NorthWesternFinancialReview.com Blog

The more I think about the Financial Stability Oversight Council, the more nervous I get. This is the council created by the Dodd-Frank Act that will be responsible for figuring out what to do with the largest financial firms when they get in trouble. Any bank holding company with more than $50 billion in assets falls under its jurisdiction. Currently, there are 26 such companies.

But the council is further authorized to supervise any number of firms that it deems capable of affecting the country’s financial stability. Technically, the Federal Reserve (which is part of the council) will supervise these other companies, which could be insurance firms, investment companies, hedge funds or other kinds of companies. The language guiding the council on the selection of such companies is so vague that, in effect, it has complete discretion to choose whatever companies it likes (or doesn’t like).

On the face of it, it just doesn’t seem like a good idea to let a regulatory body determine which companies it supervises. Congress really needs to determine which companies a specific agency or council is responsible for. It seems like a mistake to let the agency or council self-select. What kind of incentives might there be for the council or agency to select one company for supervision, but ignore another. Talk about a political football.

Congress is going to have to add some kind of clarifying language here. Companies need to know which regulators to worry about. Clear language in the law needs to specify which companies fall under the purview of the new oversight council.

I have read several summaries of the Dodd-Frank Act, but this is the first I’ve heard about a rule requiring companies to publish their CEO’s salary in relation to the mean salary atthe company. I am trying to figure our the merit of this requirement. Clearly, the author of this rule wants some kind of compensation reform — either lower wages for CEOs or higher wages for staff.

Let’s be clear that this kind of information is already available. Many newspapers and other publications publish the compensation of big company leadership. And there are many services, including the U.S. Census Bureau, that publish mean income, by household and/or individual. Looking at the two sets of data, we all have a pretty good idea of what’s going on in this country. There already are a lot of people outraged by the disparity between top earners and staff.

The Dodd-Frank Act provision will surely exacerbate the outrage. If such disparity is a legitimate Congressional concern, I would be much more impressed by actual measures to address it than mere efforts to incite hostility over it.

There is a lot of anger in this country now over a lot of issues; I am not comforted by the idea of pouring gasoline on this fire at this time. Congress needs to focus on taking real action; it needs to do much more than simply whip up sentiment. But with our polarized Congress and political scene, this may be the best they can do.

Charles Stones, president of the Kansas Bankers Association, used strong language to communicate his concern for the banking industry in light of additional regulations coming into effect. Stones was one of several people to testify at a field hearing August 23 in Kansas City, conducted by U.S. Rep. Dennis Moore (D-Kan.) chairman of the subcommittee on oversight and investigations for the House Financial Services Committee. Stones said a preponderance of new rules is going to drive many banks out of business:

Traditional banks feel the burden of regulation. For the typical small bank, more than one out of every four dollars of operating expense goes to pay the costs of government regulation. The passage of the recent financial reform legislation, which includes a new consumer financial protection bureau, will certainly add to the regulatory burden now faced by banks. In addition, the past year has seen a multitude of new regulations, from RESPA to Reg E. These new regs are taking a toll on banks, especially traditional community banks. For instance, the new RESPA rules are causing many banks, especially in rural areas to reconsider their participation in residential real estate lending. The question is: who will pick up the slack in these areas if the local community bank exits that market?…

These new regulations and laws are putting, and will continue to put, a huge amount of pressure on the earnings of banks. From exponential increases in FDIC premiums to the new laws and regs mentioned above, one consultant put it very succinctly, “Banks will have a harder time making money in the future.” This will inevitably drive banks to consolidate. Again, who will fill the void in small town Kansas if the current local bank decides it can no longer make a fair profit, and closes? It is time for Washington to realize that traditional banks have economic value in this country. It is not enough to say the words, it is time that policies, laws, rules and regulations begin to demonstrate that fact. Actions speak louder than words.”

