By W. Bernard Mason
On July 22, 2009 the Administration issued its proposed legislation regarding the establishment of a systemic risk oversight regime. The legislation fleshes out the points on systemic risk contained in the Administration’s original regulatory reform announcement on June 17th.
The legislation proposes creation of a Financial Services Oversight Council to facilitate coordination of financial regulatory policy and resolution of disputes, and to identify emerging risks in financial markets. The Council would be chaired by the Treasury Secretary and its members would include each of the principal federal prudential regulators and operate with a permanent, full-time staff within the Treasury Department.
The legislation further proposes that all financial firms found to pose a threat to economic financial stability (based upon size, leverage, and interconnectedness) will be subjected to strong, consolidated supervision and regulation by the Federal Reserve, whether or not they own insured depository institutions. The firms so identified will be subjected to higher standards on capital, liquidity and risk management and also be subjected to a prompt corrective action regime that mirrors the current provisions contained in the Federal Deposit Insurance Corporation Improvement Act (FDICIA). The proposed legislation would also require these firms to maintain a credible plan for rapid resolution of the firm in the case of severe financial distress.
The proposed legislation would also raise capital and management requirements for all financial holding companies, and would close loopholes and gaps such that all companies controlling an insured financial institution would receive consolidated supervision by the Federal Reserve. It would also tighten restrictions on bank transactions with affiliates. The legislation additionally would require federal banking regulators to coordinate assessment of fees for examinations of institutions above $10 billion in assets.
The legislation would also require securitizers to retain a 5 percent interest in the credit risk of underlying assets and would require loan-level disclosure, in a standard format, for asset-backed securities. This legislation would also provide the Federal Reserve authority to oversee systemically important payment, clearing, and settlement activities and systems.
The proposed legislation would establish the Office of National Insurance to monitor all aspects of the insurance industry, including identifying gaps in the regulation of insurers that could contribute to a systemic crisis. Finally, the proposed legislation would require prior written approval of the Treasury Secretary for lending by the Federal Reserve under its emergency lending authority (Section 13 of the Federal Reserve Act).
Friday, July 24, 2009
Wednesday, July 22, 2009
House Holds Hearing on Systemic Risk
By W. Bernard Mason
On July 21, 2009 the House Financial Services Committee heard testimony on systemic risk and issues surrounding the concept of “too big to fail”. Appearing as witnesses were: Alice Rivlin, Senior Fellow, Brookings Institution; Peter Wallison, Fellow, American Enterprise Institute; Simon Johnson, Professor, Massachusetts Institute of Technology; Mark Zandi, Chief Economist, Moody’s Economy.com, and Paul Mahoney, Dean, University of Virginia School of Law.
Committee Chairman Barney Frank opened the hearing by stating that he believes no one favors the concept of “too big to fail”, but there seems to be no consensus on what to do about it. He observed that it seemed to be much more easily denounced than dismantled. He said this hearing was not meant as a step toward structuring an approach for government “bail outs”, but instead is part of an effort to avoid the situation faced by the Bush Administration that had no alternative beyond providing government funding to large entities whose failures posed a risk to our financial system.
Ms. Rivlin began her prepared remarks by observing there is no permanent fix to this problem. She said we need some government entity charged with looking continuously at the regulatory system and markets and at whatever perverse incentives may have crept into the system, because whatever rules are adopted will become obsolete as financial innovation progresses and market participants find their way around the rules. She pointed out that the Administration makes a case for such an institution and places the responsibility with a new oversight council. She said this seems to be a cumbersome mechanism and she believes this type of responsibility should be given to the Federal Reserve. She believes this would actually enhance the Fed’s effectiveness as the central bank. Conversely, she believes designating the Federal Reserve as the consolidated regulator for systemic risk would be a mistake. She believes designating systemically important entities and giving them their own regulator would institutionalize “too big to fail” and create a new GSE-like class of institutions. Higher capital requirements and stricter regulation for these entities makes sense, but without granting them their own regulator.
Mr. Wallison stated that, if there is an entity that is "too big to fail", it can only be a large commercial bank. He said in order to be "too big to fail", its collapse must have a major adverse effect on the entire economy – not simply a mere disruption. In his view, only the failure of a large commercial bank could cause this kind of systemic breakdown. He said it would be difficult to see how a large, non-bank institution (bank holding company, securities firm, finance company, hedge fund, etc.,) can cause systemic risk and thus, be too big to fail. He pointed out that these entities do not hold deposits, and if they fail, their creditors do not suffer any immediate cash losses that would make it difficult to pay their bills. No household or business operating funds are placed with these companies. Further, he believes the freeze in lending that followed the Lehman Brothers collapse has led some to believe that Lehman caused that event. In his view, Lehman’s failure did not cause this systemic problem – it caused what he termed a “common shock” where a market freezes up because new information has come to light. This new information was the fact that the government was not going to rescue every firm larger than Bear Stearns. In this new light, every market participant had to re-evaluate the risks of lending to everyone else. He said it is no wonder lending ground to a halt. He said the government’s focus should be on keeping commercial banks sound and healthy; all other entities should be viewed as risk-takers and should be allowed to fail. He recommends that capital requirements for large banks be increased as the banks get larger. Higher capital requirements will cause banks to reconsider whether growth for its own sake really makes sense. He said regulators should develop indicators of risk-taking that banks should be required to publish regularly. Also, Congress should establish a “systemic risk council” consisting of all the bank supervisors and other financial regulators, and it should be charged with spotting conditions in the banking industry (like the acquisition of “toxic” assets) that might make all major banks weak or unstable. He said if we keep our banks stable, we will keep our financial system stable. He concluded by saying that, as a member of the Financial Crisis Inquiry Commission, he would urge Congress to wait until the Commission has delivered its report before adopting legislation.
Mr. Johnson said the issue before us is simple: we must avoid the situation where a large entity comes before the government and says "either you bail us out, or the system will collapse". He believes there are two ways to address this problem: (1) change the regulatory and bankruptcy system; and (2) reduce the size of the institutions. He does not believe the first approach will solve the fundamental problem. He said the banking system has been very persuasive in convincing itself and others (investors, regulators, Congress) that it knows how to manage risks. He pointed out that Alan Greenspan admits it was a mistake to believe that, because banks had a great deal to lose if things went bad, they understood these risks and would control and manage them – they didn’t. This was a failure of risk management, and Mr. Johnson said he sees no evidence either that the banks have improved their management of risk or that regulators have become better at spotting such a problem. He agrees that some sort of systemic risk oversight entity is desirable, but it seems we are a long way from achieving that. He believes the best approach is ratcheting up capital requirements and deposit insurance assessments as entities grow larger. He said the country has encountered massive costs in our efforts to forestall another depression, and the result has been concentration of more power and influence by these larger entities. He observed that, for this cost, we have bought nothing in terms of actually improving the financial system.
Mr. Zandi said, overall, the Administration’s plan is reasonable and well-designed. He believes the Federal Reserve is the right choice for systemic risk regulator. However, he doesn’t see the proposed new regulatory council as providing any value beyond what is already in place. He said the crisis has shown an uncomfortably large number of institutions are too big to fail. He understands the desire to break up these entities, but he believes such efforts would be futile. Breaking up large institutions would be too wrenching and would put U.S. institutions at a distinct disadvantage relative to their large, global competitors. He said large institutions are also needed to back-stop the rest of the financial system. He believes it is better to provide tighter regulation of these entities, with higher capital and liquidity requirements, greater disclosure requirements and higher deposit insurance premiums commensurate with the risks they take and present.
Mr. Mahoney described the Administration’s proposed systemic risk resolution structure as a "bail out" mechanism. He said there are two schools of thought on how to best prevent future financial crises leading to wide-scale bailouts. The first says it was wrong to bail out creditors of failed institutions so that they avoided losses they otherwise would have realized in a normal bankruptcy proceeding and the policy going forward should not be repeated. The second concedes that the government will ordinarily bail out large, systemically important entities. Under this approach, Congress should seek to limit the risks those institutions can take in order to minimize the likelihood that they will become financially distressed, because failure would result in a bail out as a matter of course. This is the Administration’s approach. Mr. Mahoney believes the first approach will produce a healthier financial services industry that will make fewer claims on taxpayers in the future. It is based on a sounder premise – that the best way to reduce moral hazard is to ensure that economic agents bear the costs of their own mistakes. He said the Administration’s plan suggests that regulatory oversight will compensate for misaligned incentives. This position is based on the premise that some institutions are too big to fail. Mr. Mahoney says it is not clear that the magnitude of this problem justifies the scale of the government intervention that we have seen in the past year. He believes bankruptcy is a more appropriate mechanism to deal with these failures, although he admits that the bankruptcy system may need to be refined and enhanced. The other approach furthers moral hazard that impacts the industry continuously, not just in times of crisis. He said that is because perceived systemically important firms ultimately do not pay a sufficient price for taking risks. The result is a dangerous feedback loop: large banks have access to cheap capital, which causes them to grow even larger and more systemically important while taking excessive risks. This all results in the higher probability of a crisis, thus a bailout regime leads to more frequent crises. He disagrees with the Administration’s premise that the higher requirements and regulatory scrutiny proposed for Tier 1 Financial Holding Companies reduces a firm’s desire to be so designated. He believes that the implicit "too big to fail" designation will cause firms to desire inclusion within such a designation. He believes that the Administration’s conclusion that the imposition of higher capital and liquidity requirements on these firms will increase their cost of capital is "wildly optimistic". Firms with an implicit government guarantee will have a valuable commodity to sell, he stated. They will have a powerful incentive to find financial products, off-balance sheet devices, and any other means to evade any limits on the risks they can purchase from others in the financial system.
Chairman Frank made it clear that there will be no official designation of any entities as Tier 1 Financial Holding Companies or any hard and fast rules or criteria for otherwise identifying systemically important firms. He said each case will be unique and will have to be judged independently. There will be no official list of systemically important entities. He said he believes the Administration now sees the weakness in the originally-announced approach. Chairman Frank asked Mr. Johnson if it would be feasible to adjust deposit insurance premiums to account for the higher risks posed by these types of entities. Mr. Johnson said this would be a workable concept and would have the effect of discouraging excessive risk-taking by insured institutions.
In response to a question, Mr. Wallison observed that no one can yet agree on what systemic risk really is; therefore, we need to concentrate on ensuring the banking industry is safe and sound and not worry about extending regulation to firms outside the banking industry.
Rep. Paul Kanjorski (D – PA) asked Ms. Rivlin to clarify whether she believes the Federal Reserve should be the systemic risk regulator. She responded that she did not hold that view for two reasons: first, she does not think there should be such a separately designated regulator; and, if there were, the Fed would not “be very good at it”. Rep. Kanjorski said he agreed with that assessment. He next asked Mr. Wallison how he could possibly believe that only banks present systemic risk, when he had just witnessed what had occurred with regard to the auto industry and the ripple effect failures of those firms would have caused. Mr. Wallison said this is an example of his observation that we don’t have a firm grasp on what systemic risk really is. He viewed the auto industry situation as a “disruption”, not a crisis.
Ranking Member Spencer Bachus (R – AL) observed that several witnesses have essentially concluded that the government’s actions in the recent crisis have increased systemic risk and created a more dangerous environment. Mr. Wallison agreed. He said every time we bail out one institution, we create the belief that others will be bailed out, creating risk and moral hazard. Mr. Bachus said he believed some firms have become bigger and more politically powerful as a result of the crisis – the competition has been eliminated. He said they have no incentive to bring down the level of risk they pose. Mr. Johnson agreed with that assessment. In response to another question from Rep. Bachus, Mr. Johnson responded that the best way to deal with large firms would be to add a new chapter to the bankruptcy code that would set forth more defined procedures for unwinding a failure. Mr. Zandi disagreed, saying he didn’t think bankruptcy courts would operate quickly enough to deal with such large failures. Public confidence would be a major issue in a situation such as this.
Chairman Frank next attacked a statement in Mr. Johnson’s prepared remarks referring to the short-term measures particularly undertaken by the Obama Administration. Mr. Frank wanted to clarify that every activity now being characterized as a "bail out" was initiated by the Bush Administration (AIG, Bear Stearns, Merrill Lynch/Bank of America, General Motors, and Chrysler). He said the first proposal for a bail out that came before the Obama Administration was CIT, and they said "no".
