 commercial banks above $50 billion in assets in Bank Director’s RankingBanking study last year, based on return on average assets, return on average equity, capital adequacy, asset quality and one-year total shareholder return in 2021. For calendar year 2020, it was building reserves for the pandemic and ranked No. 21 on a similar Bank Director ranking called the Bank Performance Scorecard. For calendar year 2019, it ranked sixth.

After Carmichael transformed the bank, he handed the reins to Spence last summer. But before that, he had executed a two-year succession plan that involved rotating Spence through different roles to see if he could lead major businesses for the bank, bringing him to investor meetings and signifying to the world that Spence was his likely successor. “So, when I actually made the announcement [that] I was stepping down in a handful of months, there was no surprise who the person was, there was no issue with confidence that Tim couldn’t step right in, because he’s been part of [the] strategy,” Carmichael says. The choice was unusual. Instead of picking someone as a potential successor who had 20 or 30 years of service in banking, Carmichael picked someone he had hired from the consulting firm Oliver Wyman as his chief strategy officer in 2015, when Spence was still in his 30s. “He was much younger than I thought he was,” Carmichael says. “But he is well beyond his years in both maturity and leadership, and knowledge base of the banking sector. So, I never thought of Tim as a young man. I always thought of him as a seasoned leader.”

Spence was an unusual pick for another reason. He had a background in the tech sector. Spence learned how to code at the same time he learned how to write, in the first grade, although he never worked as a programmer.

The son of a financial advisor and a flight attendant who divorced, he wasn’t sure what he wanted to do. He grew up in Portland, Oregon, and got a bachelor’s degree in economics and English literature from Colgate University, a private school in New York. While in school, he asked his dad to send him a copy of an Oregon business journal and wrote letters to the paper’s list of the 50 fastest growing tech companies, offering to work for free if there was a possibility of long-term employment. He started out at a small startup as a finance intern, working his way up in corporate development and management before moving to a bigger tech company. But after years at tech firms, he reached a point where he would “sit and listen to our customers, and hear them describe big opportunities and challenges. We were this little component solution. I wanted to have the opportunity to help work on the big things, not just the pieces.”

He got a job at Oliver Wyman and worked there for about a decade, becoming a senior partner of its financial services practice and doing work for its client Fifth Third before Carmichael offered him a job. Given the costs of hiring a consulting firm, Carmichael joked at the time that the hire was a money-saving measure. “He’s very thoughtful in his approach,” Carmichael says. “He [is] very detail oriented when he gets into a subject matter, and he can go very deep, which I was really, really impressed with. And then his listening skills, he listens and that’s also not a trait many consultants have.”

Carmichael says that when he decided to develop Spence as the potential next CEO, he was looking for someone who really understood technology’s impact on financial services. “He really had appreciation for the technology space and a passion for leveraging technology for the success of our business,” Carmichael says. “And I just thought that was also an extremely important attribute and skill set to have, when you think about the future of a bank CEO.”

Spence has a round, boyish face, but he’s tall enough to be a basketball player. Moving through the open offices, employees stopped what they were doing to watch him walk past. “Tim’s mind is all over the place, and I don’t mean in a sloppy, disorganized way,” says Steve D’Amico, who worked for Spence as chief innovation officer for a year and a half, starting in 2016. “He’s a very diverse thinker, bringing lots of unusual ideas to bear.”

Ben Hoffman, Fifth Third’s chief strategy officer, says that Spence has the ability to identify what matters and what doesn’t. “My belief is that Tim’s superpower is focus,” Hoffman says. He’s not a micromanager, but he’s deeply interested in the details. “There have been multiple times where he’s asked me a question about footnote seven on page 87, in the appendix of a presentation.”

One of the details Spence is intensely interested in is the particulars of digital transformation. Spence wants to learn from the best examples of technology and customer service across all industries, not necessarily in banking. “If we need engineers, what does the best employer for an engineer look like?” Hoffman says. “We spend a lot more time thinking about JPMorgan [Chase & Co.] and Goldman Sachs [Group] and LendingClub [Corp.], and the credit funds, candidly, then we do about the traditional regional bank peers.” A few years ago, the bank designed a new consumer deposit account. The walls were filled with sticky notes as staffers wrote down the best brands for customer experiences, among them, Delta Air Lines, Hertz, Domino’s Pizza and Zappos.com.

