NorthWesternFinancialReview.com Blog

August 15 was the last day a bank could charge an overdraft fee on a debit card or ATM transaction by an existing customer if that customer didn’t opt in to the bank’s overdraft program. New rules are a reaction to cries from consumer groups that the overdraft fees have been excessive.

Currently, the new rules apply only to debit card or ATM withdrawals that exceed the account balances, but the FDIC on August 11 proposed additional rules restricting overdraft practices involving checks.

Many of the financial experts have been encouraging customers not to opt-in. They say that instead, they should work with their bank to set up an automatic sweep of funds from their savings account into their checking account in the event they overdraw their checking account.

Banks can no longer cover debit card or ATM withdrawals that exceed account balances if the customer did not opt in or make some other arrangement with the bank. That means some customers could be caught unaware at the checkout counter of a grocery story or other retailer when trying to make a big purchase when they only have little money in their account.

The new federal regulations are particularly discriminatory against smaller banks which typically lack the software for its ATMs to operate on a real-time basis. For example, a bank customer could go to a bank, visit with a teller at the window and withdraw nearly all the funds in his account. An hour or two later, that same customer would likely be able to go to an ATM and use his ATM card to withdraw an equal amount of money, far exceeding his actual balance. This is possible because many banks use ATM software that is updated in “batches” every few hours, or sometimes once a day. That means the balances reported by the ATM can be different from the actual balance of the account. Banks using this older technology are prohibited by law from charging the customer any kind of an overdraft fee if the customer did not opt in.

I have yet to see any good statistics on how many banks operate with this older technology. For many of those banks, the cost to upgrade is prohibitive.

I also haven’t seen any good statistics yet showing how effective banks have been in getting customers to opt-in. Have most customers opted in, or have most ignored the notices from their bank and fallen out of the system? Eventually, this information will come to light.

Today is Art Rolnick’s last day at the Federal Reserve Bank of Minneapolis, where he is a senior vice president and economist. He is moving over to the University of Minnesota where he will head up the Humphrey Institute’s Human Capital Research Collaborative, a joint effort of the University and the Fed on issues related to early childhood education.

Mr. Rolnick has been a tremendous asset to the Fed and the broader community for more than two decades. I have listened to a lot of economists during my career and he does a better job than anyone describing the human meaning of the numbers. In other words, he not only describes the charts and graphs which provide a snapshot of the economy, but he is able to say what that snapshot means in terms of the people in that economy.

His passion is early childhood education. He is not a fan of high taxes, but he makes powerful arguments about the value of directing tax dollars into early childhood education programs. It’s not just about day care, it’s about preparing children to live fulfilling lives as contributing citizens. The Star Tribune ran this interview with Mr. Rolnick recently, which gives you some insight into his thinking.

When you talk about the value of economic research, I think Mr. Rolnick gets it right. Numbers divorced from people really aren’t very useful. Mr. Rolnick always seemed to remember that economics is a subset of sociology.

Best wishes on your new endeavor, Mr. Rolnick.

I am really enjoying following the speeches Narayana Kocherlakota is delivering as new president of the Minneapolis Federal Reserve Bank. He was in Helena, Montana last week, where the bank has a branch. He delivered a speech in which he gave an economic forecast, talked about the housing market, and talked about the Fed’s plans for discontinuing some of the programs it launched in response to the financial crisis. Read the full text here.

The Federal Reserve is supposed to be independent, that is, at least as independent as possible for an organization created by Congress. Speaking about the potential for inflation, however, Kocherlakota made a comment that seemed to offer cover for Congress.

Here’s the set up for the comment. Kocherlakota notes that federal debt held by the private sector has increase more than 30 percent since 2008. “This debt,” he said, “can only be paid by tax collections or by the Federal Reserve’s debt monetization.” (By that, he means printing money.) He said if people expect the government is going to print more money to cover its debt, it will drive inflationary expectations, which could well become a self-fulfilling prophecy.

Now, here’s the part I find curious:

I hasten to say—and I want to stress—that I view this scenario as unlikely. For it to transpire, the country would need a combination of bad monetary policy and poor fiscal management. I do not foresee this combination as likely to occur. Nonetheless, good policy requires good choices, and policymakers at the Federal Reserve and in Congress need to keep this scenario in mind when making their decisions. I can assure you that we in the Federal Reserve have every intention of keeping our end of the bargain.