Rep. Scott Garrett (R – NJ) noted Mr. Zandi’s statement that he would place systemic risk regulation with the Federal Reserve, and asked "why them"? Mr. Garrett pointed out the failures of the Fed in previous situations (the tech and real estate bubbles) where he noted Alan Greenspan later had said "maybe I missed that one". Mr. Garrett said if you review the minutes of the Federal Reserve meetings, there was no acknowledgement of a “bubble”; instead the Fed was viewing this as an increase in productivity. Rep. Garrett also noted the Fed’s “wrong” approach on Basel II. Further, he said the Fed had authority to raise capital requirements for Citibank and others, and did nothing. He then asked Mr. Zandi how he could possibly think the Fed was the best choice to assume this new responsibility. Mr. Zandi’s response was that the Fed was the best of a group of bad choices.
Rep. Kenny Marchant (R – TX) asked Mr. Wallison if it was true that he believed AIG was not too big to fail, and that AIG had not defaulted on its obligations. Mr. Wallison said that was true. He said AIG’s credit default swaps did not cause any losses to counterparties; the counterparties merely lost the “insurance” protection they had purchased. Mr. Wallison said, in his view, there is a lot of misinformation regarding the nature of credit default swaps suggesting that they are very dangerous. He believes they are not, and there was no need for the government to take action such as it did with AIG. He said Goldman Sachs, AIG’s largest CDS counterparty, was fully protected from loss by collateral and other measures, but he said due to AIG’s size and interconnectedness, the government mistakenly believed intervention was necessary. In response to another question from Rep. Marchant, Mr. Zandi offered his opinion that the primary cause of the crisis was the fact that the securitization process was “fundamentally broken”. He said no one in the securitization chain had a clear understanding of all the risks. He further said the securitization process has economic value and makes sense under certain circumstances, but the process got abused. Mr. Zandi then said he disagreed with Mr. Wallison regarding AIG and said it is very clear that, if AIG had failed, there would have been substantive risk to the entire system. He said “too big to fail” may refer to relationships such as counterparties, but it also relates to confidence, and had AIG failed, many other entities would have failed and the whole financial system might have collapsed.
Chairman Frank then asked if any of the panel members favored an outright limitation on the growth and size of institutions. Mr. Johnson was the only witness to favor a cap on growth.
Rep. Brad Sherman (D – CA) noted that in his view, the Administration’s systemic resolution proposal represents “permanent, unlimited TARP”. “Wall Street will love the money, government will love the power”. He said this proposal has no chance of passing in the House on a straight up-or-down vote.
In closing the hearing Chairman Frank indicated that there appeared to be consensus regarding the need to correct the problems caused by the credit rating agencies and he stated that, as part of this legislative process, any and all existing statutory mandates to rely upon the credit rating agencies will be repealed, and the Congress will instruct the regulatory agencies to examine theirs.
On July 21, 2009 the House Financial Services Committee heard testimony on systemic risk and issues surrounding the concept of “too big to fail”. Appearing as witnesses were: Alice Rivlin, Senior Fellow, Brookings Institution; Peter Wallison, Fellow, American Enterprise Institute; Simon Johnson, Professor, Massachusetts Institute of Technology; Mark Zandi, Chief Economist, Moody’s Economy.com, and Paul Mahoney, Dean, University of Virginia School of Law.
Committee Chairman Barney Frank opened the hearing by stating that he believes no one favors the concept of “too big to fail”, but there seems to be no consensus on what to do about it. He observed that it seemed to be much more easily denounced than dismantled. He said this hearing was not meant as a step toward structuring an approach for government “bail outs”, but instead is part of an effort to avoid the situation faced by the Bush Administration that had no alternative beyond providing government funding to large entities whose failures posed a risk to our financial system.
Ms. Rivlin began her prepared remarks by observing there is no permanent fix to this problem. She said we need some government entity charged with looking continuously at the regulatory system and markets and at whatever perverse incentives may have crept into the system, because whatever rules are adopted will become obsolete as financial innovation progresses and market participants find their way around the rules. She pointed out that the Administration makes a case for such an institution and places the responsibility with a new oversight council. She said this seems to be a cumbersome mechanism and she believes this type of responsibility should be given to the Federal Reserve. She believes this would actually enhance the Fed’s effectiveness as the central bank. Conversely, she believes designating the Federal Reserve as the consolidated regulator for systemic risk would be a mistake. She believes designating systemically important entities and giving them their own regulator would institutionalize “too big to fail” and create a new GSE-like class of institutions. Higher capital requirements and stricter regulation for these entities makes sense, but without granting them their own regulator.
Mr. Wallison stated that, if there is an entity that is "too big to fail", it can only be a large commercial bank. He said in order to be "too big to fail", its collapse must have a major adverse effect on the entire economy – not simply a mere disruption. In his view, only the failure of a large commercial bank could cause this kind of systemic breakdown. He said it would be difficult to see how a large, non-bank institution (bank holding company, securities firm, finance company, hedge fund, etc.,) can cause systemic risk and thus, be too big to fail. He pointed out that these entities do not hold deposits, and if they fail, their creditors do not suffer any immediate cash losses that would make it difficult to pay their bills. No household or business operating funds are placed with these companies. Further, he believes the freeze in lending that followed the Lehman Brothers collapse has led some to believe that Lehman caused that event. In his view, Lehman’s failure did not cause this systemic problem – it caused what he termed a “common shock” where a market freezes up because new information has come to light. This new information was the fact that the government was not going to rescue every firm larger than Bear Stearns. In this new light, every market participant had to re-evaluate the risks of lending to everyone else. He said it is no wonder lending ground to a halt. He said the government’s focus should be on keeping commercial banks sound and healthy; all other entities should be viewed as risk-takers and should be allowed to fail. He recommends that capital requirements for large banks be increased as the banks get larger. Higher capital requirements will cause banks to reconsider whether growth for its own sake really makes sense. He said regulators should develop indicators of risk-taking that banks should be required to publish regularly. Also, Congress should establish a “systemic risk council” consisting of all the bank supervisors and other financial regulators, and it should be charged with spotting conditions in the banking industry (like the acquisition of “toxic” assets) that might make all major banks weak or unstable. He said if we keep our banks stable, we will keep our financial system stable. He concluded by saying that, as a member of the Financial Crisis Inquiry Commission, he would urge Congress to wait until the Commission has delivered its report before adopting legislation.
Mr. Johnson said the issue before us is simple: we must avoid the situation where a large entity comes before the government and says "either you bail us out, or the system will collapse". He believes there are two ways to address this problem: (1) change the regulatory and bankruptcy system; and (2) reduce the size of the institutions. He does not believe the first approach will solve the fundamental problem. He said the banking system has been very persuasive in convincing itself and others (investors, regulators, Congress) that it knows how to manage risks. He pointed out that Alan Greenspan admits it was a mistake to believe that, because banks had a great deal to lose if things went bad, they understood these risks and would control and manage them – they didn’t. This was a failure of risk management, and Mr. Johnson said he sees no evidence either that the banks have improved their management of risk or that regulators have become better at spotting such a problem. He agrees that some sort of systemic risk oversight entity is desirable, but it seems we are a long way from achieving that. He believes the best approach is ratcheting up capital requirements and deposit insurance assessments as entities grow larger. He said the country has encountered massive costs in our efforts to forestall another depression, and the result has been concentration of more power and influence by these larger entities. He observed that, for this cost, we have bought nothing in terms of actually improving the financial system.
Mr. Zandi said, overall, the Administration’s plan is reasonable and well-designed. He believes the Federal Reserve is the right choice for systemic risk regulator. However, he doesn’t see the proposed new regulatory council as providing any value beyond what is already in place. He said the crisis has shown an uncomfortably large number of institutions are too big to fail. He understands the desire to break up these entities, but he believes such efforts would be futile. Breaking up large institutions would be too wrenching and would put U.S. institutions at a distinct disadvantage relative to their large, global competitors. He said large institutions are also needed to back-stop the rest of the financial system. He believes it is better to provide tighter regulation of these entities, with higher capital and liquidity requirements, greater disclosure requirements and higher deposit insurance premiums commensurate with the risks they take and present.
Mr. Mahoney described the Administration’s proposed systemic risk resolution structure as a "bail out" mechanism. He said there are two schools of thought on how to best prevent future financial crises leading to wide-scale bailouts. The first says it was wrong to bail out creditors of failed institutions so that they avoided losses they otherwise would have realized in a normal bankruptcy proceeding and the policy going forward should not be repeated. The second concedes that the government will ordinarily bail out large, systemically important entities. Under this approach, Congress should seek to limit the risks those institutions can take in order to minimize the likelihood that they will become financially distressed, because failure would result in a bail out as a matter of course. This is the Administration’s approach. Mr. Mahoney believes the first approach will produce a healthier financial services industry that will make fewer claims on taxpayers in the future. It is based on a sounder premise – that the best way to reduce moral hazard is to ensure that economic agents bear the costs of their own mistakes. He said the Administration’s plan suggests that regulatory oversight will compensate for misaligned incentives. This position is based on the premise that some institutions are too big to fail. Mr. Mahoney says it is not clear that the magnitude of this problem justifies the scale of the government intervention that we have seen in the past year. He believes bankruptcy is a more appropriate mechanism to deal with these failures, although he admits that the bankruptcy system may need to be refined and enhanced. The other approach furthers moral hazard that impacts the industry continuously, not just in times of crisis. He said that is because perceived systemically important firms ultimately do not pay a sufficient price for taking risks. The result is a dangerous feedback loop: large banks have access to cheap capital, which causes them to grow even larger and more systemically important while taking excessive risks. This all results in the higher probability of a crisis, thus a bailout regime leads to more frequent crises. He disagrees with the Administration’s premise that the higher requirements and regulatory scrutiny proposed for Tier 1 Financial Holding Companies reduces a firm’s desire to be so designated. He believes that the implicit "too big to fail" designation will cause firms to desire inclusion within such a designation. He believes that the Administration’s conclusion that the imposition of higher capital and liquidity requirements on these firms will increase their cost of capital is "wildly optimistic". Firms with an implicit government guarantee will have a valuable commodity to sell, he stated. They will have a powerful incentive to find financial products, off-balance sheet devices, and any other means to evade any limits on the risks they can purchase from others in the financial system.
Chairman Frank made it clear that there will be no official designation of any entities as Tier 1 Financial Holding Companies or any hard and fast rules or criteria for otherwise identifying systemically important firms. He said each case will be unique and will have to be judged independently. There will be no official list of systemically important entities. He said he believes the Administration now sees the weakness in the originally-announced approach. Chairman Frank asked Mr. Johnson if it would be feasible to adjust deposit insurance premiums to account for the higher risks posed by these types of entities. Mr. Johnson said this would be a workable concept and would have the effect of discouraging excessive risk-taking by insured institutions.
In response to a question, Mr. Wallison observed that no one can yet agree on what systemic risk really is; therefore, we need to concentrate on ensuring the banking industry is safe and sound and not worry about extending regulation to firms outside the banking industry.
Rep. Paul Kanjorski (D – PA) asked Ms. Rivlin to clarify whether she believes the Federal Reserve should be the systemic risk regulator. She responded that she did not hold that view for two reasons: first, she does not think there should be such a separately designated regulator; and, if there were, the Fed would not “be very good at it”. Rep. Kanjorski said he agreed with that assessment. He next asked Mr. Wallison how he could possibly believe that only banks present systemic risk, when he had just witnessed what had occurred with regard to the auto industry and the ripple effect failures of those firms would have caused. Mr. Wallison said this is an example of his observation that we don’t have a firm grasp on what systemic risk really is. He viewed the auto industry situation as a “disruption”, not a crisis.
Ranking Member Spencer Bachus (R – AL) observed that several witnesses have essentially concluded that the government’s actions in the recent crisis have increased systemic risk and created a more dangerous environment. Mr. Wallison agreed. He said every time we bail out one institution, we create the belief that others will be bailed out, creating risk and moral hazard. Mr. Bachus said he believed some firms have become bigger and more politically powerful as a result of the crisis – the competition has been eliminated. He said they have no incentive to bring down the level of risk they pose. Mr. Johnson agreed with that assessment. In response to another question from Rep. Bachus, Mr. Johnson responded that the best way to deal with large firms would be to add a new chapter to the bankruptcy code that would set forth more defined procedures for unwinding a failure. Mr. Zandi disagreed, saying he didn’t think bankruptcy courts would operate quickly enough to deal with such large failures. Public confidence would be a major issue in a situation such as this.
