NorthWesternFinancialReview.com Blog

Have you ever had an experience where you look around you and draw a conclusion — perhaps a conclusion that seems obvious — but then begin to doubt yourself because all the experts tell you otherwise? That’s the way I felt about the housing crisis. I am grateful, however, that Federal Reserve Board Chairman Ben Bernanke is now acknowledging the obvious. He writes in a New Yorker magazine article that he under-estimated the impact of the mortgage meltdown on the overall economy.

Bernanke wasn’t alone. In June of 2005, I had the privilege of sitting in the board room at the Federal Reserve in Washington, D.C. I was listening in with about 50 bankers who were participating in the Stonier Graduate School of Banking, which took place that year at Georgetown University. Our  host was Fed. Gov. Ed Gramlich and other Federal Reserve officials. They led an hour-long discussion about the economy.

At that time, the economy was going pretty well, although several of the bankers asked questions about the housing market. Bankers said real estate markets were heating up and they wondered what the impact would be when the pricing bubble burst. There also were questions about the new-fangled mortgages (interest-only, stated-income, etc.,) that helped people get into over-priced homes. Gramlich (who has since passed away) and others at the Fed said we shouldn’t worry. Their consensus was that real estate problems were regionalized, and that housing was just one sector an an enormous economy.

“Hmm,” I thought, as I left that meeting. “Maybe I am getting nervous for nothing.” Well, as we now know, two years later everything began to fall apart. Turns out the real estate problems were not as limited as some experts thought; turns out that housing does have a pretty big impact on the overall economy.

The Fed should be a mecca for the brightest people in the world. And I believe it is. But even they missed it. How could that have happened? Why did the real estate market and the corresponding market for mortgages have to collapse before the Fed figured out what was going on? There were a lot of people in the room that June ‘05 day who seemed to understand that the real estate markets were headed in the wrong direction, with implications that could be far-reaching. Unfortunately, they weren’t the people working at the Fed.

Bankers have been hearing about Prosper.com for more than a year now. They know that the direct lending web site poses an interesting form of competition. Typical consumers who are looking for loans of up to $25,000 can go to the web site, post information about why they need the money, and consumers willing to lend money can fund those loans. Prosper acts as an intermediary. It is a concept that could only be made possible through the internet.

Well, if bankers have been wondering how to compete with Prosper, they are getting a little reprieve. Prosper is suspending business, pending registration with “appropriate securities authorities.” If you go to www.Prosper.com now, you will see on the home page a notice that reads: “We are not accepting new lender registration or new commitments from existing lenders as this time.” If you click on a link for further information you get the site’s “Prosper Filing Registration Statement.” It says it “Enters Quiet Period.” It explains the site is not transacting new business. In addition to decining additional money from lenders, Prosper also is not accepting any new requests for loans from potential borrowers. Loan repayment arrangements with loans that previously were established remain in place.

The site is vague about when business will get back to normal, saying only that registration could “take several months.”

However, there are other internet lenders that operate similar to Prosper. One that bankers might particularly dislike is www.Zopa.com which facilites loans to consumers, who request them the same way they do on Prosper. The difference? The loans are funded by credit unions.

NBC news and Bloomberg are reporting that President-elect Obama will name NY Fed President Timothy Geithner as Treasury secretary for the incoming administration. Geithner has been at the center of the stabilization storm, working closely with the current Treasury secretary on the evolving economic rescue efforts. Bloomberg attributes a sharp, late-day stock rally to Geithner’s likely selection. NBC is also reporting that New Mexico Governor Bill Richardson will be named as Commerce Secretary.

Brad Rock of Smithtown, N.Y. was the chairman of the American Bankers Association for 2007-2008. He concluded his year in the association’s top spot with a speech he delivered last week at the organization’s convention in San Francisco. These are a few of the salient points he made.

First, he noted the effects of the nation’s home-ownership push of the last couple of decades:

The housing mission is an important, laudable purpose. Every American has the right to live in a good and decent home.

But the fact is, in a free-market, capitalist economy some of those homes are going to have to be rental housing, Because not every American will be able to afford to own his or her home.