Congress, of course, is responsible for fiscal management. Kocherlakota is saying that the Fed will not screw up monetary policy, so he seems to be saying that even if Congress continues to make a mess of this country’s fiscal situation, we will all be okay. That’s quite a gift to hand to the members of Congress!

I would be a lot more assured if Kocherlakota had said something along the lines of: “policymakers at the Fed and in Congress need to make good choices if we are to keep inflation in check.” But that is not what he said. He assures the Fed will do its job, which means we will avoid the dangerous combination he warns of. To me, it seems like this reasoning gives Congress a pass on hard decisions.

Even if Kocherlakota is completely confident that the Fed can contain inflation despite irresponsible congressional behavior, I don’t know that the rest of the American people believe that. I know I don’t.

Commercial real estate, liquidity and capital are the main near-term problems facing community banks, said Federal Reserve Board Governor Daniel Tarullo in New York last week. Speaking April 8 at the New York Community Bankers Conference, Tarullo also called loan concentration and net interest margin major problems for community bankers in the longer term.

“Coping with CRE problems will not be easy. I expect these problems to be with us for some time to come,” he said. Solutions will require bankers to rethink credit administration practices, and force them to expand their loan work-out capability. He commented that the task is complicated by the large volume of properties on the market.

Saying that many banks have relied heavily on noncore funding sources, Tarullo said bankers will have to come up with new contingency funding plans to bolster their liquidity. “Additionally, capital planning will need to be strengthened across all institutions,” he said, noting that high capital cushions are likely to become the norm.

Although many banks will survive the challenges, Tarullo said the industry cannot expect to emerge unscathed. “These immediate financial challenges will, I am afraid, overwhelm quite a number of community banks this year,” he said.

Furthermore, Tarullo said, bankers will need to avoid high concentrations of any single loan type. A move toward loan portfolio diversification will prove difficult for some banks, and will likely lead to lower returns for nearly all banks.

Finally, Tarullo commented on the shrinking net interest margin. “Despite all the emphasis on noninterest revenues in recent years, community banks have continued to rely heavily on spread income,” he said. He further noted that the “aggregate net intrest margin for banks with assets of $10 billion or less has tightened considerably.” Compressing by more than 70 basis points over the last 10 years, the net interest margin for those banks is now 3.63 percent. “As a result, it becomes more difficult for community banks to cover their overhead, pressuring their earnings and their ability to support capital needs fron internal sources,” Tarullo said.

The speech, in which Tarullo also discusses the Fed’s so-called “exit strategy,” can be read here.

A decade or more ago, community bankers would argue that they need their own regulator. They said that the existing regulators were focused on large banks, which had an entirely different business model. They said they wanted their own regulator, an agency that understood the economic dynamics of a small town, who understood agricultural banking, and an agency that understand what “character” means in a loan decision.

But the community bankers seemed to drop their call for a dedicated regulator. With so many other issues to resolve, the groups that advocate for community banks turned their attention to other, more pressing, issues.

But now, an advocate emerges who is calling for a community bank regulator. John Bowman, acting director of the Office of Thrift Supervision, said that Congress should terminate the existing scheme of regulatory agencies and start over. “Our proposal is simple: instead of four federal banking regulators, there should be two: one for community-based banks and thrifts and one for complex commercial banks.”

Speaking in Orlando 10 days ago, Bowman made the case for a dedicated regulatory agency that would focus solely on community banks.

Whether a community bank holds a state charter, a national charter or a federal thrift charter, that institution should not be supervised by the same agency that oversees complex commercial banks. The one-size-fits-all regulator, by necessity, will pay the greatest attention to the complex commercial banks, because they pose the greatest potential risks to the financial system. As a result, the community banks and thrifts that by far make up the largest number of institutions will receive “afterthought” supervision, rather than a regulatory approach tailored to their unique business model.

Bowman said he finds it “ironic” that none of the regulatory reform proposals being considered in Congress include a stand-alone agency for community banks.