Chairman Frank next attacked a statement in Mr. Johnson’s prepared remarks referring to the short-term measures particularly undertaken by the Obama Administration. Mr. Frank wanted to clarify that every activity now being characterized as a "bail out" was initiated by the Bush Administration (AIG, Bear Stearns, Merrill Lynch/Bank of America, General Motors, and Chrysler). He said the first proposal for a bail out that came before the Obama Administration was CIT, and they said "no".
Rep. Scott Garrett (R – NJ) noted Mr. Zandi’s statement that he would place systemic risk regulation with the Federal Reserve, and asked "why them"? Mr. Garrett pointed out the failures of the Fed in previous situations (the tech and real estate bubbles) where he noted Alan Greenspan later had said "maybe I missed that one". Mr. Garrett said if you review the minutes of the Federal Reserve meetings, there was no acknowledgement of a “bubble”; instead the Fed was viewing this as an increase in productivity. Rep. Garrett also noted the Fed’s “wrong” approach on Basel II. Further, he said the Fed had authority to raise capital requirements for Citibank and others, and did nothing. He then asked Mr. Zandi how he could possibly think the Fed was the best choice to assume this new responsibility. Mr. Zandi’s response was that the Fed was the best of a group of bad choices.
Rep. Kenny Marchant (R – TX) asked Mr. Wallison if it was true that he believed AIG was not too big to fail, and that AIG had not defaulted on its obligations. Mr. Wallison said that was true. He said AIG’s credit default swaps did not cause any losses to counterparties; the counterparties merely lost the “insurance” protection they had purchased. Mr. Wallison said, in his view, there is a lot of misinformation regarding the nature of credit default swaps suggesting that they are very dangerous. He believes they are not, and there was no need for the government to take action such as it did with AIG. He said Goldman Sachs, AIG’s largest CDS counterparty, was fully protected from loss by collateral and other measures, but he said due to AIG’s size and interconnectedness, the government mistakenly believed intervention was necessary. In response to another question from Rep. Marchant, Mr. Zandi offered his opinion that the primary cause of the crisis was the fact that the securitization process was “fundamentally broken”. He said no one in the securitization chain had a clear understanding of all the risks. He further said the securitization process has economic value and makes sense under certain circumstances, but the process got abused. Mr. Zandi then said he disagreed with Mr. Wallison regarding AIG and said it is very clear that, if AIG had failed, there would have been substantive risk to the entire system. He said “too big to fail” may refer to relationships such as counterparties, but it also relates to confidence, and had AIG failed, many other entities would have failed and the whole financial system might have collapsed.
Chairman Frank then asked if any of the panel members favored an outright limitation on the growth and size of institutions. Mr. Johnson was the only witness to favor a cap on growth.
Rep. Brad Sherman (D – CA) noted that in his view, the Administration’s systemic resolution proposal represents “permanent, unlimited TARP”. “Wall Street will love the money, government will love the power”. He said this proposal has no chance of passing in the House on a straight up-or-down vote.
In closing the hearing Chairman Frank indicated that there appeared to be consensus regarding the need to correct the problems caused by the credit rating agencies and he stated that, as part of this legislative process, any and all existing statutory mandates to rely upon the credit rating agencies will be repealed, and the Congress will instruct the regulatory agencies to examine theirs.
Monday, July 20, 2009
Securities Industry Perspectives on the Regulatory Reform Plan
By W. Bernard Mason
On July 17, 2009 the House Financial Services Committee heard from representatives of the securities industry regarding the issues raised by the Administration's regulatory reform plan. Appearing before the Committee were: Richard Baker, representing the Managed Funds Association; William Brodsky, representing the Chicago Board Options Exchange; Randy Snook, representing the Securities Industry and Financial Markets Association; Paul Stevens, representing the Investment Company Institute; Douglas Lowenstein, representing the Private Equity Council; Diahann Lassus, representing the Financial Planning Coalition; and Rob Nichols, representing the Financial Services Forum.
Rep. Paul Kanjorski (D -PA) chaired the Committee and began the hearing by mentioning a recent survey of investors that cited regulatory failure as the primary reason for their lack of confidence in the financial markets. He said he had advised SEC Chair Mary Shapiro earlier this week that the Commission must take bold and assertive action to strengthen enforcement. He said the Commission must also re-write the rules governing the industry to better protect investors. Additionally, he said Congress must update our security laws. He said Chairman Shapiro and the SEC's Inspector General have submitted legislative suggestions and the Administration's "white paper" and accompanying pieces of legislative language complement these suggestions, especially in the areas of hedge fund regulation and establishing a fiduciary duty for broker/dealers providing investment advice. Rep. Kanjorski said he is now developing legislation aimed at closing loopholes and stopping unscrupulous practices. Reform of credit rating agencies has a "top spot" on his agenda, as overly optimistic ratings played a significant role in the global crash.
Rep. Brad Sherman (D - CA), in his opening statement, indicated that he would be introducing legislation requiring the SEC to select the rating agency for a particular security issuance as an attempt to deal with the perceived conflict of interest created by issuer selection. Regarding custom, over-the-counter derivatives, he said these have been justified as a way to hedge legitimate risks, but he views the majority of these transactions as just "casino bets" where someone does not have a risk to hedge. He said this is a particular concern since Secretary Geithner told the Committee that he reserves the right to bail out derivatives issuers and their counterparties, so Mr. Sherman believes the federal government has an interest in restricting these instruments. Rep. Sherman says much higher capital requirements are needed for over-the-counter derivatives, and these instruments may be restricted to use only where a market instrument is not available. He said legislation should make clear that there will be no further government bailouts for these derivatives.
Rep. Randy Neugebaurer (R - TX) noted the witnesses' general agreement with the broad principles of the Administration's proposal on securities markets but he cautioned that the Congress must not take action that will put derivatives users at a competitive disadvantage and discourage businesses from properly hedging their risks. He warned that the government cannot micromanage markets to prevent future losses. Investors need to know that the responsibility rests with them and that government bailouts are not an option.
Mr. Baker, the first witness, provided a profile of the hedge fund industry by pointing out its total assets of $1.5 trillion under management make it significantly smaller than either the mutual fund industry or the banking industry and less likely to pose systemic risk. He further pointed out that many hedge funds use little or no leverage, further limiting their contribution to systemic risk. Nevertheless, he said his members have a shared interest in restoration of investor confidence and establishing a more stable and transparent marketplace. He believes this can be attained with a carefully constructed regulatory scheme and aided by adoption of industry "sound practices". He said this will require investors to do their own due diligence. He noted that SEC registration for fund advisors is a key regulatory reform. Mr. Baker said his organization supports efforts aimed at standardization and central clearing or exchange trading of OTC derivatives. However, he believes it is important for market participants to enter into customized contracts, assuming appropriate collateral is posted and adequately separated and protected. He said there should be a systemic risk regulator with key oversight of the system and with a clear mandate to protect the integrity of the financial system, not individual market participants.
Mr. Brodsky said he applauded the Administration's proposal on regulatory reform, and he believes the Congress should not squander the opportunity to design reforms that are long overdue. He believes the SEC/CFTC jurisdictional divide is dramatically antiquated. He said this bifurcation has had consistent negative consequences that we ignore at our peril. Consolidation of these two agencies is the only rational approach, he indicated. He said he applauded the Administration's proposal to create a regulatory council to oversee systemic risk.
Mr. Snook stated that establishment of a systemic risk regulator is the most important step in regulatory reform. He supports the Administration's proposal in this regard. He mirrored Mr. Baker's views with respect to regulatory oversight of derivative products.
Mr. Stevens said his organization fully supports the Administration's reform proposals, but has one concern regarding the plan to oversee systemic risk. He said his members have long subscribed to the notion of a council to oversee such issues and believes a diverse perspective is required. However, he is concerned that the council as proposed by the Administration would have only an advisory and consultative role. Vesting the authority with the Federal Reserve would strike the wrong balance. He would urge Congress to create a strong systemic risk council.
Mr Lowenstein said it is important for Congress to enact reforms, but speed should not be the goal. He stressed that private equity presents none of the factors listed in the Administration's proposal for identifying systemically important entities.
Ms. Lassus said her group was happy to see that the Administration's plan would hold broker/dealers to the same fiduciary standard as investment advisors. She said she further supported all the Administration's key principles for strengthening consumer protection.
Mr. Nichols said reform and modernization is needed and overdue. The current framework is outdated. In his view, the main deficiency with the current regulatory structure is its stovepipe structure that has led to two major problems that created the opportunity for and may have exacerbated the current crisis: gaps in the existing silos; and, no agency is responsible for systemic risks. He believes the cornerstone of reform is creation of a systemic risk supervisor. He said perhaps no factor is more regrettable than invoking the concept of "too big to fail", and it is important to establish an acceptable resolution mechanism to provide for failure of larger entities.
Rep. Kanjorski expressed his severe doubts regarding the appropriateness of designating the Federal Reserve as the systemic risk regulator. He is also concerned that "systemic risk" has not be adequately identified and defined. Mr. Stevens agreed that no one has clearly defined what "systemic risk" is. He said the Administration's criteria make specific application very uncertain.
Rep. Judy Biggert (R - IL) asked Mr. Baker his view on the proposal to establish a separate consumer agency. Mr. Baker said it is unclear to him how any such consumer agency or activity would relate to an entity regulated by either the SEC or the CFTC, and he would have to understand how that would work before he could take a position on the issue.
On July 17, 2009 the House Financial Services Committee heard from representatives of the securities industry regarding the issues raised by the Administration's regulatory reform plan. Appearing before the Committee were: Richard Baker, representing the Managed Funds Association; William Brodsky, representing the Chicago Board Options Exchange; Randy Snook, representing the Securities Industry and Financial Markets Association; Paul Stevens, representing the Investment Company Institute; Douglas Lowenstein, representing the Private Equity Council; Diahann Lassus, representing the Financial Planning Coalition; and Rob Nichols, representing the Financial Services Forum.
Rep. Paul Kanjorski (D -PA) chaired the Committee and began the hearing by mentioning a recent survey of investors that cited regulatory failure as the primary reason for their lack of confidence in the financial markets. He said he had advised SEC Chair Mary Shapiro earlier this week that the Commission must take bold and assertive action to strengthen enforcement. He said the Commission must also re-write the rules governing the industry to better protect investors. Additionally, he said Congress must update our security laws. He said Chairman Shapiro and the SEC's Inspector General have submitted legislative suggestions and the Administration's "white paper" and accompanying pieces of legislative language complement these suggestions, especially in the areas of hedge fund regulation and establishing a fiduciary duty for broker/dealers providing investment advice. Rep. Kanjorski said he is now developing legislation aimed at closing loopholes and stopping unscrupulous practices. Reform of credit rating agencies has a "top spot" on his agenda, as overly optimistic ratings played a significant role in the global crash.
Rep. Brad Sherman (D - CA), in his opening statement, indicated that he would be introducing legislation requiring the SEC to select the rating agency for a particular security issuance as an attempt to deal with the perceived conflict of interest created by issuer selection. Regarding custom, over-the-counter derivatives, he said these have been justified as a way to hedge legitimate risks, but he views the majority of these transactions as just "casino bets" where someone does not have a risk to hedge. He said this is a particular concern since Secretary Geithner told the Committee that he reserves the right to bail out derivatives issuers and their counterparties, so Mr. Sherman believes the federal government has an interest in restricting these instruments. Rep. Sherman says much higher capital requirements are needed for over-the-counter derivatives, and these instruments may be restricted to use only where a market instrument is not available. He said legislation should make clear that there will be no further government bailouts for these derivatives.
Rep. Randy Neugebaurer (R - TX) noted the witnesses' general agreement with the broad principles of the Administration's proposal on securities markets but he cautioned that the Congress must not take action that will put derivatives users at a competitive disadvantage and discourage businesses from properly hedging their risks. He warned that the government cannot micromanage markets to prevent future losses. Investors need to know that the responsibility rests with them and that government bailouts are not an option.