Stone took particular aim at the Consumer Financial Protection Bureau and Reg E:

We believe that the CFPB will actually hurt consumers. A study by David Evans and Joshua Wright showed that “Under plausible yet conservative assumptions the CFPB would increase the interest rates consumer pay by at least 160 basis points, reduce consumer borrowing by at least 2.1 percent, and reduce the net new jobs created in the economy by 4.3 percent. The unintended consequences will hurt everybody while only protecting a very small few.

Evans is Lecturer, University of Chicago Law School; executive director, Jevons Institute for Competition, Law and Economics; and visiting professor, University College London. Wright is assistant professor, George Mason University Law School and Department of Economics.

And this is only the start… the unintended consequence of new very strict RESPA rules will likely be the departure of many small banks in rural areas from the residential real estate market. The result will be that many consumers will be unable to secure credit purchasing a home in rural areas of Kansas from a local bank. They will be forced to go out of market, if they can. Most non-bank lenders are unfamiliar with rural area and the low volume makes rural areas unattractive to those types of lenders.

 

The U.S. House of Representatives’ Financial Services Committee, subcommittee on oversight and investigations, conducted a two-part field hearing earlier this week. Part one was conducted under the name: “Too big has failed: Learning from Midwest banks and credit unions.” It took place Monday, Aug. 23 at Johnson County Community College in Overland Park, Kan. See this post. Part two was titled: “Empowering consumers: Can financial literacy education prevent another financial crisis?” It took place Tuesday, Aug. 24 at the University of Kansas in Lawrence.

Whether financial education can be effective in preventing financial crisis is an interesting question. Of course financial education is important. If people are smart enough to avoid bad financial transactions, everyone will be better off. But preventing the next financial crisis will require a lot more than financial education programs.

Note, for example, that numerous financial education programs already exist. Those testifying at yesterday’s hearing cited several of them. State Securities Commissioner Marc Wilson talked about the Kansas Council on Economic Education, and State Treasurer Dennis McKinney talked about a program called Save@School and yet another program called Kansas Investments Developing Scholars (KIDS). There are many other programs, many offered by the Federal Reserve Banks. And the American Bankers Association sponsors Teach Children to Save Day and other programs. So the problem is not a lack of programs.

Wilson noted the two main problems preventing additional success of these programs. The first is that teachers already have a full plate teaching the standard curriculum. It is difficult to ask teachers to present new material which crowds valuable and limited teaching time. Furthermore, many teachers are not particularly versed in financial knowledge themselves, so there is significant ramp-up time necessary to educate the teachers.

The second is that the biggest victims of financial scams are senior citizens. Many elderly people lack financial savvy. How do you reach this demographic with a financial literacy program? It doesn’t matter how good the program is if you can’t reach the people who need it most.

I actually don’t believe the financial crisis occurred because some people are stupid. I think it occurred because some people are greedy. And I think greed is a much tougher nut to crack than knowledge.

Tom Hoenig continues to be one of the biggest advocates for community banking. President of the Kansas City Federal Reserve Bank, Hoenig said the main threat to the community bank business model is bad public policy which gives advantages to the nation’s largest banks. The U.S. House of Representatives Committee on Financial Services, subcommittee on oversight and investigations, hosted a hearing in Overland, Kan., yesterday where Hoenig spoke.

“Over the past 20 years, as the banking industry has consolidated into fewer and larger banks, a perennial question has been, ‘Is the community bank model viable?’ The short answer is yes. The longer answer is yes, if they are not put at a competitive disadvantage by policies which favor and subsidize the largest financial institutions,” Hoenig said at the hearing conducted by U.S. Rep. Dennis Moore (D-Kan.).

“The community bank business model has held up well when compared with the megabank model that had to be propped up with taxpayer funding.

“Community banks will survive the crisis and recession and will continue to play their role as the economy recovers. The more lasting threat to their survival, however, concerns whether this model will continue to be placed at a competitive disadvantage to larger banks… If allowed to compete on a fair and level playing field, the community bank model is a winner.”

Read his entire testimony here.

Look for hearing coverage in the Sept. 15 print edition of NorthWestern Financial Review magazine.

