Community banker and former ABA chairman, Betsy Duke, joined the Federal Reserve Board just as the financial crisis hit full tilt. The banking industry is glad she did 

 

The white marble building on Constitution Avenue that is Fed headquarters is nicknamed “The Temple,” not only for its classic Roman design, but because inside, it has a very quiet, almost cloistered atmosphere, with few people in view, and no evident hustle and bustle. Somehow that seems appropriate for the curator of the nation’s monetary policy, but it can take a little getting used to for newcomers to the sanctum, especially for anyone who is by nature gregarious.

The formality of the Fed was the biggest surprise for Elizabeth A. Duke—known better to friends and fellow bankers as “Betsy.” An outgoing person with a smile, hug, and good word for anyone she knows, the world of being a Federal Reserve Board Governor has taken some adjusting to. No policy precludes hugs or smiles, but the informal interaction she was used to as a banker is less common.

A community banker for most of her career, Duke says people “popping in and out” of her office was the norm. Fed Chairman Ben Bernanke, she says, has come down to her office once or twice without prior arrangement, but all other interaction with him or the other Fed Governors is by appointment or in formal meetings.

“I’m used to walking down the hall and talking with a colleague, or dropping down the bank’s organizational chain and just saying to someone, ‘How are you? What do you think about this?’,” says Duke. Part of the reason she can’t do that at the Fed, she explains, is the Sunshine Act. The act establishes that any time more than three governors are together discussing policy, it is an official meeting, requiring public notification and triggering various procedural requirements.

“We can have a briefing,” she says, “where someone speaks to us and we can ask questions, but we can’t really sit around and talk about policy.”

Baptism by crisis
Duke was nominated to become a Fed governor in May of 2007 by President Bush. At the time there were three nominees to the seven-member board. The Senate Banking Committee declined to move forward with the nominations of either Duke or two other nominees. The nominations languished for about a year, and Duke began to assume she would be staying with Virginia’s TowneBank after all, where she was COO. But then Frederic Mishkin announced he was leaving the board and Congress was forced to fill at least one spot. Duke was their choice. In June of last year, she was confirmed, being duly sworn in Aug. 5. (Two board vacancies remain.)

Seldom, if ever, has a new Fed governor had to hit the ground running quite so fast. The central bank was already on a full “war” footing, having taken several unprecedented steps in the Bear Stearns situation to keep the credit markets functioning. Within weeks of her moving into a corner office in the “temple,” Duke and the rest of the board were wrestling with the near catastrophic financial events of last September and October, including the failure of Lehman Brothers.

Need better big-bank resolution
During an interview in her office in late February, during a discussion of the concept of “too big to fail,” Duke was asked if, in hindsight, given the turmoil that followed its collapse, she thought the decision to let Lehman fail would be made differently. She said that while she wasn’t directly involved in the negotiations, “it wasn’t like we were presented with an option and said, ‘Okay, we say no and let it go.’ There just wasn’t an option. There was nobody saying they would buy them. There was nothing we could lend on to stop the runs.”

She added that many people say, “You let Lehman go and you propped up AIG.” But with AIG, she said, “we had some assets we could lend on. Remember, this was before the TARP was approved. So there was no mechanism to provide equity.”

Duke said that the availability of TARP funding was useful later as the Treasury and FDIC combined to provide “ring fencing” for asset portfolios held by Citibank and Bank of America. The term refers to having questionable assets backstopped by the Treasury and FDIC, and further supported by a loan commitment from the Fed.

The analysis and reform of the financial regulatory system that is already under way—quite properly, in her view—will look at many things. An early piece of the puzzle will be establishment of a financial stability supervisor. Related to that, she agrees that “we need some way of resolving or handling these big financial institutions—some better mechanism so that we’re not just kind of crafting the response together out of the tools that we have.”

As a banker, and during her time in an ABA leadership position, culminating in the chairmanship of the trade group for the 2004-5 year, Duke witnessed many discussions about regulatory reform. “Up until last year,” she said, “I would have said, ‘you’ll have a little bit of moving around of the boxes,’ but real change won’t happen.” She no longer feels that way, but is not sure what’s going to happen in an atmosphere of so much anger at everything to do with banks.

All painted by the same brush
The interview occurred the day after President Obama addressed a joint session of Congress. He spent considerable time talking about the economy and the financial crisis, and spoke in highly unflattering terms about “banks.” One example: “…I know how unpopular it is to be seen as helping banks right now, especially when everyone is suffering in part from their bad decisions. I promise you—I get it.”

Duke acknowledged the anger stirred by the government support required to strengthen the financial system, but believes it is useful to start distinguishing publicly between banks that “stuck to their knitting” and those that didn’t.

Likewise, policy decisions must distinguish banks that are really in trouble and the large number of banks that are still perfectly viable, she said. “This painting of all with the same brush is a critical issue.”

Some community bankers fear that the crisis and the massive government intervention it has spawned may hasten the consolidation of the industry. Duke disagrees.

“I think if anything there will be more of a return to the basics of classic banking,” she said, “and that’s really a validation of the community bank franchise.” The difficulty of dealing with very large troubled institutions, she added, will more likely lead to more restrictions on them rather than less, making it “more difficult to have the concentration of banking that we’ve had before. Right now the final outcome of all this could argue more towards moving back to the traditional, smaller-bank, smaller-resource model than to the consolidation model.”

