FDIC Policies Are Devastating Main Street America

There are now 702 banks on the FDIC’s endangered list.  That’s about 10% of all community financial institutions.  Unless something changes, very few of these will survive.  As I’ve recently blogged (The Creation of Jobs – A Systemic Failure, February 23, 2010, http://ancorawest.wordpress.com ), these are institutions that make loans to small business, and it is widely recognized that small business is the job creating engine in America.  So, imagine, 10% of this vitally important industry is being devastated.  Our politicians praise FDIC Chairwoman Shelia Bair.  But I submit that she and her organization, the FDIC, is single-handedly destroying the basic fabric of American business.

It need not be that way.  What we have is government run amok.   First, two decades of excessively easy monetary policy which has led to a devastating debt bubble.  Then, when the crisis hits, the government responds by using taxpayer dollars to save the “Too Big To Fail” (TBTF) institutions that played a key role in fostering the debt bubble.  Finally, seeing that the public is up in arms about such policies and government behavior, the government reacts by refusing to aid those institutions that are now victims of the government’s own and the TBTF institutions’ policies, but are vital to economic recovery.

In trying to make it look like it is protecting the taxpayer, the FDIC has taken heavy handed and aggressive tactics with community financial institutions.  The problem here is political.  They want to appear tough to satisfy what they perceive the public wants, especially after the government’s TARP, AIG, and TBTF “bonus” fiascos.  The result is a depleted FDIC insurance fund, a certain need for a taxpayer bailout sometime this year, and devastation for America’s small banks and small business.

Each of the 702 endangered institutions has a Cease and Desist Order (C&D), the last step before closure.  Each C&D Order and all of the correspondence from the FDIC accuses Boards and Management of “incompetence” and “mismanagement” despite the fact that in ’05 and ’06, most of these same Boards and Managements received high scores in examinations.  I simply can’t swallow the assertion that most of the 702 institutions suffer from “incompetent” management.  We are in the midst of an economic crisis, not a crisis of management.  Yet, the FDIC is addressing the issue as if only the latter is the cause.

Each of the 702 problem institutions has a capital raising mandate as part of the C&D order.  The fact is, once on this list, capital is impossible to raise.  Those with capital to inject simply only have to wait for the FDIC to close the institution to get a once in a lifetime sweetheart deal from the FDIC.  On the other hand, the TBTF easily raised capital last November and December to repay TARP in order to ensure that big bonuses could be paid.  They could raise capital because the public knows that the government won’t let these behemoths fail.

Worse, when an institution is closed, in come the Wall Street wealthy who appear to get the deal of a lifetime, at taxpayer expense.  [The FDIC will argue that the insurance funds are not taxpayer dollars, but insurance premiums paid by insured institutions.  Two points: 1) the FDIC fund is now -$20 billion, so soon taxpayers will be on the hook; 2) bank fees would be lower without insurance premiums, so, like every other tax, eventually the consumer pays.]  By the way, one must be an “approved” purchaser to purchase the failed banks, an exclusive club composed mainly of Wall Street sharks.

Capital devastation for these small banks comes mainly from souring loans (although the opening salvo was the losses many took on FNMA and FHLMC preferred stock in September, 2008, another government failure).  In many instances accounting rules require loan write-downs upon renewal of loans if appraisals come in lower than at loan inception, virtually a 100% probability.  Bank balance sheets are illiquid by design (they turn illiquid collateral assets into cash via the loan process).  Rules that force “mark to market” on such illiquid assets only erodes capital, make survival problematic, and prohibit new loans to small business, thereby prolonging the economic crisis and joblessness.  Instead of blaming management and employing Gestapo like tactics, an approach to capital that allows “healing” time for bank balance sheets appears to be a better and cheaper approach, especially in light of the FDIC’s mandate to resolve institutions using a “least cost” approach.  Most of the assets on those balance sheets will regain value as economic conditions improve.  Time is all the institutions need.

One way to provide time would be to have a special category of capital where the “write-downs” of loans due to economic circumstances could be amortized over a long period, say 10 or 20 years.  This would give the vast majority of the 702 doomed institutions new life.  If it is publicly perceived that they will survive, most will have the ability to raise capital, and the time to heal.

I believe the devastation and havoc being wreaked upon Main Street America’s financial institutions by Ms. Bair and the FDIC’s current policies will continue to cripple America’s economic engine and prolong the economic malaise.  Funny thing about America, oftentimes media heroes turn out to be real villains: Elliot Spitzer, Bernard Madoff, Alan Greenspan, Tiger Woods, to name a few.  If the FDIC’s current policies continue, we’ll soon add Shelia Bair to this list.

Robert Barone, Ph.D.

March 1, 2010