The Dodd-Frank Wall Street Reform bill awaits the president’s signature now that the Senate has passed the historic legislation. Here is some of the reaction:

From ABA’s Ed Yingling:

“The American Bankers Association is very disappointed with the regulatory reform bill that is now headed for enactment.  While its core provisions provide needed reform, it is overloaded with new rules and restrictions on traditional banks that did not cause the financial crisis.  The result will be over 5,000 pages of new regulations on traditional banks and years of uncertainty as to what the massive new rules will mean.

“Its impact will be felt not only by the banking industry itself, but by the millions of consumers and businesses that rely on financial services every day to meet their saving, borrowing and financing needs.  It will also, by extension, have a considerable impact on the broader economy and the capability of traditional banks to provide the credit needed to create jobs and drive economic growth.

“The Dodd-Frank Wall Street Reform and Consumer Protection Act does contain some key reform provisions that bankers have long supported, including creation of a new systemic regulatory body, a new process for ending the concept of too-big-to-fail, better consumer protections, and provisions designed to rein in the shadow banking system. 

“Implementation of this legislation will be challenging for regulators, and we stand ready to work with them to ensure that they have the information they need to make certain that the regulatory process is carried out as effectively and efficiently as possible.”

From the ICBA:

Independent Community Bankers of America (ICBA) Chairman Jim MacPhee, CEO of Kalamazoo County State Bank in Schoolcraft, Mich., and Camden R. Fine, ICBA president and CEO, issued this statement today following Senate passage of the financial reform bill.

“This financial and economic crisis clearly demonstrates that reform of Wall Street is needed to prevent this kind of catastrophe from ever again harming our nation’s taxpayers and our communities. While ICBA still vigorously disagrees with some sections of the final bill, the Dodd/Frank Act does create an important precedent that recognizes two distinct sectors within the financial services spectrum-Main Street community banks and Wall Street megabanks. 

“Important ICBA-advocated wins in the bill such as changes in the FDIC assessment base, stricter oversight of too-big-to-fail institutions, and the inclusion of non-bank financial firms under consumer compliance regulations will save community banks money and allow them to better compete, serve their communities and promote economic growth in their markets. Also, the bill contains important concessions for community banks, including protection for trust preferred securities and an exemption from paying higher FDIC premiums to increase the minimum size of the deposit insurance fund.  These and several other concessions establish the congressional policy for tiered regulation that recognize Main Street community banks as having a different banking model from large and internationally active institutions.    

“After the President signs this bill into law, ICBA will work to fix problem provisions in the legislation and minimize any additional burdens on community banks as regulations are written and implemented so community banks can continue to serve the needs of their local customers and do not continue to pay the price for an economic debacle they did not cause.” 

From Neil Milner of the the Conference of State Bank Supervisors:

The passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act reaffirms the importance of the dual-banking system-a system that has existed for nearly 150 years.  Just as in previous reform efforts, the dual-banking system has emerged from the debate wholly intact, refuting the claim that the structure of our financial regulatory system somehow came about by accident.  Congress once again made the deliberate decision to reject proposals that threatened to do away with the dual-banking system by creating a single federal regulator.  The consensus remains: the state supervisory structure is vital to our country’s financial system, and it is here to stay.

Congress today passed a bill that preserves the dual-banking system and all that it entails:  a system of checks and balances between state and federal regulators that prevents consolidation of regulatory authority in Washington, D.C. and influence into a handful of money-center banks; a diverse and competitive industry marked by charter choice and innovation; and access to credit for individuals and businesses in every corner of the country.  By acknowledging the essential role of state regulators and state-chartered banks in our financial system, this historic bill recalibrates the balance of power between state and federal regulators and ushers in a new era of collaboration and cooperation between the two entities-in safety and soundness as well as consumer protection regulation.

As regulators and policymakers move to implementing the Dodd-Frank law, state and federal regulators all have an obligation to set aside institutional preferences and biases and to commit to a regulatory approach that strengthens our financial institutions while ensuring that the flow of credit is not halted.  Credit must continue to flow or the bill will not have achieved one of its most important goals:  facilitating economic recovery.