Over the past 15 years, the housing mission has been distorted by government creating incentives for lenders to make home mortgage loans that people can’t afford to re-pay, and then …have government either buy or insure the bad loans to further encourage excessive risk-taking at the front end of the transaction.

This is one of our mistakes that we all have to come to grips with.

If we don’t recognize this part of the problem, 10 or 15 years from now, we will probably have to face this same whole mess again.

He acknowledged the need for additional regulation, but said the issue is making sure the new rules are aimed at the right players:

It is true that we have failed to regulate the practices that have caused most of our troubles.

But this is a very different proposition from saying …“Banks need to be regulated more”.

We don’t need to be regulated more. The vast majority of banks across the country, big and small, are very healthy.

They didn’t cause any of these problems, and …They are already very heavily regulated.

Most of our nation’s financial problems were created by people and activities outside the banking system that are either unregulated or very lightly regulated. Mortgage brokers, investment banks, hedge funds, derivatives contracts, credit default swaps and other fancy financial activities by some insurance companies.

They are the people and activities that are either unregulated, or hardly regulated at all …that caused most of these problems.

These are the people and activities that need to be the principal subject of our regulatory focus in the coming months.

We need to bring the level of regulation of those activities ….. which is down here …up to the level of bank regulation.

If lawmakers do not recognize these essential differences, and simply regulate banks more, without addressing these other unregulated activities, it may score political points with some constituents, but we will have failed to make the kind of meaningful changes to create the economic stability that we all want and need.

Rock found a silver lining in the current crisis:

And I believe that the recent “financial crisis” presents some significant opportunities for making accounting and regulatory improvements.

I will mention just 2 of those areas now:

“Mark-to-market” accounting, and Purchase accounting for bank acquisitions. We don’t have time here today for me to review those 2 sets of rules in depth …but I think that if you closely examine those rules, and …their underlying assumptions, and …the results that those rules produce in a variety of circumstances …It is plain that these rules do not work well. These rules need to be changed in a way that will result in more accurate financial reporting, and in a way that will serve our nation’s economic system better.

And if they can’t be changed …Then we need to re-evaluate who makes those rules, and …how the rules are made, and …what purposes the rules being designed to serve.

And, I thought this was a very interesting anecdote about how things work in Washington, D.C.:

On Monday, September 29th, the House of Representatives voted down the first version of the economic rescue bill. That evening at 5 p.m., the Secretary of the Treasury, Henry Paulson, did a press conference on national T.V. in which he said that he was very disappointed with the result, But that he and others would go back to the drawing board to try to address the problems.

An hour and 10 minutes later …Mr. Paulson called me on the telephone, and he said:

“Brad, I understand that you and your folks at ABA have done quite a job building an effective grassroots network.”

“If ever there was an issue upon which you should bring that grassroots capability to bear, this is the issue.”

And then we went on to talk about what I thought it would take to garner more broad-based support, and We talked mostly about increased FDIC insurance and some other matters, and I think that that conversation, and a whole lot of subsequent work by many other people, was part of the shift toward the law that was eventually enacted.

Again, look for thorough convention coverage in the Dec. 1 edition of NorthWestern Financial Review magazine.

Des Moines–In a presentation to the ABA’s National Agricultural Bankers Conference, Floyd Stoner, EVP of Congressional Relations and Public Policy for the ABA, said, “I don’t think Treasury fully understood the variety of charters out there when they got involved in their capital infusion,” however, “it is their intention that banks of all sizes and all charter types will be able to participate.”

Stoner forecasts an announcement for “non-publicly-traded companies that are not sub-S or mutuals” in “a day or two.”

He specified that “I don’t have a time frame for sub-S or mutuals, and frankly Treasury is looking for  a real justification for a way to  do that.  We are suggesting they could do subordinated debt with some bells and whistles.”

And yes, Mr. Stoner did allow that TARP is a howling misnomer at this point. But unless and until we get another acronym…

I saw Ed Yingling, president and CEO of the American Bankers Associations, deliver what was possibly the most impassioned speech of his career at the organization’s annual convention last week in San Francisco. Here are few of the highlights from that speech, delivered Nov. 10:

…It was only a few weeks ago that, driving to work on a Friday at 7:00a.m., I heard that Treasury had just announced it was guaranteeing money market mutual funds. We knew that Treasury was worried about large withdrawals from the funds.