Mr. Baker, the first witness, provided a profile of the hedge fund industry by pointing out its total assets of $1.5 trillion under management make it significantly smaller than either the mutual fund industry or the banking industry and less likely to pose systemic risk. He further pointed out that many hedge funds use little or no leverage, further limiting their contribution to systemic risk. Nevertheless, he said his members have a shared interest in restoration of investor confidence and establishing a more stable and transparent marketplace. He believes this can be attained with a carefully constructed regulatory scheme and aided by adoption of industry "sound practices". He said this will require investors to do their own due diligence. He noted that SEC registration for fund advisors is a key regulatory reform. Mr. Baker said his organization supports efforts aimed at standardization and central clearing or exchange trading of OTC derivatives. However, he believes it is important for market participants to enter into customized contracts, assuming appropriate collateral is posted and adequately separated and protected. He said there should be a systemic risk regulator with key oversight of the system and with a clear mandate to protect the integrity of the financial system, not individual market participants.
Mr. Brodsky said he applauded the Administration's proposal on regulatory reform, and he believes the Congress should not squander the opportunity to design reforms that are long overdue. He believes the SEC/CFTC jurisdictional divide is dramatically antiquated. He said this bifurcation has had consistent negative consequences that we ignore at our peril. Consolidation of these two agencies is the only rational approach, he indicated. He said he applauded the Administration's proposal to create a regulatory council to oversee systemic risk.
Mr. Snook stated that establishment of a systemic risk regulator is the most important step in regulatory reform. He supports the Administration's proposal in this regard. He mirrored Mr. Baker's views with respect to regulatory oversight of derivative products.
Mr. Stevens said his organization fully supports the Administration's reform proposals, but has one concern regarding the plan to oversee systemic risk. He said his members have long subscribed to the notion of a council to oversee such issues and believes a diverse perspective is required. However, he is concerned that the council as proposed by the Administration would have only an advisory and consultative role. Vesting the authority with the Federal Reserve would strike the wrong balance. He would urge Congress to create a strong systemic risk council.
Mr Lowenstein said it is important for Congress to enact reforms, but speed should not be the goal. He stressed that private equity presents none of the factors listed in the Administration's proposal for identifying systemically important entities.
Ms. Lassus said her group was happy to see that the Administration's plan would hold broker/dealers to the same fiduciary standard as investment advisors. She said she further supported all the Administration's key principles for strengthening consumer protection.
Mr. Nichols said reform and modernization is needed and overdue. The current framework is outdated. In his view, the main deficiency with the current regulatory structure is its stovepipe structure that has led to two major problems that created the opportunity for and may have exacerbated the current crisis: gaps in the existing silos; and, no agency is responsible for systemic risks. He believes the cornerstone of reform is creation of a systemic risk supervisor. He said perhaps no factor is more regrettable than invoking the concept of "too big to fail", and it is important to establish an acceptable resolution mechanism to provide for failure of larger entities.
Rep. Kanjorski expressed his severe doubts regarding the appropriateness of designating the Federal Reserve as the systemic risk regulator. He is also concerned that "systemic risk" has not be adequately identified and defined. Mr. Stevens agreed that no one has clearly defined what "systemic risk" is. He said the Administration's criteria make specific application very uncertain.
Rep. Judy Biggert (R - IL) asked Mr. Baker his view on the proposal to establish a separate consumer agency. Mr. Baker said it is unclear to him how any such consumer agency or activity would relate to an entity regulated by either the SEC or the CFTC, and he would have to understand how that would work before he could take a position on the issue.
House Panel to Mark Up Legislation on Executive Compensation
By W. Bernard Mason
On July 17, 2009 House Financial Services Committee Chairman Barney Frank (D - RI) made public draft legislation that would require all U.S. banks, brokerages and other financial firms to disclose how they compensate top executive officers. It also would require nonbinding shareholder votes on compensation (say on pay) and require compensation committees to consist of independent directors.
More specifically, the legislation in its current form contains four components:
On July 17, 2009 House Financial Services Committee Chairman Barney Frank (D - RI) made public draft legislation that would require all U.S. banks, brokerages and other financial firms to disclose how they compensate top executive officers. It also would require nonbinding shareholder votes on compensation (say on pay) and require compensation committees to consist of independent directors.
More specifically, the legislation in its current form contains four components:
- Say on pay (similar to legislation passed by the House in 2007) that would apply to all public companies and would require annual nonbinding shareholder vote on compensation and golden parachutes.
- Independent compensation committee requirement that would apply to all public companies and a requirement that compensation consultants satisfy SEC-established criteria.
- Incentive-based compensation would require disclosure by all banks, bank holding companies, broker-dealers, credit unions, investment advisors and any others identified through joint rulemaking by federal financial regulators.
- Federal financial regulators would be required to establish compensation standards for financial institutions that would identify inappropriate or imprudently risky compensation practices as part of solvency regulation.
Rep. Frank released this draft bill on the heels of the Administration's submission of similar legislation to Congress the day before. Congressman Frank stated that he expects a mark-up of this bill to be completed by the end of this week.
House Hears Financial Industry Perspective on Reform Plan
By W. Bernard Mason
On July 15, 2009, the House Financial Services Committee held a hearing to obtain financial services industry representatives' perspectives on the Administration's regulatory reform plan. Testifying were: Steve Bartlett, representing the Financial Services Roundtable; John Courson, representing the Mortgage Bankers Association; Chris Stinebert, representing the American Financial Services Association; Steven Zeisel, representing the Consumer Bankers Association; Todd Zywicki, Professor of Law; Denise Leonard, representing the National Association of Mortgage Brokers; Edward Yingling, representing the American Bankers Association; and, Michael Menzies, representing the Independent Community Bankers Association.
Committee Chairman Barney Frank (D - RI) opened this hearing by indicating that he will be attempting to complete mark-ups on some pieces of the regulatory reform effort by the end of July, but other portions (he specifically mentioned issues dealing with systemic risk) will not be completed until September. He stated that he had scheduled a separate hearing for July 21 specifically to deal with the issue of "too big to fail". He stated that, while he felt the Administration's proposal had dealt with this matter in a reasonable way, he wanted to provide an opportunity to air all points of view on the issue.
Regarding matters relevant to the current hearing, he mentioned that his staff had compiled documentation regarding the many consumer complaints that he said had been received from Members on both sides of the aisle regarding the actions of credit card companies doing things in anticipation of the effective date of the recently signed legislation. He said that there had been agreement to hold off the effective date of the law as an accommodation to the industry, but he now questions to wisdom of the action because of moves taken by credit card lenders. He specifically cited a move by lenders to significantly increase minimum monthly payment requirements on existing balances, which he feels is particularly egregious, as it is "changing the rules after people have starting playing". He said had borrowers known their payments were going to be increased, they might have made other choices regarding their loan balances. He said credit card holders of one major lender had been told by bank personnel that the payment increases were mandated by federal law. He said these actions are the very types of things that strengthen the case for the creation of a Consumer Financial Protection agency. He said "We cannot pass a law every time there is a set of complaints." He said what we need are rules, and it has not been the case that existing regulators have used the statutory authority given to them. He said the complaints about credit card banks have become very significant.
Chairman Frank stated that the hearing's witnesses may object to the creation of a new consumer agency, but he made clear that no objection should be raised based upon a concern that this might cause a regulated institution to get conflicting messages from two regulators. He said he can guarantee that this law can be written to prevent that. He admits that, in his view, the Administration made a mistake in including CRA as a matter to fall under the purview of the new agency, as he believes this "is of a different order or activity". On another issue, he said that the concept of merging the OTS and the OCC would be a true "merger" of the two, not a take-over by the OCC, since Rep. Frank believes the thrift charter and function should be preserved and there will be no move to abolish the charter. He said the intention would be to narrow the focus of the charter so that it is "a thrift charter only" and not a license to engage in other activities.
Rep. Randy Neugebauer (R - TX), in his opening remarks, stated his concern that the entire process had been directed toward new legislation. He said the fact is there is already legislation on the books that addresses much of the problem areas; the problem is that regulators didn't do their jobs regarding proper enforcement.
The first witness, Mr. Bartlett, stated there were many factors that caused the problems that brought us to this point, but he believes the main one was a regulatory system in chaos that was just not functioning properly. He said the Financial Services Roundtable supports bold, comprehensive reform. He said the Roundtable strongly opposes creation of a new consumer protection agency and strongly supports the designation of the Federal Reserve as the systemic risk regulator. He believes the creation of a strong federal insurance regulator should be an essential part of this regulatory reform.
Mr. Courson seconded most of Mr. Bartlett's statements, emphasizing the need for uniform regulation of all mortgage service providers. Mr. Stinebert remarked that the proposed legislation has the potential to "roll back the clock 30 years", back to a time when consumers had no choice of products, and he believes this proposal will stifle industry innovation. He also pointed out that, under this proposal, institutions could "wind up with 50 different state requirements" and "that is not a formula for simplification." He also emphasized the importance of preserving the industrial bank charter, since it played no role in the current crisis and he believes they should be part of the solution.
Mr. Ziesel stated that safety and soundness and consumer protection are intimately related and the two functions should not be separated. He said there should be stronger supervision of non-bank lenders so there is consistent and competent oversight of mortgage lenders. He also cited the problem of subjecting retail banks to the consumer laws of 50 states, making nationwide lending a costly and complex undertaking. He indicated that this would limit the range of products and perhaps drive banks to avoid doing business in certain states. Even simple uniform disclosures, one of the goals of this legislation, would have to be supplemented to meet the requirements of each individual state, he stated. He believes the better approach is to maintain a uniform national standard. He further stated that the push for "plain vanilla" products makes it unclear that banks will be able to offer the range of products they now do. This is because the proposal discourages the offering of other products consumers may find useful by creating regulatory uncertainty regarding how these "non-vanilla" products must be described, how they can be advertised, and what disclosures will be required to accompany them. He said it is also unclear if institutions would be required to offer the same "plain vanilla" product to everyone regardless of whether they qualify.
Mr. Zywicki stated his view that there are three fatal problems with the proposal to create a new consumer agency: it is based on misguided paternalism; it misdiagnoses the underlying problems and could lead to unintended consequences; and, it creates an unworkable new government planning apparatus.
Ms. Leonard said her organization supports the general concept of a separate consumer agency. She said consumers would greatly benefit from a uniform disclosure requirement that clearly and simply explains critical loan terms. She also pointed out that the board structure of the new agency, as proposed, is flawed, since its board members would not be limited as to party affiliation. She said the five-person board should have no more than three members of any one political party.
Mr. Yingling said ABA believes there are three areas that should be the primary focus of regulatory reform: the creation of a systemic regulator; the creation of a new resolution mechanism; and, filling the gaps in regulation of the shadow banking industry. Regarding systemic regulation, Mr. Yingling said this should not be about focusing on specific entities or institutions, but about looking at information and trends on the economy and different sectors within the economy. Such problematic trends from the recent past would have included: the rapid appreciation of home prices; the proliferation of mortgages that ignored the long-term ability to repay; excess leverage in some Wall Street firms; the rapid growth and complexity of some mortgage-backed securities and how they were rated; and, the rapid growth of the credit default swap market. The new regulator should be focused and nimble; involving it in day-to-day regulation would be a distraction. He noted that, while most of the early focus had been on giving this systemic risk authority to the Federal Reserve, now the focus is on giving it to an independent council. He said this approach makes since, but it should not be a committee. The council should have its own dedicated staff, but it should not be a large bureaucracy. The council should have "carefully calibrated back-up authority" when systemic issues are not being properly addressed. He believes a board consisting of the primary regulators plus Treasury seems logical. He believes the systemic regulator should have authority over accounting rulemaking, due to the critical relationship of accounting rules to systemic risk. Regarding systemic resolution authority, Mr. Yingling said whatever is done on this front will set the parameters for "too big to fail". He said ABA is concerned that this issue is not adequately addressed in the Administration's proposal. ABA believes the goal should be to eliminate, as much as possible, moral hazard and unfairness. When an institution goes into this resolution process, its top management, board, and major stakeholders should be subject to clearly set out rules of accountability, change, and financial loss. He said no one should want to be considered "too big to fail". He said the ABA strongly supports maintaining the federal thrift charter.