An important part of accomplishing this goal is ensuring that no lender has an institutionalized competitive advantage over another.  This disparate treatment among institutions can be seen in the funding advantage systemic banks enjoy over other institutions.  Until this differential between institutions is eliminated, then the implications of having “too big to fail” banks will be a financial system driven not by market forces, but by the unequal application of an implied government guarantee of a handful of banks.

CSBS appreciates Congress’s acknowledgement of the integral role of the dual-banking system and we look forward to working with our federal counterparts to implement these monumental reforms.

From former Comptroller of the Currency Eugene Ludwig:

“With today’s Senate vote, a sweeping and well intentioned financial reform bill is on the verge of becoming the law of the land. Although the impact on banks will undoubtedly be profound, we won’t know how profound for some time. We can now see the contours of the ‘new normal’-a tougher, more prescriptive regulatory environment for all. However, it is up to financial regulators to fill in the details. They have a massive task ahead of them, as they set about crafting and implementing literally hundreds of new regulations. This process will take at least a year, and it will certainly be painful at times.”

From Don Childears, president of the Colorado Bankers Association:

“The Colorado Bankers Association is deeply disappointed that Congress filled this bill with unnecessary and harmful provisions instead of focusing on the reform our country needed. The unfortunate reality is that this bill will raise the costs of credit and stifle credit availability - two things that don’t help us recover from this recession - while placing new burdens on our local regulated banks - burdens from which Wall Street is enforceability exempt.”  

“Colorado bankers have advocated for smart, needed financial reform that would help protect our communities, our mortgage markets and our businesses from the threats of another financial meltdown. CBA has advocated that Congress take action to implement a systemic oversight council, responsibly improve consumer protections, create a system that allows appropriate bodies to step in and stop companies that are too big to fail, and create a system of regulation that places nonbank financial institutions on a similar level of regulation as our country’s regulated banking industry.”

“The Dodd-Frank bill does contain some needed reforms, however, Congress’ enormous 2,300 page bill contains so many additional unrelated proposals that we believe there is no way to implement this bill without having an overall negative impact on credit availability and financial services our Colorado banks supply to consumers, communities and businesses.”  

“The reality is that the Congress’ bill will require regulators to write 500+ new rules, 5,000+ new pages of regulations, create a massive new government bureau to oversee consumer protection, keep the unregulated nonbanks out of the reach of enforcement of these rules, and implement special interest price fixing for big retailers, like Wal-Mart, that bank customers will have to swallow. ”

While everyone is watching the House-Senate conference committee work through the 2,000-page financial reform bill, one of the most significant developments for community banks took place in the House on a different bill — the Small Business Lending Fund Act of 2010 (H.R. 5297). This is the bill that would create a $30 billion fund to help banks make small business loans.

Much more important than the main bill, however, is an amendment the House approved by voice vote to allow banks with fewer than $10 billion in assets to amortize losses or write-downs on commercial real estate loans over a 10-year period. I have written about the need for such a thing. U.S. Rep. Ed Perlmutter of Colorado authored the amendment. Read the details here.

The House passed the bill, with the Perlmutter amendment, on Thursday, by a vote of 241-182. The Senate is expected to consider the bill after the Independence Day recess. I hope they move on it quickly and this bill gets signed into law by Labor Day.

The Senate passed financial reform legislation last night by a vote of 59-39. The bill is expected to go to a conference committee headed by Rep. Barney Frank (D-Mass.) which will reconcile it with the House version of a similar bill passed in December. Congressional leaders hope to have a bill to the president for signing by Independence Day.

Some of the notable provisions in the bill that would directly affect bankers include the creation of the consumer financial protection bureau, a rule that has the Fed setting rates for interchange fees on debit cards, and a rule that prevents banks from counting trust preferred securities as Tier 1 capital.

The House bill takes a slightly different approach on many issues. For example, the House bill includes creation of a $150 billion fund that the largest banks would have to pay into. The money would be used to resolve the failure of very large financial institutions. The Senate bill originally included the creation of a $50 billion fund, but the provision was ultimately dropped.