Pick a plan and go with it
Fed governors tend to specialize in certain areas, and Betsy Duke has two: housing and consumer affairs. She chairs the board’s Committee on Consumer and Community Affairs, and serves on the Committee on Supervisory and Regulatory Affairs. She also sits on the Oversight Board of the Hope for Homeowners Program, which was rolled out last October. As she acknowledges, the “take up” with this Federal Housing Administration program has been disappointingly small—approximately 500 files and just 42 loans as of late February. The program is not popular with either borrowers or servicers. President Obama’s housing rescue plan addresses several of the drawbacks of the Hope program and may supersede it, ultimately.

The banker in Duke prefers a sustainable solution—or, as she put it, “as we go through and try to redo these loans, we ought to do loans that we would have been happy with in the first place.” On the other hand, she’s pragmatic and recognizes that doing that would take longer. It would involve gathering information and customizing the modifications, in contrast to a blanket program that essentially makes everybody an offer. And right now, she said, the magnitude of the problems argues for speed. People may not be buying because they think prices will fall further, or because they can’t get financing, or because they’re afraid of losing their jobs. Returning to the traditional 20% down payment, she added, is not realistic now, because savings are still low and net worth has been depleted. But a higher loan-to-value ratio could help reduce the backlog of inventory for people with good credit and steady income. Duke said that Realtors tell her that they’ve got contracts backed up five deep, because each contract is contingent on the other party selling their house. One sale, she said, could result in five properties coming off the market.

“Regardless of what I think about loan modifications, it’s even more important to pick a lane and go with it. Everybody following one path is better than continuing to stand around and argue over which is the best plan.”

Micro mini-perms could help
Regarding commercial real estate, Duke, who made many construction loans while she was CEO of Bank of Tidewater, in Virginia Beach, a rapidly growing area for many years, said that about half of the CRE loans on the books of banks that are maturing this year are construction loans. Typically, she said, banks would be looking for a permanent takeout on those loans, but the securitization market for commercial real estate is moribund.

The Fed recently said it was prepared to expand its Term Asset-Backed Securities Loan Facility (TALF) to include new commercial real estate securities. Until that gets going, Duke thought that banks may end up rolling construction loans into mini perms—which used to be five years, but may end up becoming “micro mini perms” of a year, or as long as the bank has to hold the loan.

Desperate sellers and vulture buyers
One example of why bankers feel it is so important to have a former banker on the Fed board is the issue of mark-to-market—or fair-value—accounting. Duke has a banker’s understanding of why this issue has been, and continues to be, so important. As she said in the interview, the Fed does not have a “bright-line position” on mark to market, but she does and has been voicing her concerns.

“When you start listening to journalistic or other reports about banking, almost anybody’s estimate of what the losses are going to be in this thing gets all mixed up between market losses and credit losses,” she said. “Sometimes they add them together; sometimes you have one person talking about market losses and somebody else talking about credit losses. Those who trade assets, such as the investment banks, think in terms of market value. Commercial banks think in terms of credit losses, and they think in terms of uncollectability and the ultimate cash flows.”

Under the Financial Accounting Standards Board’s “other than temporary impairment” rules, said Duke, banks have been concerned about having to write down assets to levels lower than they believe they can ultimately collect. As a result, they are unwilling to sell assets for less than they think they can collect, and purchasers are unwilling to buy at the bank’s price because they’re worried the asset will get marked down further.

“So instead of a willing buyer, and a willing seller,” said Duke, “you have a vulture buyer and a desperate seller. The bid/ask is way too wide.”

Since the interview, several developments have occurred, with FASB agreeing to make changes quickly on key rules relating to fair value.

You need a thick skin
One thing Betsy Duke has done from her earliest days as a community bank president is talk with other bankers. She likes to get different perspectives and views on issues. She does the same now, but for different reasons—reaching out by phone to bankers and others around the country to stay in touch and hear what’s going on. She also meets with consumer advocacy groups as well as the staff of the ABA and other industry groups.

Ultimately, though, she is one of a relative handful of key Washington policymakers grappling with a highly complex, fast-moving, and difficult series of situations. In a word, she is in the spotlight—if not always personally, like Ben Bernanke—then institutionally. And the criticism can be withering.

Asked how she handles that aspect of the job, Duke laughed and said, “I have a hard time dealing with that!” In an earlier article about her in this publication, it mentioned how as a high-school swimmer, she always swam harder in competition than practice, because, as she said, “I hated to lose.”

She says much the same now: “I don’t like to fail, or to be wrong.”

But she’s learning that in Washington, “anything I do or say—or even stuff I had nothing to do with—I’m going to be criticized for by somebody somewhere.”

She also acknowledges that most of the heat falls on the chairman.

“I always admired his intellect,” she said of Bernanke, “but now I admire his courage more than anything.” What it comes down to, she said, “is I’ve just got to be true to myself; to my own beliefs of what’s the best thing to do. A lot of times it’s a choice between bad options, and I’ve just got to make the best choice I can and live with the way it comes out.”

As she sums it up, “If you want a friend in Washington, get a dog!” BJ

 

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