The three were: Thomas Hoenig, long-time president and CEO of the Federal Reserve Bank of Kansas City; Jeffrey Lacker, president of the Federal Reserve Bank of Richmond; and Sandra Pianalto, president and CEO of the Federal Reserve Bank of Cleveland. The session was moderated by Stephen Wilson, ABA chairman-elect, and president and CEO of LCNB National Bank, Lebanon, Ohio.
Much of the conversation centered around financial reform legislation and one of the questions the three addressed was how to get rid of “too big to fail,” or “TBTF.”
“Too big to fail is the critical issue to judge any reform legislation by,” said Jeffrey Lacker. The solution needs to distinguish between an explicit federal safety net—deposit insurance being a primary example—and implicit safety nets, such as those that backed Fannie Mae and Freddie Mac. There is a great deal of ambiguity in the latter, he said, and policymakers err on the side of intervention in such cases, which in turn leads to expansion of the implicit safety net. That leads, in turn, to instability in the financial markets.
Thomas Hoenig stated that to get rid of too-big-to-fail you’ve got to take away the discretion from the process and bring it under the rule of law. TBTF “is a competitive disadvantage to all the other banks,” he told the bankers. “You know it and your customers know it.”
The Fed must supervise
The three presidents weighed in on the proposed elimination of bank supervision responsibility for the Fed. The Restoring American Financial Stability Act of 2010, now being considered in the Senate, would limit the Fed to supervising only bank holding companies of $50 billion and up.
Sandra Pianalto acknowledged there are weaknesses in the regulatory structure that need to be addressed, but stated that the Federal Reserve has to stay involved in the supervision of small and medium-sized banks. “It helps with the conduct of monetary policy and in being the lender of last resort,” she said. “Making the setting of monetary policy political would be devastating for us [the U.S.] and the world.”
During his nearly 20 years as a Fed president, Hoenig said he had been asked some pretty outrageous questions. One recent example was, “Will community banks continue to be viable, and should the Fed only supervise the largest institutions?”
“People who ask questions like that have never been in a community bank,” said the outspoken Hoenig. Community banks, he said, have increased loans to small businesses when other institutions pulled back.
“It’s a travesty to think the Fed should be pulled out of bank supervision. It would institutionalize ‘too big to fail.’ I would hate to find out Wall Street wins at the expense of community banks,” Hoenig added.
Lacker noted that the Fed is decentralized and is deeply rooted in local economies by virtue of its 12 Federal Reserve Banks and their branch offices. “This is underappreciated inside the ‘Beltway’,” said Lacker, using an expression describing Washington’s insular thinking.
A point raised by Pianalto offers an example of the district banks’ local knowledge. She said she is frequently asked why banks are not lending. “Strong companies are not borrowing,” she replies; “they’re working down debt. They’re also concerned with taxes, and health care reform.” With weaker companies, she said, banks are not lending.
A community banker from the audience—CEO of a northeastern bank—confirmed that view. In his market, many small businesses’ sales are way down and they are seeking loans to pay the rent or make payroll—loans to prevent the death of the business, basically. “These are not good loans,” said the banker, “and the economy is not there yet for loans based on receivables. Unfortunately this feeds comments that banks are not lending.”
Examiners vs. the IG
Steve Wilson asked the panel what they could say about overzealous examiners and the return of the “nonperforming performing loan.”
Lacker responded that the problem is not exactly a surprise in a downturn. It occurred in 1990-91, as well. He said the Richmond Fed has been training its people in how to deal with current conditions. Pianalto said she has been meeting with exam teams and said that she, too, was not relying solely on guidance, but also on training.
Hoenig elaborated a bit more in his answer:
“Examiners are always in a difficult position to call it as they see it without being overzealous. Examiners I know do not want to see a bank fail. They also know the inspector general will inspect everything they did. I’ve met with [examiners] and said, ‘if you follow the CRE guidelines and use good judgment, I will stand behind you no matter what the IG says.
“I started in bank supervision and went through the ag crisis and the first CRE crisis. “You can’t ask the examiners to change the facts—just as you can’t change the facts about your customers’ situation,” said Hoenig. Both have to find the best approach through the situation.
Nonbanks must be examined
One of the most controversial provisions of both the House and Senate versions of regulatory reform legislation is the creation of an independent consumer financial protection unit. Bankers maintain that most of the problems in subprime lending were created by nonbanks—mortgage brokers and others—not by traditional banks. A banker in the audience asked the Fed presidents, “How can we reach the nonbank sector with consumer protection regulation?
Pianalto observed that it’s the enforcement side that is the problem. Enforcement is clear for banks, she said, but for nonbanks, some are overseen by the Department of Justice, some by the Department of Housing and Urban Affairs. Congress has to figure out who is the appropriate regulator.
“Without regularly scheduled exams [for nonbank players],” said Lacker, “we will have an uneven playing field.”
Hoenig noted that nonbanks are not one homogenous group, whereas “it’s easy to identify who the banks are, that’s why you’re always first in line” [to be regulated]. The solution, he believes, is a combination of rule writing for the nonbank sector combined with figuring out which agency (i.e. the Federal Trade Commission or HUD) should enforce them. He did not favor creating a new agency.
On a different question—the controversial accounting rules being pushed for banks by the Financial Accounting Standards Board—Hoenig had this to say:
“We respect the accounting industry’s independence, but hope they listen to ‘people on the ground’ as we do. Theory is just that. It often runs [smack into] the real world.”