Also, the House created an independent, stand-alone consumer financial protection agency, which is slightly different from the Senate’s idea of putting the new agency inside the Federal Reserve.

The next step for Congress is to name members of the conference committee. Amendment can be considered in conference so advocates representing various interested parties will still be working this legislation, seeking last-minute changes. Bankers would really like to see the restrictions on interchange fees dropped, as well as the proposed restrictions regarding the categorization of trust preferred securities.

The ABA has a largely negative view of the Senate legislation. Here is the statement issued by ABA’s president/CEO Ed Yingling.

The American Bankers Association has supported broad financial regulatory reform since the beginning of this debate.  However, ABA and traditional bankers across the country oppose the legislation approved by the Senate because it now contains very negative provisions that will ultimately hurt American consumers, small businesses and the broader economy.

This bill contains some of the key reform principles that we support, but it also has been loaded down with provisions that will greatly undermine traditional banks’ ability to provide credit and help create jobs in their communities.

Many of these negative provisions have nothing to do with the financial crisis.  Despite all the talk about this being a Wall Street bill, it, in fact, does tremendous harm to traditional banks on Main Street that had nothing to do with the crisis and that will now be less able to support the economy.  This bill promised much-needed reform but has gone terribly wrong.

In testimony before Congress, in correspondence with policymakers, and in our outreach to the press, ABA has consistently expressed our support for the key principles of reform.  These include creation of a systemic risk council, creation of a strong mechanism for handling the failure of large institutions, ending the concept of too-big-to-fail, closing gaps in regulation and enhancing consumer protection.

We have also continuously stressed that reform must be done right because if it is not, it will only set the stage for future bailouts, undermine thousands of traditional banks that had nothing to do with causing the financial crisis, hurt banks’ ability to lend, and drive more financial business into poorly regulated firms and overseas.

The ICBA was a little more upbeat, issuing this statement under the name of its chairman, Jim MacPhee, CEO of Kalamazoo County State Bank in Schoolcraft, Mich.:

The recent financial and economic crisis clearly demonstrates that some reform of Wall Street is needed to safeguard our financial system and the nation’s taxpayers from a future catastrophe. ICBA appreciates that this legislation includes measures that hold accountable the too-big-to-fail megafirms and nonbanks that were the root cause of this crisis—measures for which ICBA has been a leading proponent.  ICBA thanks Senate Banking Committee Chairman Christopher Dodd (D-Conn.) for his leadership on this legislation and for considering the needs of our nation’s more than 8,000 Main Street community banks. ICBA appreciates the Senate’s recognition of the differences between Main Street and Wall Street by ensuring megabanks pay their fair share for the risk they pose to the FDIC’s Deposit Insurance Fund (DIF), and ultimately our entire financial system.  This is a major victory for ICBA and community banks.  This measure will alleviate the disproportional burden on community banks, will reduce the assessments of 98 percent of banks with less than $10 billion in assets and will keep nearly $4.5 billion in community banks and their communities over the next three years—something that is critical to aiding America’s economic recovery. ICBA thanks Sens. Jon Tester (D-Mont.) and Kay Bailey Hutchison (R-Texas) for their efforts to create much-needed parity between large and small banks.

ICBA still has grave concerns about a separate Consumer Financial Protection Bureau (CFPB).  While we appreciate that community banks will have some exemptions from the proposed CFPB, the changes do not go far enough.  We are disappointed that further changes were not included in the legislation.  Community banks have always viewed consumer protection as a cornerstone to their business model, so it makes sense that the CFPB focus on those too-big-to-fail and shadow institutions that were at the heart of the financial crisis.  ICBA will continue to work for additional revisions to the CFPB.

ICBA is pleased that the bill maintains the Federal Reserve’s examination authority over state member banks, which allows the regional Federal Reserve Banks to keep their finger on the pulse of the Main Street communities that community banks serve each and every day.  These communities have diverse regional economies, and the insights provided by the current system are crucial to the ability of the Federal Reserve to exercise its monetary functions and gauge the impact of banking regulations across various institutions.  ICBA thanks Sens. Kay Bailey Hutchison (R-Texas) and Amy Klobuchar (D-Minn.) for their efforts to maintain the Fed’s examination authority.