Then, they came up with ideas about what the app should do, Hoffman says.

Chief Digital Officer Melissa Stevens was deeply involved in launching the bank’s Momentum Banking consumer deposit account product in 2021, all of it built in-house. Notably, it’s not called a checking account. It has an automatic savings tool and free access to wages up to two days in advance with direct deposit, even for gig workers. The account also gives customers additional time to make a deposit to avoid overdrafts and the ability to get an advance of funds against future pay. It has no minimum deposit opening amount, and it costs $0 per month.

Although none of those features are hugely unique in the world of fintechs, what is unique is Fifth Third’s approach to fintech partnerships. Fifth Third is a superregional bank with a tech budget of more than $700 million last year, growing at a compound annual rate of 10%. “They’re not going to have the technology budget of a Chase or a Bank of America [Corp.],” says Alex Johnson, creator of the Fintech Takes newsletter. “And they can’t keep up with those banks if they insist on building everything themselves. But if they can focus their own development resources just on the things that they can’t get by partnering or buying, they can have a much more efficient technology budget where they get more per dollar out of their tech budget because it’s more focused on the highest priorities.” That’s not easy to do, because it’s hard to tell a chief technology officer not to build what that person wants to build, Johnson adds. “I think Fifth Third, for the most part, has managed to sidestep that problem from of an internal politics perspective and just be really aligned from the top down on what their strategy is,” he says.

Fifth Third works with fintech partners for years before it decides, in some cases, to buy them. Hoffman’s team is responsible for venture capital funding and partnerships with fintechs. The bank was an early investor in 2018, for example, in Provide, a digital lending platform for medical practices, according to a 2022 article by Bonnie McGeer for Bank Director’s FinXTech.com division. The bank announced a deal to buy Provide in 2021 and purchased another fintech that finances solar panels in 2022. “I think the other competency you have to have if you’re going to do this well is you have to be really good at partnering and acquiring technology,” Johnson says. “Some of the best technology out there is coming from fintech companies, and most banks have no idea how to work with fintech companies.”

Spence’s job is to get the company’s managers and employees to think differently, and he sees working with fintechs as part of that strategy. “The single best way to do that,’’ he says, was to partner with and invest in fintechs who could help the bank’s employees grow. “One of the big mental model changes that has to still trickle into our industry is this idea of product life cycle management … [Instead of] build it and launch it and leave it, we have to move much more into a software-oriented mindset, where you develop a product and then every six to 12 months, you make it better.”

Spence acknowledges that he’s in an enviable position compared to his predecessors. He was handed a banking franchise in good shape and now needs to sustain it. “What Greg did was remarkable,” Spence says. “We need to continue the focus on profitability and operational excellence and resilience through cycles. We need to maintain those disciplines. We need to grow organically and take advantage of opportunities, particularly in terms of technology that allows us to inhabit a different position in people’s lives.”

Despite the focus on innovation, analysts such as Siefers get the impression that Spence is equally focused on careful, strategic thinking when it comes to the bank’s balance sheet. He doesn’t get the impression that Fifth Third is interested in big gambles, and the bank seems well positioned even heading into a potential downturn.

“Kevin [Kabat] and then Greg Carmichael, they’ve been in reputation rebuild mode for the better part of the last decade,” Siefers says. “And they’ve done so quite successfully, particularly during Greg’s tenure. And ideally, that continuity will continue with Tim.”

Marinac also thinks the bank is well positioned given rising rates. “I think their ability to reset loan yields is better than other banks,” he says. “The industry is craving new ideas, new approaches, whether it’s taking out costs or building these new lending channels, or kind of rethinking the business. That’s where Tim comes in … 85% of banks follow and 15% lead. I think Fifth Third is demonstrating that they’re a leader.”

This article has been updated to reflect that Tim Spence was a senior partner in the financial services practice at Oliver Wyman.