Mr. Menzies said ICBA supports identifying specific institutions that may pose systemic risk and systemic danger, and subjecting them to stronger supervision, capital and liquidity requirements. He said the Administration's plan could be enhanced by imposing fees on systemically important holding companies for their supervisory costs and to fund, in advance, a new systemic risk fund. He said the plan should also implement procedures to downsize "too big to fail" institutions in an orderly way. He stated that ICBA urges continuation of both the state bank and the federal thrift charter. He said ICBA opposes the proposal for a new consumer protection agency, in its current form. ICBA urges the addition of an Assistant Secretary for Community Institutions within the Treasury Department to provide an internal voice for main street concerns.
Chairman Frank observed that most of the witnesses hold concerns regarding the extent to which the proposal would recognize state consumer protection authority. He said he assumes it is the position of the witnesses that any proposal should include federal preemption of such state authority. Except for Ms. Leonard, they all concurred that a national uniform standard was called for.
Rep. Neugebauer observed that, in his past experience as a banker, he was often called upon to tailor products to fit specific customer needs. He fears that the Administration's proposal is not a consumer protection bill, but a product regulation bill. He requested the panel's views on the federal government becoming very prescriptive in the types of products allowed to be offered. Mr. Bartlett said the government should regulate for safety and soundness and consumer protection but should not dictate products. The other panelists agreed with that observation.
Rep. Paul Kanjorski (D - PA) asked the panel if any of them believed either CRA or the activities of Fannie Mae and Freddie Mac had been contributing factors to the current crisis. None of the panelists felt that those factors were contributors to the crisis. Rep. Kanjorski then asked the panel if any of them recognized this problem building. Mr. Bartlett said the Roundtable saw troubling signs in 2006 but did not move quickly enough to deal with them. Mr. Yingling said that the failure to recognize the signs is clear evidence and support for the creation of a systemic risk authority.
Rep. Edward Royce (R - CA) stated his view that both Freddie and Fannie were driven by the misguided altruistic belief that the highest possible stretch for homeownership was to the benefit of consumers. He believes it would be very difficult to create a separate regulatory entity, charge it with consumer protection oversight, and then not expect it to come up with a similar, politically driven mandate. He believes these politically driven mandates caused the financial collapse. He asked the panel to comment on the prospect of the Consumer Financial Protection Agency being used for politically mandated purposes in the future. Mr. Courson said he is concerned that we are attempting an experiment that may ultimately cause safety and soundness concerns. Mr. Zywicki agreed.
Rep. Maxine Waters (D - CA) inquired as to why mortgage servicers cannot understand that we have a crisis and that we need to intensify the loan modification process to avoid massive foreclosures. Mr. Bartlett said Roundtable members are now modifying approximately 250,000 mortgages per month and he admitted this pace was woefully inadequate.
Rep. Frank Lucas (R - OK) asked Messrs. Yingling and Menzies to comment on the effect of the Administration's proposal on community banks and small businesses. Mr. Yingling said his main concern is the directive that products should be standardized, since loans in small communities are not "cookie-cutter", they are individually designed. Based upon the strong language in the Administration's proposal, community banks would be discouraged from making custom-designed loans due to the potential adverse consequences from the consumer agency. Mr. Menzies said community banks were the victims in this crisis due to the toxic products created by Wall Street and the mega-banks. He said the government should not take away his ability as a community banker to be creative in order to take care of the needs of his customers.
Rep. Mel Watt (D - NC) said he recognized the opportunity for conflict between two regulators working on the same turf, but he does not necessarily see the conflict between safety and soundness and consumer protection disciplines. He said there may be cases where the two overlap, but he says he is troubled by the notion that if the two are separated, there will be some sort of inherent conflict. He understood the resistance to change, but in his view the current structure "didn't work". He believes the industry's "conflict" argument is more a motivation to keep consumer protection subordinate to the other objectives. He said he is also puzzled about Mr. Bartlett's suggestion that the federal government set up a new insurance regulator, which will represent new costs, yet we shouldn't spend the money to set up a new agency whose sole responsibility is to deal with consumer issues. Mr. Bartlett said he is not advocating the status quo. He said important pieces of existing consumer protection legislation are not in the hands of the safety and soundness regulators, and they should be.
Rep. Judy Biggert (R - IL) asked how a federal standard would promote consistent regulation if it allowed the states to add on their various requirements. Mr. Courson said that is one of his concerns. In his view, if there had been a national standard, many of the current problems could have been avoided. He pointed out that state requirements would add more complexity, which is the opposite of the Administration's stated intention.
Rep. Gary Miller (R - CA) said he disagreed with many of his Republican colleagues that Fannie and Freddie should be phased out. He believes they perform an essential function, but need to be more strongly regulated. He then cited some consistent thoughts among the witnesses' testimony: concern about creating winners and losers; more government could be more confusion; more uniformity; need for systemic risk oversight; national standards; and inconsistent or inadequate enforcement. He asked the panel their views regarding an alternative outcome had the regulators enforced the rules already on the books, and if they believed the regulators already have most of the authority needed to accomplish the goals stated in the Administration's proposal. Mr. Zeisel stated that there are a lot of tools already available and some new ones that have just now been implemented that would permit the Administration's objectives to be achieved. Mr. Bartlett said the laws themselves may be adequate, but the allocation of responsibility for enforcement is inadequate and needs to be addressed by Congress. He said this does not mean that a new agency is justified; the existing agencies should be further empowered.
Rep. Dennis Moore (D - KS) asked about the costs of the Administration's proposals. Mr. Yingling said the cost of the new consumer agency is entirely unknown; however, it would be mandated to examine and administer enforcement actions with respect to the currently unregulated lending entities now operating, and that would require a significant budget. He stressed that the ABA wants this done, but the question is how to pay for it. He said if the budget is prepared "on the cheap", it cannot do what it is required to do and will end up discriminating by concentrating its enforcement actions on insured institutions. Mr. Courson says his organization has advocated for more regulation of the "shadow" banking industry, and has argued that these entities will have to share in the costs of running the agency. He said everyone recognizes there will be additional costs associated with more consumer regulation, whether it is housed within the existing safety and soundness regulator, or in a new agency.
Rep Jeb Hensarling (R - TX) asked if, under the proposed legislative language, a prepayment penalty included in a 30-year mortgage would be considered "fair". Mr. Yingling responded by stating that the regulatory discretion contained in the language of this legislation "changes everything". "There has been no law authorized by Congress in the consumer area, no regulation that isn't trumped by this." Rep. Hensarling observed that this legislation is aimed at consumers but, based upon Federal Reserve data, most small businesses use credit sources under an individual name and would thereby be brought under the legislation's purview. He inquired if this proposed legislation, and its potential to limit financing choices, could harm small businesses and job creation. Mr. Zeisel said small businesses definitely would be impacted by this.
Rep. Adam Putnam (R - FL) asked whether the crisis is far enough behind us for us to understand the causes and make the sweeping regulatory reforms that are being contemplated. Mr. Menzies said there are differing opinions as to whether the problem is fully behind us, and it also presupposes a need for legislation to deal with the problem. He said it is very important to focus on what caused the problem. "We can have all the product legislation in the world, we can do everything possible to protect the consumer, but the greatest damage to the consumer was the failure of the system because of concentrations and excesses across the board of the Wall Street vehicles that gathered together substandard, subprime, weird mortgages that community bankers didn't make, created a warehouse to slice and dice those entities, made huge profits selling off those items and had very little skin in the game, very little capital at risk." He emphasized that this is what deserves attention. He said "too big to fail" and "too big to regulate" are issues that must be dealt with. "And from the perspective of community banks, that is the crisis of the day, that's what destroyed the free market system", he concluded.
On July 15, 2009, the House Financial Services Committee held a hearing to obtain financial services industry representatives' perspectives on the Administration's regulatory reform plan. Testifying were: Steve Bartlett, representing the Financial Services Roundtable; John Courson, representing the Mortgage Bankers Association; Chris Stinebert, representing the American Financial Services Association; Steven Zeisel, representing the Consumer Bankers Association; Todd Zywicki, Professor of Law; Denise Leonard, representing the National Association of Mortgage Brokers; Edward Yingling, representing the American Bankers Association; and, Michael Menzies, representing the Independent Community Bankers Association.
Committee Chairman Barney Frank (D - RI) opened this hearing by indicating that he will be attempting to complete mark-ups on some pieces of the regulatory reform effort by the end of July, but other portions (he specifically mentioned issues dealing with systemic risk) will not be completed until September. He stated that he had scheduled a separate hearing for July 21 specifically to deal with the issue of "too big to fail". He stated that, while he felt the Administration's proposal had dealt with this matter in a reasonable way, he wanted to provide an opportunity to air all points of view on the issue.
Regarding matters relevant to the current hearing, he mentioned that his staff had compiled documentation regarding the many consumer complaints that he said had been received from Members on both sides of the aisle regarding the actions of credit card companies doing things in anticipation of the effective date of the recently signed legislation. He said that there had been agreement to hold off the effective date of the law as an accommodation to the industry, but he now questions to wisdom of the action because of moves taken by credit card lenders. He specifically cited a move by lenders to significantly increase minimum monthly payment requirements on existing balances, which he feels is particularly egregious, as it is "changing the rules after people have starting playing". He said had borrowers known their payments were going to be increased, they might have made other choices regarding their loan balances. He said credit card holders of one major lender had been told by bank personnel that the payment increases were mandated by federal law. He said these actions are the very types of things that strengthen the case for the creation of a Consumer Financial Protection agency. He said "We cannot pass a law every time there is a set of complaints." He said what we need are rules, and it has not been the case that existing regulators have used the statutory authority given to them. He said the complaints about credit card banks have become very significant.
Chairman Frank stated that the hearing's witnesses may object to the creation of a new consumer agency, but he made clear that no objection should be raised based upon a concern that this might cause a regulated institution to get conflicting messages from two regulators. He said he can guarantee that this law can be written to prevent that. He admits that, in his view, the Administration made a mistake in including CRA as a matter to fall under the purview of the new agency, as he believes this "is of a different order or activity". On another issue, he said that the concept of merging the OTS and the OCC would be a true "merger" of the two, not a take-over by the OCC, since Rep. Frank believes the thrift charter and function should be preserved and there will be no move to abolish the charter. He said the intention would be to narrow the focus of the charter so that it is "a thrift charter only" and not a license to engage in other activities.
Rep. Randy Neugebauer (R - TX), in his opening remarks, stated his concern that the entire process had been directed toward new legislation. He said the fact is there is already legislation on the books that addresses much of the problem areas; the problem is that regulators didn't do their jobs regarding proper enforcement.
The first witness, Mr. Bartlett, stated there were many factors that caused the problems that brought us to this point, but he believes the main one was a regulatory system in chaos that was just not functioning properly. He said the Financial Services Roundtable supports bold, comprehensive reform. He said the Roundtable strongly opposes creation of a new consumer protection agency and strongly supports the designation of the Federal Reserve as the systemic risk regulator. He believes the creation of a strong federal insurance regulator should be an essential part of this regulatory reform.
Mr. Courson seconded most of Mr. Bartlett's statements, emphasizing the need for uniform regulation of all mortgage service providers. Mr. Stinebert remarked that the proposed legislation has the potential to "roll back the clock 30 years", back to a time when consumers had no choice of products, and he believes this proposal will stifle industry innovation. He also pointed out that, under this proposal, institutions could "wind up with 50 different state requirements" and "that is not a formula for simplification." He also emphasized the importance of preserving the industrial bank charter, since it played no role in the current crisis and he believes they should be part of the solution.
Mr. Ziesel stated that safety and soundness and consumer protection are intimately related and the two functions should not be separated. He said there should be stronger supervision of non-bank lenders so there is consistent and competent oversight of mortgage lenders. He also cited the problem of subjecting retail banks to the consumer laws of 50 states, making nationwide lending a costly and complex undertaking. He indicated that this would limit the range of products and perhaps drive banks to avoid doing business in certain states. Even simple uniform disclosures, one of the goals of this legislation, would have to be supplemented to meet the requirements of each individual state, he stated. He believes the better approach is to maintain a uniform national standard. He further stated that the push for "plain vanilla" products makes it unclear that banks will be able to offer the range of products they now do. This is because the proposal discourages the offering of other products consumers may find useful by creating regulatory uncertainty regarding how these "non-vanilla" products must be described, how they can be advertised, and what disclosures will be required to accompany them. He said it is also unclear if institutions would be required to offer the same "plain vanilla" product to everyone regardless of whether they qualify.