But no one could have imagined that overnight, with no notice or consultation, Treasury would use an obscure fund designed to stabilize exchange rates to guarantee $3.5 trillion dollars in these funds. $3.5 trillion! And, they had not even talked to the bank regulators.

Apparently Treasury had not considered that by doing this they had created an unlimited federal guarantee on funds that paid a higher interest rate than bank deposits. In other words, they were about to suck hundreds of billions of dollars out of banks.

I’m still mad. By noon that day we had sent a letter to the Treasury explaining the ramifications. By 2 p.m., ABA’s Wayne Abernathy and I were meeting with top Treasury officials. Our staff worked all weekend, and by Sunday evening, the Treasury had changed the program so that the guarantee would no longer apply to new investments in the funds. Therefore, there would be no giant sucking sound from bank deposits.

Bankers saw this important change. But what you didn’t see was all the work behind the scenes. You received the ABA Newsbytes Sunday night telling you of the change, but what you didn’t see was that we had drafted, in advance, three different versions of that to send, depending on the outcome.

And you did not see that over that weekend, as a contingency, we had drafted, costed-out, and discussed with the bank regulators a detailed legislative response – an expanded deposit insurance plan – to enable us to compete with the guaranteed funds in case Treasury would not change its plan. Fortunately it was not needed. At least not then.

It has been that way virtually non-stop for several months.

Imagine what it was like during the drafting, defeat, and rebirth of the Emergency Stabilization Act. At one point I remember sending an email at 4:00am on a Sunday morning and having two ABA staffers immediately respond.

Frankly, our staff is also a little angry.

We are angry for the same reason many of you are. And frankly we all have a right to be angry at what has happened.

Three weeks ago, I testified before the House. I told Congress that there are thousands of banks across the country that never made one toxic subprime loan. These banks have been hurt deeply by this crisis. It is a classic case of how good institutions are badly hurt by unscrupulous players and regulatory failures.

First, I said, banks watched as they lost loan business to mortgage brokers who made loans that good bankers would not make.

Second, banks watched their local economies suffer when the housing bubble, caused by others, burst.

Third, banks watched as their reputation was tarnished as the word “bank” was used to cover all sorts of financial institutions. They cringed as they heard Bear Stearns, Lehman Brothers, Fannie Mae, Freddie Mac, and even AIG referred to as “banking failures.”

Fourth, banks have seen their deposit insurance premiums increase dramatically as a result of the housing bust.

Fifth, a number of banks watched as their preferred shares in Fannie and Freddie were wiped out overnight by government fiat.

And, sixth, banks watched as the freeze-up in international credit markets caused the Congress to pass a massive rescue package. It was a solution that these banks did not seek, for a problem they did not cause, and yet it is often labeled the “bank bailout.”

… A strong banking industry is important, not just important, but critical, more critical than ever, to our country’s success. Yes, we are all angry, and we have a right to be, but we need to channel that anger into a dedication to tell our story to the public, the press, and especially to Members of Congress every day.

To tell our story so that we create a new, better financial system, a system that has at its core bankers like you and the sound principles and dedication to your communities for which you stand.

People who follow the banking industry will long remember that last week of September/first week of October when the House rejected the emergency economic rescue package, the Senate Passed it, then the House reconsidered a revised version and passed it, with the president signing it into law on Oct. 3. It was fast moving stuff with Treasury Secretary Henry Paulson at one point even getting down on one knee before House Speaker Nancy Pelosi begging for support.

At the American Bankers Association convention earlier this week in San Francisco, 2007-2008 Chairman Brad Rock talked about that week and the role ABA played in the negotiations:

The Secretary of the Treasury Henry Paulson did a press conference on national T.V. in which he said that he was very disappointed with the result and he and other would go back to the drawing board to try and address the problems.