The following feature appeared in the first quarter 2023 edition of Bank Director magazine. It and other stories are available to magazine subscribers and members of Bank Director’s Bank Services Membership Program. Learn more about subscribing here.

The Deregulation Promise Beginning to Bear Fruit


regulation-5-14-18.pngEd Mills, a Washington policy analyst at Raymond James, answers some of the most frequent questions swirling around the deregulation discussion working its way through Congress, the changing face of the Fed and other hot-button issues within the banking industry.

Q: You see the policy stars aligning for financials – what do you mean?
The bank deregulatory process anticipated following the 2016 election is underway. The key personnel atop the federal banking regulators are being replaced, the Board of Governors at the Federal Reserve is undergoing a near total transformation, and Congress is set to make the most significant changes to the Dodd-Frank Wall Street Reform Act since its passage. This deregulatory push, combined with the recently enacted tax changes, will likely result in increased profitability, capital return, and M&A activity for many financial services companies.

Perhaps no regulator has been more impactful on the implementation of the post-crisis regulatory infrastructure than the Federal Reserve. As six of seven seats on the board of governors change hands, this represents a sea change for bank regulation.

We are also anticipating action on a bipartisan Senate legislation to increase the threshold that determines if an institution is systemically important – or a SIFI institution – on bank holding companies from $50 billion to $250 billion, among other reforms.

Q: Can you expand on why Congress is changing these rules?
Under existing law, banks are subject to escalating levels of regulation based upon their asset size. Key thresholds include banks at $1 billion, $10 billion, $50 billion and $250 billion in assets. These asset sizes may seem like really large numbers, but are only a fraction of the $1 trillion-plus held by top banks. There have been concerns in recent years that these thresholds are too low and have held back community and regional banks from lending to small businesses, and have slowed economic growth.

Responding to these concerns, a bipartisan group in the Senate is advocating a bill that would raise the threshold for when a bank is considered systemically important and subjected to increased regulations. The hope among the bill’s advocates is that community and regional banks would see a reduction in regulatory cost, greater flexibility on business activity, increased lending, and a boost to economic growth.

The bill recently cleared the Senate on a 67-31 vote, and is now waiting for the House to pass the bill and the two chambers to then strike a deal that sends it to the president’s desk.

Q: What changes do you expect on the regulatory side with leadership transitions?
In the coming year, we expect continued changes to the stress testing process for the largest banks (Comprehensive Capital Analysis and Review, known as CCAR), greater ability for banks to increase dividends, and changes to capital, leverage and liquidity rules.

We expect the Fed will shift away from regulation to normalization of the fed funds rate. This could represent a multi-pronged win for the banking industry: normalized interest rates, expanded regulatory relief, increased business activity and lower regulatory expenses.

Another key regulator we’re watching is the CFPB (Consumer Financial Protection Bureau), which under Director Richard Cordray pursued an aggressive regulatory agenda for banks. With White House Office of Management and Budget Director Mick Mulvaney assuming interim leadership, the bureau is re-evaluating its enforcement mechanisms. Additionally, Dodd-Frank requires review of all major rules within five years of their effective dates, providing an opportunity for the Trump-appointed director to make major revisions.

Q: We often hear concerns that the rollback of financial regulations put in place to prevent a repeat of one financial crisis will lead to the next. Are we sowing the seeds of the next collapse?
There is little doubt the lack of proper regulation and enforcement played a strong role in the financial crisis. The regulatory infrastructure put in place post-crisis has undoubtedly made the banking industry sounder. Fed Chairman Jerome Powell recently testified before Congress that the deregulatory bill being considered will not impact that soundness.

Q: In your view, what kind of political developments will have effects on markets?
We are keeping our eyes on the results of the increase in trade-related actions and the November midterms. The recent announcement on tariffs raises concerns of a trade war and presents a potentially significant headwind for the economy. The market may grow nervous over a potential changeover in the House and or Senate majorities, but it could also sow optimism on the ability to see a breakthrough on other legislative priorities.

What is the Worst Aspect of Dodd-Frank?