Mr. Zywicki stated his view that there are three fatal problems with the proposal to create a new consumer agency: it is based on misguided paternalism; it misdiagnoses the underlying problems and could lead to unintended consequences; and, it creates an unworkable new government planning apparatus.
Ms. Leonard said her organization supports the general concept of a separate consumer agency. She said consumers would greatly benefit from a uniform disclosure requirement that clearly and simply explains critical loan terms. She also pointed out that the board structure of the new agency, as proposed, is flawed, since its board members would not be limited as to party affiliation. She said the five-person board should have no more than three members of any one political party.
Mr. Yingling said ABA believes there are three areas that should be the primary focus of regulatory reform: the creation of a systemic regulator; the creation of a new resolution mechanism; and, filling the gaps in regulation of the shadow banking industry. Regarding systemic regulation, Mr. Yingling said this should not be about focusing on specific entities or institutions, but about looking at information and trends on the economy and different sectors within the economy. Such problematic trends from the recent past would have included: the rapid appreciation of home prices; the proliferation of mortgages that ignored the long-term ability to repay; excess leverage in some Wall Street firms; the rapid growth and complexity of some mortgage-backed securities and how they were rated; and, the rapid growth of the credit default swap market. The new regulator should be focused and nimble; involving it in day-to-day regulation would be a distraction. He noted that, while most of the early focus had been on giving this systemic risk authority to the Federal Reserve, now the focus is on giving it to an independent council. He said this approach makes since, but it should not be a committee. The council should have its own dedicated staff, but it should not be a large bureaucracy. The council should have "carefully calibrated back-up authority" when systemic issues are not being properly addressed. He believes a board consisting of the primary regulators plus Treasury seems logical. He believes the systemic regulator should have authority over accounting rulemaking, due to the critical relationship of accounting rules to systemic risk. Regarding systemic resolution authority, Mr. Yingling said whatever is done on this front will set the parameters for "too big to fail". He said ABA is concerned that this issue is not adequately addressed in the Administration's proposal. ABA believes the goal should be to eliminate, as much as possible, moral hazard and unfairness. When an institution goes into this resolution process, its top management, board, and major stakeholders should be subject to clearly set out rules of accountability, change, and financial loss. He said no one should want to be considered "too big to fail". He said the ABA strongly supports maintaining the federal thrift charter.
Mr. Menzies said ICBA supports identifying specific institutions that may pose systemic risk and systemic danger, and subjecting them to stronger supervision, capital and liquidity requirements. He said the Administration's plan could be enhanced by imposing fees on systemically important holding companies for their supervisory costs and to fund, in advance, a new systemic risk fund. He said the plan should also implement procedures to downsize "too big to fail" institutions in an orderly way. He stated that ICBA urges continuation of both the state bank and the federal thrift charter. He said ICBA opposes the proposal for a new consumer protection agency, in its current form. ICBA urges the addition of an Assistant Secretary for Community Institutions within the Treasury Department to provide an internal voice for main street concerns.
Chairman Frank observed that most of the witnesses hold concerns regarding the extent to which the proposal would recognize state consumer protection authority. He said he assumes it is the position of the witnesses that any proposal should include federal preemption of such state authority. Except for Ms. Leonard, they all concurred that a national uniform standard was called for.
Rep. Neugebauer observed that, in his past experience as a banker, he was often called upon to tailor products to fit specific customer needs. He fears that the Administration's proposal is not a consumer protection bill, but a product regulation bill. He requested the panel's views on the federal government becoming very prescriptive in the types of products allowed to be offered. Mr. Bartlett said the government should regulate for safety and soundness and consumer protection but should not dictate products. The other panelists agreed with that observation.
Rep. Paul Kanjorski (D - PA) asked the panel if any of them believed either CRA or the activities of Fannie Mae and Freddie Mac had been contributing factors to the current crisis. None of the panelists felt that those factors were contributors to the crisis. Rep. Kanjorski then asked the panel if any of them recognized this problem building. Mr. Bartlett said the Roundtable saw troubling signs in 2006 but did not move quickly enough to deal with them. Mr. Yingling said that the failure to recognize the signs is clear evidence and support for the creation of a systemic risk authority.
Rep. Edward Royce (R - CA) stated his view that both Freddie and Fannie were driven by the misguided altruistic belief that the highest possible stretch for homeownership was to the benefit of consumers. He believes it would be very difficult to create a separate regulatory entity, charge it with consumer protection oversight, and then not expect it to come up with a similar, politically driven mandate. He believes these politically driven mandates caused the financial collapse. He asked the panel to comment on the prospect of the Consumer Financial Protection Agency being used for politically mandated purposes in the future. Mr. Courson said he is concerned that we are attempting an experiment that may ultimately cause safety and soundness concerns. Mr. Zywicki agreed.
Rep. Maxine Waters (D - CA) inquired as to why mortgage servicers cannot understand that we have a crisis and that we need to intensify the loan modification process to avoid massive foreclosures. Mr. Bartlett said Roundtable members are now modifying approximately 250,000 mortgages per month and he admitted this pace was woefully inadequate.
Rep. Frank Lucas (R - OK) asked Messrs. Yingling and Menzies to comment on the effect of the Administration's proposal on community banks and small businesses. Mr. Yingling said his main concern is the directive that products should be standardized, since loans in small communities are not "cookie-cutter", they are individually designed. Based upon the strong language in the Administration's proposal, community banks would be discouraged from making custom-designed loans due to the potential adverse consequences from the consumer agency. Mr. Menzies said community banks were the victims in this crisis due to the toxic products created by Wall Street and the mega-banks. He said the government should not take away his ability as a community banker to be creative in order to take care of the needs of his customers.
Rep. Mel Watt (D - NC) said he recognized the opportunity for conflict between two regulators working on the same turf, but he does not necessarily see the conflict between safety and soundness and consumer protection disciplines. He said there may be cases where the two overlap, but he says he is troubled by the notion that if the two are separated, there will be some sort of inherent conflict. He understood the resistance to change, but in his view the current structure "didn't work". He believes the industry's "conflict" argument is more a motivation to keep consumer protection subordinate to the other objectives. He said he is also puzzled about Mr. Bartlett's suggestion that the federal government set up a new insurance regulator, which will represent new costs, yet we shouldn't spend the money to set up a new agency whose sole responsibility is to deal with consumer issues. Mr. Bartlett said he is not advocating the status quo. He said important pieces of existing consumer protection legislation are not in the hands of the safety and soundness regulators, and they should be.
Rep. Judy Biggert (R - IL) asked how a federal standard would promote consistent regulation if it allowed the states to add on their various requirements. Mr. Courson said that is one of his concerns. In his view, if there had been a national standard, many of the current problems could have been avoided. He pointed out that state requirements would add more complexity, which is the opposite of the Administration's stated intention.
Rep. Gary Miller (R - CA) said he disagreed with many of his Republican colleagues that Fannie and Freddie should be phased out. He believes they perform an essential function, but need to be more strongly regulated. He then cited some consistent thoughts among the witnesses' testimony: concern about creating winners and losers; more government could be more confusion; more uniformity; need for systemic risk oversight; national standards; and inconsistent or inadequate enforcement. He asked the panel their views regarding an alternative outcome had the regulators enforced the rules already on the books, and if they believed the regulators already have most of the authority needed to accomplish the goals stated in the Administration's proposal. Mr. Zeisel stated that there are a lot of tools already available and some new ones that have just now been implemented that would permit the Administration's objectives to be achieved. Mr. Bartlett said the laws themselves may be adequate, but the allocation of responsibility for enforcement is inadequate and needs to be addressed by Congress. He said this does not mean that a new agency is justified; the existing agencies should be further empowered.
Rep. Dennis Moore (D - KS) asked about the costs of the Administration's proposals. Mr. Yingling said the cost of the new consumer agency is entirely unknown; however, it would be mandated to examine and administer enforcement actions with respect to the currently unregulated lending entities now operating, and that would require a significant budget. He stressed that the ABA wants this done, but the question is how to pay for it. He said if the budget is prepared "on the cheap", it cannot do what it is required to do and will end up discriminating by concentrating its enforcement actions on insured institutions. Mr. Courson says his organization has advocated for more regulation of the "shadow" banking industry, and has argued that these entities will have to share in the costs of running the agency. He said everyone recognizes there will be additional costs associated with more consumer regulation, whether it is housed within the existing safety and soundness regulator, or in a new agency.
Rep Jeb Hensarling (R - TX) asked if, under the proposed legislative language, a prepayment penalty included in a 30-year mortgage would be considered "fair". Mr. Yingling responded by stating that the regulatory discretion contained in the language of this legislation "changes everything". "There has been no law authorized by Congress in the consumer area, no regulation that isn't trumped by this." Rep. Hensarling observed that this legislation is aimed at consumers but, based upon Federal Reserve data, most small businesses use credit sources under an individual name and would thereby be brought under the legislation's purview. He inquired if this proposed legislation, and its potential to limit financing choices, could harm small businesses and job creation. Mr. Zeisel said small businesses definitely would be impacted by this.
Rep. Adam Putnam (R - FL) asked whether the crisis is far enough behind us for us to understand the causes and make the sweeping regulatory reforms that are being contemplated. Mr. Menzies said there are differing opinions as to whether the problem is fully behind us, and it also presupposes a need for legislation to deal with the problem. He said it is very important to focus on what caused the problem. "We can have all the product legislation in the world, we can do everything possible to protect the consumer, but the greatest damage to the consumer was the failure of the system because of concentrations and excesses across the board of the Wall Street vehicles that gathered together substandard, subprime, weird mortgages that community bankers didn't make, created a warehouse to slice and dice those entities, made huge profits selling off those items and had very little skin in the game, very little capital at risk." He emphasized that this is what deserves attention. He said "too big to fail" and "too big to regulate" are issues that must be dealt with. "And from the perspective of community banks, that is the crisis of the day, that's what destroyed the free market system", he concluded.
Monday, July 13, 2009
Senate Hears Testimony Regarding Effects of Economic Crisis on Community Banks and Credit Unions in Rural Communities
By W. Bernard Mason
On July 8, 2009 the Senate Financial Institutions Subcommittee held a hearing focused on the role smaller financial institutions play in the nation’s economy, particularly in rural communities. In opening the hearing, Subcommittee Chairman Tim Johnson (D – SD) stated: “Throughout our nation’s economic crisis there has often been too little distinction made between troubled banks and the many banks that have been responsible lenders.” He said that community banks and credit unions, for the most part, did not contribute to the current crisis, yet small lending institutions in rural communities and their customers are feeling the effects of the subprime mortgage crisis. “Jobs are disappearing, ag loans are being called, small businesses can’t get the lines of credit they need to continue operation, and homeowners are struggling to refinance.”
The Subcommittee heard from the following witness panel: Jack Hopkins, President and CEO of CorTrust Bank N.A., Sioux Falls, SD, testifying on behalf of the Independent Community Bankers of America; Frank Michael, President and CEO of Allied Credit Union, Stockton, CA, testifying on behalf of the Credit Union National Association; Arthur Johnson, Chairman and CEO of United Bank of Michigan, Grand Rapids, MI, testifying on behalf of the American Bankers Association; Ed Templeton, President and CEO of SRP Federal Credit Union, North Augusta, SC, testifying on behalf of the National Association of Federal Credit Unions; and, Peter Skillern, Executive Director of the Community Reinvestment Association of North Carolina.
Mr. Hopkins stated that “community banks played no part in causing the financial crisis and have watched as taxpayer dollars have been used to bail out Wall Street investment firms and our nation’s largest banks considered ‘too big to fail’”. “During this same time period, dozens of community banks have been allowed to fail while the largest and most interconnected banks have been spared the same fate due to government intervention”. He cited an ICBA study completed in March indicating that community banks are still lending and 40 percent have seen an increase in origination volumes in the last year, while 11 percent believe the financial crisis has “significantly curtailed” their lending ability. He said the survey indicated that some of the reduction in lending activity was a reaction to the mixed messages coming from the government. While banks are being told by policymakers to lend money, he said they also feel the agencies are dissuading them from lending by putting them through overzealous regulatory exams. He said that, while the largest banks saw a 3.23 percent decrease in lending in 2008, institutions will less than $1 billion in assets experienced a 5.53 percent increase.