You could argue that the FDIC serves as a regulator for community banks, but Bowman dismissed that idea, saying the agency has an inherent conflict of interest. Minimizing losses to the deposit insurance fund is a different mission than assuring the safety and soundness of banks, he said. Bowman also said the Federal Reserve should not be involved in the supervision of community banks, but instead should focus on monetary policy. He said the Fed could rely on other agencies for information about community banks.

I believe community bank supervision would best be managed by a new independent agency that would have the sole mission of supervising community banks and thrifts, supervising their holding companies and protecting consumers. For the first time, the health and welfare of this nation’s community banking sector and its consumers would be the top priority of a federal agency.

Read Bowman’s entire speech here.

Of course, the way things are going, OTS is likely to be merged out of existence. Such a pending fate likely emboldens Bowman to propose this radical idea. But it is unlikely anyone in Congress will pick up Bowman’s idea and run with it. And that’s too bad. It is really not a bad idea and at one time, most of the industry was advocating for something along these lines.

Lots of talk about the need to resolve the too-big-to-fail problem in banking at the two big industry pow-wows earlier this month. It was THE topic at the ICBA convention in Orlando, and it was one of the top two industry challenges discussed at the ABA’s Government Relations Summit in Washington, D.C., March 17-18. The other big issue discussed at the ABA meeting was the need to stop reform legislation provisions that would create a new consumer financial protection agency or bureau. (More on that in future posts.) 

ABA brought in several top industry speakers, including a panel of Federal Reserve Bank presidents. Sandra Pianalto of the Cleveland Fed, Jeffrey Lacker of the Richmond Fed and Tom Hoenig of the Kansas City Fed all talked about the need to resolve too big to fail.

“Too big to fail is the central issue that reform needs to face,” Lacker said. He explained that ten years ago, 45 percent of the liabilities in the financial system were perceived to be guaranteed, either implicitly or explicitly, by the federal government. Today, he said, it is 58 percent. While the percentage has increased, the actual percentage of assets with an explicit guarantee has dropped to 22 percent today from 27 percent in 2000, he said.

“We know that too big to fail won’t go away without legislation that brings it under the rule of law,” Hoenig said. Too big to fail results in a “tremendous mis-allocation of resources,” he said. Furthermore, Hoenig explained that too-big-to-fail banks have a cost of funds advantage over community banks. Read Hoenig’s comments here.

While ICBA and ABA agree on the need to resolve too big to fail, they differ on whether the largest banks should be required to pre-fund a pool of money that regulators could use to unwind a systemically important financial institutions that gets into trouble. ICBA wants to see the largest banks put $50 billion into a fund in advance, while ABA argues that pre-paying such a fund only institutionalizes too big to fail. A banker put the question to Pianalto at the ABA summit.

“The issue of the fund, I don’t have a specific answer. The fund would come from those institutions that are too big to fail. The issue is open for discussion,” she said. “If you have an appropriate supervisory structure in place to begin with, then you won’t have to deal with that question.”

Narayana Kocherlakota addressed the Minnesota Bankers Association yesterday, in his first public speech since taking over as president of the Minneapolis Fed last October. Kocherlakota said a “nascent recovery is under way,” and he expects the recovery to continue with 3 percent growth over the next two years. He characterized his forecast as a little more pessimistic than the FOMC’s, which expects growth of 3 percent this year and 4 percent next year.

Political uncertainty is a factor in his lower forecast:

“There is a great deal of political uncertainty related to major policy initiatives underway in Washington. Congress is considering proposals for enormous changes in health care and in the structure of financial regulation…[and] the capricious winds of politics seem to change them on a near-daily basis.”

Kocherlakota expressed concern about the nation’s unemployment rate and discussed scenarios that could cause inflation to rise:

“Deposit institutions are holding over a trillion dollars of excess reserves (that is, over 15 times what they are required to hold given their deposits). These excess reserves create the potential for high inflation. Suppose that households believe that prices will rise. They would then demand more deposits to use for transactions…these extra deposits become extra money chasing the same amount of goods and so generate upward pressure on prices.”

He hastened to add, and to emphasize, that he did not expect high inflation to set in:

“We would need a combination of bad monetary policy and poor fiscal management. I do not foresee this combination as likely to occur.”