The Dodd-Frank Act is the most substantial piece of financial legislation since the Great Depression, and also one of the least popular among bankers. But not everyone agrees what part of Dodd-Frank should be thrown out the window or changed. Is it the Volcker Rule? The Durbin amendment? How about the Consumer Financial Protection Bureau? Bank Director asked a group of attorneys to answer that question.

If you could change one thing in the Dodd-Frank Act, what would it be?

Smith_Phillip.pngI would not have established the Consumer Financial Protection Bureau (CFPB). It was not community financial institutions that initiated unfair, deceptive or abusive consumer practices, yet the trickle-down effect on smaller banks from enforcement endeavors against larger organizations will have a negative impact. Instead of punishing banks that did not cause the crisis with a brand new investigative arm of the government, what about focusing on the true troublemakers?

— Philip K. Smith, Gerrish McCreary Smith, PC

Lynyak-Joe.pngTitle XIV of the Dodd-Frank Act has required the CFPB to substantially rewrite the substantive and procedural rules governing the U.S. residential mortgage system, including application, underwriting and servicing of home mortgage loans. As part of that statutory mandate, severe limitations were placed on the origination of mortgages, including the creation of so-called qualified mortgages and rules on loan originator compensation. To enforce those limitations, penalties were expanded for originators, servicers and assignees of mortgages—without a statute of limitations. The optimum change would be to modify these mortgage rules in a manner that would facilitate the availability of credit by lenders by providing greater flexibility in the types of loans permitted, as well as limiting the liability for originators and assignees for violations. Failure to do so may inhibit the availability of credit to the home mortgage segment.

— Joe Lynyak, Pillsbury Winthrop Shaw Pittman LLP

fisher_keith.pngThe Dodd-Frank Act pretends to eliminate so-called too big to fail while actually enshrining it (using different words) in federal statutory law. Worse, the Act expands the scope of potential bailouts to include nonbank financial companies. Title I of Dodd-Frank, which creates the Financial Stability Oversight Council, greatly multiplies the degree of moral hazard and creates structural incentives for institutions not currently large enough to be considered Systemically Important Financial Institutions (SIFIs) to expand so as to aspire to join that exclusive club. From a public policy viewpoint, this is simply awful. Adding yet another unwieldy federal bureaucracy—the Financial Stability Oversight Council—to the mix is also fundamentally misguided. Outright repeal of Title I would be a vast improvement. Secondly, while the creation of a federal agency devoted to consumer financial protection may have been inevitable, having a large bureaucracy with a broad and diffuse legislative mandate and virtually unlimited funding seems misguided. At a minimum, the CFPB should be made subject to congressional oversight and the appropriations process.

— Keith Fisher, Ballard Spahr LLP

Mark-Nuccio.jpgThat’s an easy one—the Volcker Rule! Hugely reactionary and draconian, the post-Depression idea that banks should be kept almost entirely out of proprietary trading and private fund investment is epic silliness. Since Gramm-Leach Bliley, plenty of organizations handled their freedoms in these areas well. Instead, why not ban mortgage lending? There has to be a better way to address the perceived risks of the banned Volcker Rule activities. The risk to the economy created by the law (as well as the risk of further boggling the implementation of it) outweighs any possible benefit. Adopted more than three years ago and still waiting for final regulations (or better yet re-proposed regulations)—there’s a reason for that kind of delay—it’s a bad law!

— Mark Nuccio, Ropes & Gray LLP

Gregory-Lyons.jpgI would add a provision that expressly permits the agencies to tailor the law, either by regulation or on an individual institution basis, to ensure the rules to which an institution will be subject are appropriate for that institution. Dodd-Frank is a very broad, sweeping law, and that necessarily will result in it having unintended consequences for some institutions. For example, should insurance companies and other nonbank-centric financial services firms that either are designated as non-bank SIFIs or that retain a reasonably small bank presence be subject to the same capital rules as bank-centric institutions?