Mr. Hopkins said bankers are concerned with the potential for their regulators to second-guess their desire to make additional loans and some bankers are under pressure from their regulators to decrease their loan-to-deposit ratios. He said bankers also stated regulators do not want them to use FHLBank advances for loan funding purposes, suggesting they are not as stable as core deposits. He commented that bankers believe the real issue is the FDIC does not want to have a secondary position behind the FHLB should there be widespread bank failures. Mr. Hopkins stated that FHLBank advances have become an important source of funding for community banks and that it must be allowed to continue.
Mr. Michael testified that credit unions are careful lenders and that their incentives are aligned in a way that ensures little or no harm is done to member-owners. He said toxic mortgages such as subprime loans were made by non-credit union lenders and were focused on maximizing loan originations even though many of these loans were not in the borrowers’ best interests. Further, credit unions hold most of their loans in portfolio. He observed that strong asset quality and high capital kept most credit unions “in the game” while the other lenders pulled back. He pointed out that, for the year ending March 2009, real estate loans at credit unions grew by nearly 9 percent, while banking industry real estate loans declined by approximately 2 percent. He also said business loans at credit unions grew by nearly 16 percent during this period, whereas commercial loans at banking institutions declined by 3 percent. In his view, the credit crisis has been exacerbated by the fact that credit unions are subject to a statutory cap on the amount of business lending they can do. He said Federal Reserve and SBA surveys have shown that it is now more difficult for small businesses to obtain loans and this is a market that credit unions are well suited to serve. He indicated a growing list of small business and public policy groups agree that now is the time to eliminate the cap and he hopes Congress will act on this issue.
Mr. Johnson stated that, in spite of the recession, community banks located in rural communities have expanded lending. He said loans from banks headquartered outside metropolitan statistical areas increased by 7 percent in 2008, and lending by farm banks had increased by 9.2 percent. He warned that these trends are not likely to be sustained and it is unlikely that loan volumes will increase in 2009. Although credit quality has suffered, he pointed out that community banks entered the recession with strong capital levels; however, he said it was extremely difficult to raise new capital in the current climate and without access to capital, the flow of credit in rural communities will be difficult to maintain. He pointed out that the Capital Purchase Program and other initiatives have been focused on the largest banks. Additionally, the changing nature of the CPP and its restrictive selection process prevented banks that could have benefited from the CPP from doing so. He suggested that now is a critical time to focus on strategies to assist community banks. He proposed the following: broadening capital programs to enable participation by a greater cross-section of banks; revising the risk-based capital rules to better reflect the risks presented; and, avoiding inappropriately conservative appraisal/asset valuations. Mr. Johnson said the ABA believes creation of a systemic risk regulator, providing a mechanism for resolving systemically important institutions, and filling gaps in the regulation of the shadow banking industry should be the focus of Congressional action.
Mr. Templeton reiterated most of the points made by Mr. Michael, including the appeal to remove the business lending cap. He also suggested a legislative change that would clarify the ambiguity regarding the ability of federal credit unions to add “underserved areas” to their fields of membership. He said NAFCU supports creation of a Consumer Financial Protection Agency, but believes that its mission should be limited to currently non-regulated institutions operating in the financial services marketplace.
Mr. Skillern reported that while a number of small banks across the nation have failed, far more have been lost through consolidation over time. He said that nationally, the number of banks under $100 million in assets dropped by 5,410 from 1992 to 2008. By contrast, he stated that in 1995, the top five banks had 11 percent deposit share; today, they hold nearly 40 percent. He noted that small banks are at a competitive disadvantage in terms of pricing, products and geographical area. He said that, while the effects of the recession are felt by every community, rural communities will shake off its effects much more slowly.
Subcommittee Chairman Johnson sought the panel’s views on the FDIC’s move to base its special assessment on institution assets, not deposits. Mr. Hopkins said he supported the move, since assets represent the risk, not deposits. He said it is a positive move for community banks and he suggested it be adopted for regular assessments going forward. Mr. Johnson said he had some concerns about a rush to make this change without further analysis of the impact. He further felt that no changes should be adopted until a decision is made on the program and process for a systemic risk resolution mechanism.
Chairman Johnson then asked the panel whether loan modification programs would be useful for rural areas. Mr. Michael said subprime, zero-down mortgages clearly contributed to the current problem and, while credit unions did not originate these loans, his institution is trying to assist customers who have these loans with other lenders. He said he had found those lenders to be slow on the modification process and were not geared to process these requests. He said delays are substantial and results generally are not positive. Mr. Johnson said his bank was experiencing higher levels of delinquencies and foreclosures. He said these problems had all been driven by unemployment issues, not product-type or initial underwriting issues, and his bank was working diligently to keep these families in their homes. He said he is also seeing customers who opted to take out mortgages from other broker/originators come in to request a solution to their problem, and he said he has been able to refinance approximately 20 percent of these cases. Mr. Templeton said he had not seen many questionable loans made in his market area, mainly because brokers were not interested in loans on homes in rural areas since they could not be packaged and sold – there was no appreciation in value.
Ranking Member Mike Crapo (R - ID) said he was concerned about the Administration’s plan to bifurcate prudential supervision and consumer protection functions and requested the panel’s views on this topic. Mr. Johnson said he does not believe the case has been made to do this and he believes it would be very difficult to administer, since the two interests may conflict. He said 94 percent of the high-risk lending that got us into this problem was originated by unregulated entities, and he felt the focus should be on that problem, not over-regulating the other 6 percent. Messrs. Hopkins, Michael and Templeton stated their agreement with Mr. Johnson. Mr. Skillern said he would disagree that the federal regulators had done their jobs well. Countrywide and Washington Mutual pursued their subprime and predatory lending practices under the watchful eye of the OTS and Wachovia crashed itself on exotic mortgage lending while regulated by the OCC. He said he is currently in a fight with the OCC over formal enforcement of its rules regarding a refund anticipation program at another institution. He concludes that proper consumer protection is just not happening. He stated that federal regulators have lost credibility on their willingness and ability to enforce the existing consumer laws. He believes a separate agency is needed to bring standardization to the application of consumer rules and reduce the apparent conflict of interest federal regulators have in enforcing such laws.
Senator Michael Bennet (D – CO) asked the panel’s views on how well TARP is working for small, community banks. Mr. Hopkins said in his view TARP has helped pick winners and losers. He said the big banks have been chosen as winners, because even though they were technically broke, they were bailed out. He noted that smaller community banks that are not 1- or 2-CAMELS rated cannot qualify for these funds. He observed that this creates an unfair advantage for larger banks. Mr. Johnson said that to some degree, everyone is guessing as to what the criteria are and how the process works, because details have not been made public either by Treasury or the regulatory agencies making the recommendations. He argues Treasury and the agencies should work hard to determine which banks are viable and make sure that they have access to capital, so that banks are not closed unnecessarily.
Senator Bob Corker (R – TN) implored Mr. Johnson to have the ABA weigh in on the Administration’s proposal on “too big to fail”. Senator Corker said it is evident that the Administration wants to continue business as it has been over the past year and basically “codify” TARP so they can decide on an ad hoc basis which firms will succeed and which will fail. He also expressed his concern that the Banking Committee had not held hearings on Fannie Mae and Freddie Mac in over one year. Senator Corker then asked the panel if they believed it would be better if Fannie and Freddie did not exist. Both Mr. Hopkins and Mr. Johnson firmly stated that it was essential that community bankers have a secondary market source where they could sell their originated loans. They explained to Senator Corker how lending capacity would quickly be reached if all loans were retained in portfolio. In response to a follow-up question from Senator Corker, Messrs. Hopkins and Johnson stated that their correspondent banking sources had significantly declined in the past year, making Fannie and Freddie “the only game in town”. Senator Corker retorted that the regional banks – “those folks who we are here constantly talking to about making loans and they are constantly telling us they are making more loans than they made in the past, those folks, as far as their correspondent relationship, from your perspective, that has gone away”? “It has gone away in that respect”, replied Mr. Hopkins.
Senator Corker concluded his questioning by stating his belief that regulators are helping create a self-fulfilling prophecy by virtue of the way they are dealing with institutions. He feels “regulators are clamping down and making this recession more severe than it otherwise would have been”.
Senator Jon Tester (D – MT) began his questioning by stating his agreement with Senator Corker’s assessment of regulator actions. Senator Tester then inquired as to the panel’s view on the Administration’s proposal to combine banking agencies. Mr. Hopkins said that, even if the OTS were merged into OCC, there should be a separate office that focuses on mortgage lenders. Senator Tester concluded his questioning by stating that “community banks need to be regulated, but you are not the ones who caused the problem. The Wall Street people were the ones and the ‘too big to fail’ is something I have a great disdain for, and we need to re-think some of these operating systems we have in this country.”
Subcommittee Chairman Johnson said that the Banking Committee will continue its review of the current structure of the financial system and develop legislation to create the kind of transparency, accountability, and consumer protection that is now lacking. As this process moves forward, he said it will be important to consider the unique needs of smaller institutions and to preserve their viability.
On July 8, 2009 the Senate Financial Institutions Subcommittee held a hearing focused on the role smaller financial institutions play in the nation’s economy, particularly in rural communities. In opening the hearing, Subcommittee Chairman Tim Johnson (D – SD) stated: “Throughout our nation’s economic crisis there has often been too little distinction made between troubled banks and the many banks that have been responsible lenders.” He said that community banks and credit unions, for the most part, did not contribute to the current crisis, yet small lending institutions in rural communities and their customers are feeling the effects of the subprime mortgage crisis. “Jobs are disappearing, ag loans are being called, small businesses can’t get the lines of credit they need to continue operation, and homeowners are struggling to refinance.”
The Subcommittee heard from the following witness panel: Jack Hopkins, President and CEO of CorTrust Bank N.A., Sioux Falls, SD, testifying on behalf of the Independent Community Bankers of America; Frank Michael, President and CEO of Allied Credit Union, Stockton, CA, testifying on behalf of the Credit Union National Association; Arthur Johnson, Chairman and CEO of United Bank of Michigan, Grand Rapids, MI, testifying on behalf of the American Bankers Association; Ed Templeton, President and CEO of SRP Federal Credit Union, North Augusta, SC, testifying on behalf of the National Association of Federal Credit Unions; and, Peter Skillern, Executive Director of the Community Reinvestment Association of North Carolina.
Mr. Hopkins stated that “community banks played no part in causing the financial crisis and have watched as taxpayer dollars have been used to bail out Wall Street investment firms and our nation’s largest banks considered ‘too big to fail’”. “During this same time period, dozens of community banks have been allowed to fail while the largest and most interconnected banks have been spared the same fate due to government intervention”. He cited an ICBA study completed in March indicating that community banks are still lending and 40 percent have seen an increase in origination volumes in the last year, while 11 percent believe the financial crisis has “significantly curtailed” their lending ability. He said the survey indicated that some of the reduction in lending activity was a reaction to the mixed messages coming from the government. While banks are being told by policymakers to lend money, he said they also feel the agencies are dissuading them from lending by putting them through overzealous regulatory exams. He said that, while the largest banks saw a 3.23 percent decrease in lending in 2008, institutions will less than $1 billion in assets experienced a 5.53 percent increase.
Mr. Hopkins said bankers are concerned with the potential for their regulators to second-guess their desire to make additional loans and some bankers are under pressure from their regulators to decrease their loan-to-deposit ratios. He said bankers also stated regulators do not want them to use FHLBank advances for loan funding purposes, suggesting they are not as stable as core deposits. He commented that bankers believe the real issue is the FDIC does not want to have a secondary position behind the FHLB should there be widespread bank failures. Mr. Hopkins stated that FHLBank advances have become an important source of funding for community banks and that it must be allowed to continue.
Mr. Michael testified that credit unions are careful lenders and that their incentives are aligned in a way that ensures little or no harm is done to member-owners. He said toxic mortgages such as subprime loans were made by non-credit union lenders and were focused on maximizing loan originations even though many of these loans were not in the borrowers’ best interests. Further, credit unions hold most of their loans in portfolio. He observed that strong asset quality and high capital kept most credit unions “in the game” while the other lenders pulled back. He pointed out that, for the year ending March 2009, real estate loans at credit unions grew by nearly 9 percent, while banking industry real estate loans declined by approximately 2 percent. He also said business loans at credit unions grew by nearly 16 percent during this period, whereas commercial loans at banking institutions declined by 3 percent. In his view, the credit crisis has been exacerbated by the fact that credit unions are subject to a statutory cap on the amount of business lending they can do. He said Federal Reserve and SBA surveys have shown that it is now more difficult for small businesses to obtain loans and this is a market that credit unions are well suited to serve. He indicated a growing list of small business and public policy groups agree that now is the time to eliminate the cap and he hopes Congress will act on this issue.