Kocherlakota waded into the debate about limiting the Fed’s supervisory role, saying that its firsthand knowledge of banks helped the Fed react to the financial crisis. Kocherlakota said the Fed “has every incentive to do a good job in assessing the borrower quality” before extending a loan through the discount window or programs like the Term Auction Facility; if the loan goes bad the loss is on the Fed’s balance sheet.

“Suppose instead that some other agency were responsible for providing this information to the Federal Reserve. What exactly are this other agency’s incentives to provide…the best possible information? This other agency is not going to suffer a loss for making a bad loan–the Federal Reserve is.”

He also noted that the Fed’s supervisory experience gave it the scope to conduct last year’s stress tests of the country’s 19 largest banks, something no other “institution in the government would have the kind of collective expertise to orchestrate.”

Ben Bernanke won a second term as Fed chairman last week. In renomination terms the Senate vote was a squeaker, with 30 senators voting against. The next closest not-very-close vote was for Paul Volcker, who was reconfirmed as Fed chair in 1983 by a vote of 84 to 16.

Eight of the 28 Senators who represent NorthWestern Financial Review’s readership area voted against Bernanke: Sam Brownback (R-Kan.), Byron Dorgan (D-N.D.), Russ Feingold (D-Wis.), Al Franken (D-Minn.), Charles Grassley (R-Iowa), Tom Harkin (D-Iowa), Pat Roberts (R-Kas.) and John Thune (R-S.D.).

Opposition spanned the political spectrum. Democrats Harkin and Franken said the Fed under Bernanke was lax in consumer protection; Feingold also opposed the Fed’s reluctance to have its actions reviewed. Republican Brownback criticized the Fed as too beholden to Washington and Wall Street. In an interesting regional twist, he proposed that Tom Hoenig, president of the Kansas City Fed, would make an able alternative to Bernanke.

“Mr. Bernanke is a gentleman and has a powerful intellect, but we need a different perspective at the Fed,” Brownback said. Hoenig “is a practical Midwesterner from outside the Beltway who would bring a common sense view to the Fed and to our monetary policy,” he said.

Richard Vigilante, a good friend of this magazine and coauthor of an upcoming book on the financial crisis, says the attempt to undermine Ben Bernanke’s reappointment as Fed chair “is just one more part of the great cover-up of the government’s responsibility for the mortgage crisis and the crash itself.” Likening the latest mau-mauing to a taste for “beat[ing] up the smart kid,” Vigilante and coauthor Andrew Redleaf say Washington elites are “contemplating throwing Bernanke to the wolves to distract attention from their own guilt.” The authors offer a measured defense of Bernanke:

“The Fed, meanwhile, under Bernanke, actually did go out into credit markets and buy some paper, (even if not the right paper) trying to put some kind of a floor on bond prices and some kind of a ceiling on yields. Moreover, both before and after the crash Bernanke did about as well as one could expect just the sort of things one can expect a central banker to do under such circumstances: hand out free money to any banker he could find wandering the streets. It did not work especially well, which was predictable, but it was exactly what theory says a central banker is supposed to do.”

The government’s main tools for controlling the economy are monetary policy and fiscal policy. The Federal Reserve is in charge of monetary policy, while Congress handles fiscal policy.

Congress is about to vote to raise its debt limit. This story gives you some idea of how Congress has been handling fiscal policy. Clearly, there is no discipline in Congress when it comes to spending, regardless of who is in the White House.  Unabashed spending has completely gutted fiscal policy as an effective means of controlling the economy. Monetary policy alone is only minimally effective. If the value of the dollar keeps falling as our debt mounts, even low interest rates won’t be able to hold prices down in this country.

This is why I am bothered by Congressional attempts to reduce the authority of the Federal Reserve. Congress wags its finger at the Fed like the recession of 2007-2009 should be laid at the feet of Ben Bernanke. The fact is, the Fed has behaved far more responsibly during the last few years than has the Congress.

Fiscal and monetary policy in this country are way out of balance and power grabs by an undisciplined Congress threaten to throw that balance of power even further off the mark. Ultimately, such imbalance means our economy will be driven more by political forces than by market forces.

One of the problems with the Wall Street Reform and Consumer Protection Act (H.R. 4173), which the House passed Dec. 11, is that is threatens the independence of the Federal Reserve. As the Senate debates financial reform legislation, I hope it will get serious about controlling public spending and recognize the importance of a strong and independent central bank.