— Gregory Lyons, Debevoise and Plimpton LLP

Why We Need the CFPB


capitol.jpgFew pieces of legislation in recent years have riled up the financial services industry as thoroughly as the Dodd-Frank Act. And the white hot center of that controversial law is probably the new Consumer Financial Protection Bureau (CFPB), which the Act created to police the marketplace for personal financial services. If you’ve been reading the news lately, you know that the CFPB has a new director—former Ohio Attorney General Richard Cordray—who received a sharply-criticized recess appointment recently from President Obama. Senate Republicans had refused to hold confirmation hearings on Cordray until certain changes were made to the agency’s organizational structure, and Obama finally lost his patience and made Cordray’s appointment official while Congress was in recess.

If you have been paying attention, you also know there’s a difference of opinion between Senate Republicans like Majority Leader Mitch McConnell (R-Kentucky) and the White House over whether Congress was technically still in session, so the legality of Cordray’s appointment might be challenged in court. It’s also entirely possible—perhaps even likely—that the CFPB will be legislated out of existence should the Republican Party recapture the White House and both houses of Congress this fall. No doubt many bankers, their trade associations and the U.S. Chamber of Commerce would like to see that happen.

On the other hand, if the president wins reelection, I am sure he would veto any such bill that might emerge from a Republican controlled Congress, should the Republicans hold the House and retake the Senate this fall, which is possible but by no means assured. And if you give Obama a 50/50 chance of being reelected—which is my guess at this point having watched the Republican presidential race closely—then you can reasonably assume the CFPB has a 50/50 chance of surviving at least until January 2016.

And I think that’s a good thing.

cfpb-richard-cordray.jpgThis probably puts me at odds with most of Bank Director magazine’s readers. There’s no question that Dodd-Frank, combined with a variety of recent initiatives that have come directly from agencies like the Federal Reserve, will drive up compliance costs for banks and thrifts. And the CFPB‘s information demands alone will be a component of those higher costs. However, I have a hunch that what scares some people the most is the specter of a wild-eyed liberal bureaucrat imposing his or her consumer activist agenda on the marketplace. I don’t think Cordray quite fits that description, based on what I’ve read about him, but obviously we won’t know for sure until he’s been in the job for a while, so the naysayers’ apprehension is understandable. At the very least he seems determined to get on with the job, so we should know soon enough what kind of director he will be.

Here’s my side of the argument. Among the primary causes of the global financial crisis of 2008, which was precipitated by the collapse of the residential real estate market in the United States, were some of the truly deplorable practices that occurred during—and contributed to—the creation of a housing bubble. Chief among them were the notorious option-payment adjustable rate mortgages and similar permutations that allowed borrowers to pay less than the amortization rate that would have paid down their mortgages, which essentially allowed them to buy more house and take out a bigger mortgage than they could afford to repay. Some of these buyers were speculators who didn’t care about amortization because they planned on flipping the house in two years. But many of them were just people who wanted a nicer, more expensive house than they could afford and figured optimistically that things would work out. And the expansion of the subprime mortgage market brought millions of new home buyers into the market just when housing prices were becoming over inflated.

I’m not suggesting that the CFPB, had it been in existence during the home mortgage boom, could have single-handedly prevented the housing bubble. The causes of the bubble and the financial panic that eventually ensued were many and varied, including the interest rate policies of the Federal Reserve, the laxness on the bank regulatory agencies when it came to supervising the commercial banks and thrifts, the laxness of the Securities and Exchange Commission when it came to supervising the Wall Street investment banks and the fact that no one regulated the securitization market. But an agency like the CFPB, had it been doing its job, would have cracked down on dangerous practices like the so-called liar loans, or loans that didn’t require borrowers to verify their income. It would have put an end to phony real estate appraisals that overstated a home’s worth, making it easier for borrowers to qualify for a mortgage. And it would have been appropriately suspicious of option-ARMs if a super-low teaser rate and negative amortization were the only way that a borrower could afford to buy a home.

The CFPB is not a prudential bank regulator and will not focus on bank safety and soundness like the Federal Reserve, Office of the Comptroller of the Currency and Federal Deposit Insurance Corp. But in cracking down on some of these dangerous marketplace practices, the CFPB might have reigned in institutions like Wachovia, Washington Mutual, IndyMac and Countrywide that ultimately failed, or were forced to sell out, because it would have discouraged many of the shenanigans that helped feed the housing bubble.