Mr. Johnson stated that, in spite of the recession, community banks located in rural communities have expanded lending. He said loans from banks headquartered outside metropolitan statistical areas increased by 7 percent in 2008, and lending by farm banks had increased by 9.2 percent. He warned that these trends are not likely to be sustained and it is unlikely that loan volumes will increase in 2009. Although credit quality has suffered, he pointed out that community banks entered the recession with strong capital levels; however, he said it was extremely difficult to raise new capital in the current climate and without access to capital, the flow of credit in rural communities will be difficult to maintain. He pointed out that the Capital Purchase Program and other initiatives have been focused on the largest banks. Additionally, the changing nature of the CPP and its restrictive selection process prevented banks that could have benefited from the CPP from doing so. He suggested that now is a critical time to focus on strategies to assist community banks. He proposed the following: broadening capital programs to enable participation by a greater cross-section of banks; revising the risk-based capital rules to better reflect the risks presented; and, avoiding inappropriately conservative appraisal/asset valuations. Mr. Johnson said the ABA believes creation of a systemic risk regulator, providing a mechanism for resolving systemically important institutions, and filling gaps in the regulation of the shadow banking industry should be the focus of Congressional action.
Mr. Templeton reiterated most of the points made by Mr. Michael, including the appeal to remove the business lending cap. He also suggested a legislative change that would clarify the ambiguity regarding the ability of federal credit unions to add “underserved areas” to their fields of membership. He said NAFCU supports creation of a Consumer Financial Protection Agency, but believes that its mission should be limited to currently non-regulated institutions operating in the financial services marketplace.
Mr. Skillern reported that while a number of small banks across the nation have failed, far more have been lost through consolidation over time. He said that nationally, the number of banks under $100 million in assets dropped by 5,410 from 1992 to 2008. By contrast, he stated that in 1995, the top five banks had 11 percent deposit share; today, they hold nearly 40 percent. He noted that small banks are at a competitive disadvantage in terms of pricing, products and geographical area. He said that, while the effects of the recession are felt by every community, rural communities will shake off its effects much more slowly.
Subcommittee Chairman Johnson sought the panel’s views on the FDIC’s move to base its special assessment on institution assets, not deposits. Mr. Hopkins said he supported the move, since assets represent the risk, not deposits. He said it is a positive move for community banks and he suggested it be adopted for regular assessments going forward. Mr. Johnson said he had some concerns about a rush to make this change without further analysis of the impact. He further felt that no changes should be adopted until a decision is made on the program and process for a systemic risk resolution mechanism.
Chairman Johnson then asked the panel whether loan modification programs would be useful for rural areas. Mr. Michael said subprime, zero-down mortgages clearly contributed to the current problem and, while credit unions did not originate these loans, his institution is trying to assist customers who have these loans with other lenders. He said he had found those lenders to be slow on the modification process and were not geared to process these requests. He said delays are substantial and results generally are not positive. Mr. Johnson said his bank was experiencing higher levels of delinquencies and foreclosures. He said these problems had all been driven by unemployment issues, not product-type or initial underwriting issues, and his bank was working diligently to keep these families in their homes. He said he is also seeing customers who opted to take out mortgages from other broker/originators come in to request a solution to their problem, and he said he has been able to refinance approximately 20 percent of these cases. Mr. Templeton said he had not seen many questionable loans made in his market area, mainly because brokers were not interested in loans on homes in rural areas since they could not be packaged and sold – there was no appreciation in value.
Ranking Member Mike Crapo (R - ID) said he was concerned about the Administration’s plan to bifurcate prudential supervision and consumer protection functions and requested the panel’s views on this topic. Mr. Johnson said he does not believe the case has been made to do this and he believes it would be very difficult to administer, since the two interests may conflict. He said 94 percent of the high-risk lending that got us into this problem was originated by unregulated entities, and he felt the focus should be on that problem, not over-regulating the other 6 percent. Messrs. Hopkins, Michael and Templeton stated their agreement with Mr. Johnson. Mr. Skillern said he would disagree that the federal regulators had done their jobs well. Countrywide and Washington Mutual pursued their subprime and predatory lending practices under the watchful eye of the OTS and Wachovia crashed itself on exotic mortgage lending while regulated by the OCC. He said he is currently in a fight with the OCC over formal enforcement of its rules regarding a refund anticipation program at another institution. He concludes that proper consumer protection is just not happening. He stated that federal regulators have lost credibility on their willingness and ability to enforce the existing consumer laws. He believes a separate agency is needed to bring standardization to the application of consumer rules and reduce the apparent conflict of interest federal regulators have in enforcing such laws.
Senator Michael Bennet (D – CO) asked the panel’s views on how well TARP is working for small, community banks. Mr. Hopkins said in his view TARP has helped pick winners and losers. He said the big banks have been chosen as winners, because even though they were technically broke, they were bailed out. He noted that smaller community banks that are not 1- or 2-CAMELS rated cannot qualify for these funds. He observed that this creates an unfair advantage for larger banks. Mr. Johnson said that to some degree, everyone is guessing as to what the criteria are and how the process works, because details have not been made public either by Treasury or the regulatory agencies making the recommendations. He argues Treasury and the agencies should work hard to determine which banks are viable and make sure that they have access to capital, so that banks are not closed unnecessarily.
Senator Bob Corker (R – TN) implored Mr. Johnson to have the ABA weigh in on the Administration’s proposal on “too big to fail”. Senator Corker said it is evident that the Administration wants to continue business as it has been over the past year and basically “codify” TARP so they can decide on an ad hoc basis which firms will succeed and which will fail. He also expressed his concern that the Banking Committee had not held hearings on Fannie Mae and Freddie Mac in over one year. Senator Corker then asked the panel if they believed it would be better if Fannie and Freddie did not exist. Both Mr. Hopkins and Mr. Johnson firmly stated that it was essential that community bankers have a secondary market source where they could sell their originated loans. They explained to Senator Corker how lending capacity would quickly be reached if all loans were retained in portfolio. In response to a follow-up question from Senator Corker, Messrs. Hopkins and Johnson stated that their correspondent banking sources had significantly declined in the past year, making Fannie and Freddie “the only game in town”. Senator Corker retorted that the regional banks – “those folks who we are here constantly talking to about making loans and they are constantly telling us they are making more loans than they made in the past, those folks, as far as their correspondent relationship, from your perspective, that has gone away”? “It has gone away in that respect”, replied Mr. Hopkins.
Senator Corker concluded his questioning by stating his belief that regulators are helping create a self-fulfilling prophecy by virtue of the way they are dealing with institutions. He feels “regulators are clamping down and making this recession more severe than it otherwise would have been”.
Senator Jon Tester (D – MT) began his questioning by stating his agreement with Senator Corker’s assessment of regulator actions. Senator Tester then inquired as to the panel’s view on the Administration’s proposal to combine banking agencies. Mr. Hopkins said that, even if the OTS were merged into OCC, there should be a separate office that focuses on mortgage lenders. Senator Tester concluded his questioning by stating that “community banks need to be regulated, but you are not the ones who caused the problem. The Wall Street people were the ones and the ‘too big to fail’ is something I have a great disdain for, and we need to re-think some of these operating systems we have in this country.”
Subcommittee Chairman Johnson said that the Banking Committee will continue its review of the current structure of the financial system and develop legislation to create the kind of transparency, accountability, and consumer protection that is now lacking. As this process moves forward, he said it will be important to consider the unique needs of smaller institutions and to preserve their viability.
Monday, July 6, 2009
FDIC Issues Proposed Policy Statement on Qualifications for Failed Bank Acquisitions
By W. Bernard Mason
On Thursday the FDIC Board authorized publication of a proposed statement of policy on qualifications for failed bank acquisitions. This proposed policy statement would provide guidance to private capital investors interested in acquiring or investing in failed insured institutions regarding the terms and conditions for such investments or acquisitions.
The FDIC notes that private capital investors have indicated interest in purchasing insured institutions in receivership. The FDIC recently completed two such resolution transactions involving new private capital investors, stating that the bids from these investors were the least costly to the Deposit Insurance Fund (DIF).
In considering private investments in failed institutions, the FDIC states that it must carefully weigh the potential contribution that investors could make to strengthening the capital position of these banks and the statutory and regulatory framework aimed at: (a) maintaining well capitalized banks; (b) support for these banks when they face difficulties; and, (c) the protections against insider and affiliate transactions. Capital support and management expertise are essential considerations.
These proposed guidelines would apply to: (a) private capital investors in a company that is proposing to directly or indirectly assume deposit liabilities from a failed insured institution in receivership; and (b) applicants for insurance in the case of de novo charters issued in connection with the resolution of failed depository institutions. Under the proposal, these investors would be required to maintain a minimum 15 percent Tier 1 leverage ratio for a period of at least three years; thereafter, the institution’s capital could not decline below the “well capitalized” level during the investors’ ownership. A contractual cross guarantee would be required for commonly owned depository institutions. There would also be a prohibition on extensions of credit to investors, their funds, affiliates, and portfolio companies. Investors would also be required to maintain continuity of ownership through a prohibition on the sale or transfer of their interest in the acquired or de novo institution or its parent holding company for a period of three years. Investors holding ten percent or more of the equity of a bank in receivership would not be eligible to bid to become an investor in that failed institution. Finally, investors generally would be expected to avoid secrecy law jurisdiction vehicles as the channel for their investments.
The FDIC Board is clearly wrestling with how best to encourage private investor interest in acquiring failing institutions while protecting the institution and the DIF from undue risk. Board Member John Dugan expressed his concern that the proposed guidelines may be too onerous, but recognized that some restrictions and limitations were essential. Chairman Sheila Bair stated that the FDIC does not want to see these acquired institutions fail again due to the nature of the acquisition.
The proposed Federal Register document provides the FDIC’s support for each of these provisions, and will be published for a 30-day comment period.
On Thursday the FDIC Board authorized publication of a proposed statement of policy on qualifications for failed bank acquisitions. This proposed policy statement would provide guidance to private capital investors interested in acquiring or investing in failed insured institutions regarding the terms and conditions for such investments or acquisitions.
The FDIC notes that private capital investors have indicated interest in purchasing insured institutions in receivership. The FDIC recently completed two such resolution transactions involving new private capital investors, stating that the bids from these investors were the least costly to the Deposit Insurance Fund (DIF).
In considering private investments in failed institutions, the FDIC states that it must carefully weigh the potential contribution that investors could make to strengthening the capital position of these banks and the statutory and regulatory framework aimed at: (a) maintaining well capitalized banks; (b) support for these banks when they face difficulties; and, (c) the protections against insider and affiliate transactions. Capital support and management expertise are essential considerations.
These proposed guidelines would apply to: (a) private capital investors in a company that is proposing to directly or indirectly assume deposit liabilities from a failed insured institution in receivership; and (b) applicants for insurance in the case of de novo charters issued in connection with the resolution of failed depository institutions. Under the proposal, these investors would be required to maintain a minimum 15 percent Tier 1 leverage ratio for a period of at least three years; thereafter, the institution’s capital could not decline below the “well capitalized” level during the investors’ ownership. A contractual cross guarantee would be required for commonly owned depository institutions. There would also be a prohibition on extensions of credit to investors, their funds, affiliates, and portfolio companies. Investors would also be required to maintain continuity of ownership through a prohibition on the sale or transfer of their interest in the acquired or de novo institution or its parent holding company for a period of three years. Investors holding ten percent or more of the equity of a bank in receivership would not be eligible to bid to become an investor in that failed institution. Finally, investors generally would be expected to avoid secrecy law jurisdiction vehicles as the channel for their investments.
The FDIC Board is clearly wrestling with how best to encourage private investor interest in acquiring failing institutions while protecting the institution and the DIF from undue risk. Board Member John Dugan expressed his concern that the proposed guidelines may be too onerous, but recognized that some restrictions and limitations were essential. Chairman Sheila Bair stated that the FDIC does not want to see these acquired institutions fail again due to the nature of the acquisition.
The proposed Federal Register document provides the FDIC’s support for each of these provisions, and will be published for a 30-day comment period.
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