An hour and ten minutes later, Mr. Paulson called me on the telephone and he said “Brad, I understand that you and your folks at ABA have done quite a job of building an effective grassroots network. If there was ever an issue upon which you should bring that grassroots capability to bear, this is the issue.”  And then we went on to talk about what I thought it would take to garner more broad-based support. We talked mostly about increased FDIC insurance, and some other matters. And I think that that conversation and a whole lot of work subsequently by many, many, many other people was part of the shift toward the law that was eventually enacted.

But I want us all to realize what happened. Secretary Paulson did not call me or Ed Yingling or Diane Casey Landry to say “I think you have good ideas on this subject, tell me your ideas.” Instead, he called to say, in effect, “I think that you and your friends at ABA carry a lot of political weight and I would like you to put that political weight, that demonstration of the votes you represent, behind this proposal.” If we were only in there slugging with words on issues, I never would have received that call.

Rock went on to encourage the 1,700 bankers in the audience to remain active in political issues through the ABA.

NorthWestern Financial Review magazine will have thorough coverage of the ABA convention in its Dec. 1 edition.

The Troubled Asset Relief Program won’t be used to buy troubled assets after all. In an update this morning, Treasury Secretary Henry Paulson said some of the remaining TARP funds may be used to spur activity in the asset-backed securitization market. “Illiquidity in this sector is raising the cost and reducing the availability of car loans, student loans and credit cards. This is creating a heavy burden on the American people and reducing the number of jobs in our economy,” he said.

This would expand economic stabilization efforts beyond the banking system into “the non-bank consumer finance sector.”

People attending the American Bankers Association in San Francisco today had the opportunity to vote on several questions posed by the association. Answers were instantly reported. Here are the opinions of the group:

Will President Obama be positive for the United States globally?

Yes – 64 percent

No – 36 percent

Will President Obama be positive for the United States domestically?

Yes - 46 percent

No – 54 percent

Was the surge so successful that it made Iraq less of an issue, therefore hurting McCain’s campaign?

Yes – 70 percent

No – 30 percent

Who will have the upper hand during the next four years?

President Obama – 38 percent

Democratic leadership in Congress – 62 percent

How would you evaluate the current regulatory environment for banks?

Positive - 11 percent

Negative – 89 percent

What is the most pressing regulatory issue of the day?

Regulatory burden - 26 percent

Fair value accounting – 48 percent

CPP and FDIC guarantee program – 26 percent

Have you been asked to increase capital above 10 percent risk based capital level?

No – 74 percent

Yes – 26 percent

Do you plan to apply for CPP?

Yes - 31 percent

No – 49 percent

Undecided - 20 percent

Would you favor a two-tiered regulatory system?

Yes – 84 percent

No – 10 percent

Undecided – 6 percent

Which countries pose the greatest challenge to American competitiveness?

India - 24 percent

China – 70 percent

European Union – 5 percent

Japan – 1 percent

President-elect Obama has done exactly what Bill Clinton did right after he was elected in November of 1992 — gather some of the best financial minds together to discuss what to do about the economy. Obama convened a meeting of several luminaries in Chicago on Friday, including Warren Buffett, former vice chairman of the Federal Reserve Roger Ferguson, former Treasury Secretaries Robert Rubin, and Lawrence Summers and former Fed Chairman Paul Volcker. It will be interesting to note what comes of that meeting.

One of the first things Clinton did after he was elected the first time was convene an economic summit. The meeting was conducted in Arkansas and involved many business leaders of the day. One man who was part of that 1992 meeting was Bill Brandon, the banker from Arkansas who was president of the American Bankers Association at the time. Brandon was a friend of Bill Clinton. The annual convention of the ABA opened today in San Francisco and one of the first people I ran into was Bill. I asked him about that 1992 meeting.

Brandon said the situation back then with the banks was similar to today where banks were reluctant to make loans because the field examiners were criticizing so many of their loans. “The people at the top wanted us to make more loans but that same message is not what we were getting from our examiners,” Brandon said. “So our message at that meeting was to get the examiners on the same page as the agencies heads.” Brandon said it worked.

Brandon joked that President-Elect Obama “didn’t ask me to join him” for the meeting, this time around.