While ICBA is pleased with several measures in the Wall Street reform bill, we continue to have critical concerns with language that will inadvertently harm Main Street community banks.   ICBA opposes the interchange language that will harm community banks that offer credit and debit card products to their customers. The current interchange system makes it possible for small community bank issuers to serve their customers because card networks apply the same interchange rates for small issuers that they do for large issuers.  By reducing interchange fees through government regulation, consumers will face higher costs through annual fees and increasing interest rates, as well as fewer choices as community banks are forced to exit the market, thereby leaving consumers with few options and ultimately forcing them to use cards provided by the megabanks.

ICBA also has significant concerns with language that was originally intended to ensure that large banks and bank holding companies would have to meet capital standards that are as strict as those that apply to small banks and bank holding companies.  However, the language is worded broadly enough so that it excludes capital instruments such as trust preferred securities from the consolidated Tier 1 capital of bank holding companies.  This will cause serious harm to community bank holding companies and their underlying banks—the very institutions it originally aimed to avoid burdening.  ICBA will work with the House and Senate to ensure that these onerous measures are not included in the final legislation.

The House Judiciary Committee is conducting a hearing today on the Credit Card Fair Fee Act (H.R. 2695), a bill the banking industry strongly opposes. While so much attention is focused on industry reform, this bill would have a far more significant impact on community banks than most of the provisions in the reg reform bills. H.R. 2695 would basically make it uneconomical for smaller banks to offer credit and debit card services to local merchants. If the bill passes, that business will completely migrate to the largest players, leaving smaller players and their communities out in the cold.

Here is how Kenneth Clayton, senior vice president and general counsel for the American Bankers Association, explained it in a statement issued earlier today:

“The Credit Card Fair Fee Act represents yet another attempt by the merchant community to try, at the behest of large retailers, to get Congress to lower their cost of doing business, all to the detriment of consumers and the broader economy.

“Banks of all sizes…take on significant risks and costs when they issue both debit and credit cards. These include extensive infrastructure costs, fraud costs and the real risk of non-payment. Interchange fees compensate banks for taking on these burdens and make it possible for banks to offer consumers better services, more competitive choices, and lower prices.

“The legislation under consideration today would take away these benefits and inappropriately shift the cost burdens onto consumers…”

I encourage you to learn more about this issue. The Electronic Payments Coalition has an excellent web site providing the details.

I can’t believe the headlines in this morning’s newspapers about the 57-41 vote last night in the Senate on financial reform. Sixty votes were needed for the legislation to advance.

The New York Times headlines says “GOP blocks debate on financial oversight bill,” and my local newspaper, picking up the same story, used this headline: “GOP blocks debade on financil overhaul.” What a bunch of bunk.

The truth is, now the debate can continue. Republicans and Democrats will continue to negotiate and real changes in the Senate bill are possible. Had the Democrats gotten 60 votes yesterday, the debate would be over. The bill would have moved to the Senate floor, but with 60 votes, what incentive would Democrats have to listen to Republicans? The answer is none, so if there is going to be debate it needs to happen now.

And we hear from Sen. Shelby, who spoke to hundreds of community bankers yesterday in Washington, D.C., for ICBA’s policy summit, that he is in negotiations with Sen. Dodd, and that compromises may be reached.

The Senate bill has a lot of problems. It won’t help most bankers. Fact it, both the House and Senate approaches to this problem simply rely more on the regulators who failed to avert a crisis in the first place. Regulators completely failed before so I am puzzled why lawmakers think it makes more sense to plow more resources and power into the regulatory apparatus to prevent a future crisis. To be fair, I don’t think more regulators will necessarily hurt, but I am highly skeptical that they will help.

I stated my solution back in the Feb. 1 edition of NorthWestern Financial Review. What we really need are capital requirements that increase with the level of risk a financial institution takes on, and rules which require lenders to retain some percentage of every loan they originate. Add rules for increasing transparency, and you will have what you need to prevent a future crisis.