Of course, many of the unsound practices that helped inflate the bubble were widespread outside the banking industry, and one of the CFPB’s principal—and I would say most important—duties will be to regulate the mortgage brokers and nonbank mortgage originators who accounted for a significant percentage of origination volume during the housing boom. Banks and thrifts should benefit greatly from this effort if it leads to the creation of a level playing field where nonbank lenders can no longer exploit the advantages of asymmetrical regulation.

A truism of our financial system is that money and institutional power will always be attracted to those sectors that have the least amount of regulation. For all intents and purposes, both the gigantic secondary market and the large network of mortgage brokers and nonbank mortgage lenders went unregulated during the boom years, and this is where the greatest abuses occurred. (Dodd-Frank also addressed the secondary market, although the jury is out whether its prescribed changes will work. Indeed, at this point it’s unclear whether the secondary market for home mortgages will ever recover.)

In hindsight, having two mortgage origination markets—one highly regulated, the other unregulated—was asking for trouble. And that’s exactly what we got.

Which is why we need the CFPB.

Will National Banks Lose the Protection of Federal Preemption?


justice.jpgIf you are the director of a nationally chartered bank or thrift, there’s a date coming up real fast that you must pay attention to. 

One of the many changes mandated by the Dodd-Frank Act is a significant restriction in the protection that banks and thrifts with national charters have enjoyed from many state consumer protection laws. That protection—under a legal principle known as federal preemption—is set to change significantly on July 21. While much angst has been expressed over the disruptive impact that the new Consumer Financial Protection Agency could have on the banking industry, that agency is still getting organized and its impact at this point is—at best—speculative. The end of federal preemption, on the other hand, could have immediate ramifications for national banks and thrift.

The idea of federal preemption in banking is a creature of the National Bank Acts (there were actually two, one in 1863 and another in 1864 which superseded the original law), which among other things created a federal charter for commercial banks and placed them under the control of the Office of the Comptroller of the Currency (OCC). Preemption received a huge boost in 1996 when the U.S. Supreme Court issued a landmark ruling that invalidated a state law that prohibited national banks from selling insurance in small Florida towns. 

And in 2004, under former Comptroller John D. “Jerry” Hawk, the OCC issued rules that preempted national banks and their operating subsidiaries from state laws that “obstruct, impair or condition” their ability to make loans and take in deposits, and also granted sole authority to examine and supervise national banks to—itself!

An apt description of this royal doctrine might have been: “The divine right of the OCC,” and it comes as no surprise that legitimate state interests have railed against the agency’s protective stance ever since. Consider this one example: During the home mortgage boom some years back, national banks doing business in Georgia were exempted from that state’s robust anti-predatory lending law while state chartered banks were forced to comply. Needless to say, state attorneys general and legislatures have been among the most vocal opponents of the OCC’s stand on preemption.

Although Dodd-Frank does not invalidate federal preemption altogether, it does state that the OCC can no longer issue sweeping rulings like it did in 2004, but instead will have to make preemption decisions on a case-by-case basis. It’s also possible that the scope of protection under federal preemption will end up being more narrowly constructed under Dodd-Frank, although it might take years of litigation before national banks and thrifts know exactly how much protection they have against state laws.

Who should be most concerned about the Dodd-Frank restrictions on federal preemption, set to take effect on July 21? Logically, it would be large national banks and thrifts with multi-state operations that include branch banking, home mortgages and/or servicing, home equity lending, auto finance, student lending and credit cards–in short, practically any consumer lending or servicing business.

Being forced to comply with multiple—and differing—state laws will drive up operating and compliance costs for large multi-state banks. Worse yet, it will expose them to the wrath of state attorneys general who couldn’t touch them before. As Arthur J. Rotatori, a Cleveland, Ohio-based member at the McGlinchey Stafford law firm puts it, “The purpose of this provision in Dodd-Frank is to empower state attorneys general to go after national banks.”

And no doubt they will.