Among the legion of culprits who helped bring on the financial panic, the banking regulators haven’t gotten nearly enough attention. They blew it, just the same. At the critical moment when regulators should have been hyper-alert, they were snoozing—and allowed lending practices that we now know (as they should have known at the time) ranged from imprudent to plain stupid. If the regulators had done their job, a lot of this mess could have been avoided.
And now that the system has crashed, regulators have responded by—you guessed it—overreacting in the other direction. Whenever we write about the capricious and unfair actions regulators are lately taking, our servers nearly crash from the torrent of emails from bankers who have horror stories of their own to tell. (Keep ’em coming, by the way!) The emails confirm that the very same people who helped create the problem in the first place are now doing their darndest to make it all even worse.
I simply don’t get it! Why can’t the President and his chief advisors leave Washington and sit down and talk to bankers from small and mid-sized institutions around the country to find out how they’re actually being regulated? It’s easy enough for us to find out about the nutty stuff going on. Why doesn’t the White House know?
The President says he believes that banks aren’t doing enough to supply sufficient amounts of credit, particularly to small business. His proposals so far to unclog the pipes have been mainly naïve and ineffective. What he needs to do instead is have a summit with all the bank regulators and (metaphorically) give ’em all a good slap.
The reason I mention all this is that I just finished reading the testimony that FDIC vice chairman Martin J. Gruenberg gave before the Committee on Financial Services and the Committee on Small Business in the House on February 26th.
You should read it, too. But as you do, keep in mind that what Gruenberg says the FDIC examiners are doing in the field, and what they are actually doing, are poles apart. Either he knows that, and is simply lying to Congress, or he’s a blinded, cocooned bureaucrat who doesn’t have a clue about what’s happening in the real world.
More likely, the latter. In his testimony, Gruenberg cites seven white papers written by the FDIC that he says describe the FDIC’s current regulatory policies and practices.
Earth to Martin Gruenberg—and to Sheila Bair, too! Just because you write a white paper that tells your examiners what they should be doing doesn’t mean they’re actually doing it!
Let me pull out some of the most outrageous statements from Gruenberg’s testimony, and give you my take.
Gruenberg: “The new guidance states that examiners will not adversely classify loans solely on the basis of a decline in the collateral value below the loan balance or the borrower’s association with a particularly stressed industry or geographic location.”
TKB: This is flatly untrue. When the current appraised value of the collateral falls to less than the loan balance, examiners require that loans be classified as non-accrual all the time. That’s how we got the wonderful term “performing non-performing loans.”
There are plenty of examples (and I’m sure I will hear more) but my favorite recent one is Preferred Bank (NASDAQ:PFBC) of Los Angeles. The company’s third-quarter earnings release included the disclosure that it has $93 million of non-accrual loans. But then on December 30, the company reported that “as a result of a recent regulatory examination,” it was forced to restate its third quarter earnings and add $77 million of non-accrual loans.
After the change, the company had $170 million of non-accrual loans (from $93 million earlier), of which $66 million were current with respect to their loan agreements. So virtually the entire addition to the non-accrual total consisted of loans still performing. Hello! It is preposterous for bank regulators (including the FDIC, the Fed, the OCC, and the states) to claim that they’re not requiring banks to classify loans as non-accrual once appraised collateral value falls below the loan balance!
Similarly, regulators required that Preferred restate vastly higher its net chargeoffs and loan loss provision, as well. So NCOs were restated to $34.8 million from $13.5 million, while loss provision went to $48.3 million from $18.5 million.
You won’t be surprised to learn that these retrospective, regulator-instigated additions to NCOs and loan loss provision turned out to be needless. In the fourth quarter, Preferred’s NCOs fell from the third quarter’s $34.8 million to $3.6 million in recoveries, while loss provision fell from $48.3 million in the third quarter to zero.
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Gruenberg: “There are assertions that examiners are instructing banks to curtail loan originations and renewals, and are criticizing sound performing loans where collateral values have declined.”
TKB: Wrong. Regulators are indeed telling banks to curtail lending, particularly commercial real estate lending. Ask any bank.
Gruenberg: “We also have heard criticism that regulators are requiring widespread re-appraisals on performing commercial real estate mortgage loans, which then precipitate a write down or a curtailment of credit commitment based on a downward revision to collateral values.”
TKB: Ask bankers how often they’re required to get outside appraisals of non-accrual loans, classified loans, and performing loans, and you’ll get a huge range of answers. It all depends on who the primary regulator is, or who the individual examiner is, and what sort of mood he might be in that day. The decision can seem nearly random. And yet as we’ve seen, the results of a reappraisal can have an enormous effect on a bank’s balance sheet. This is a perfect example of how capricious decisions of bank regulators are making a bad situation worse.
Gruenberg: “FDIC examiners are not directly involved in credit decisions. . . We do not instruct banks to curtail prudently managed lending activities.”
TKB: Gruenberg chooses his words very carefully here, and is misleading. The FDIC can claim to not directly involve itself in banks’ credit decisions, but its indirect involvement is all that matters. The agency can correctly claim it doesn’t instruct banks to curtail “prudently managed lending activities,” but it can certainly arbitrarily define what “prudently managed” means without any accountability.
Gruenberg: “We would not require a re-appraisal for a healthy performing loan.”
TKB: Nonsense—and it’s hard to believe Gruenberg doesn’t know it. Please, go out and meet with some bankers! Accompany your examiners, and see what you find out!
My head hurts again! The effect of all this restrictive regulatory freelancing has been to make the credit contraction worse. Regulators are arbitrarily forcing banks to reclassify loans. They’re arbitrarily forcing banks to adhere to new, higher capital standards. They’re arbitrarily being too tough in their bank exams. If President Obama wants banks to start supplying more credit to the economy (and he does) he needs to put an end to these practices.
I know it’s a politically unpopular position lately to stick up for the banks, but some politicians need to step forward. The implementation of a more rational regulatory approach would quickly lead to better credit intermediation, which would help fuel economic growth.
If I were president, I would immediately ask for the resignations of FDIC head Sheila Bair and OCC head John Dugan, and would replace them with individuals capable of running organizations that would actually carry out stated regulatory policy. I’m not counting on it, however. That’s too bad. President Obama has had a tough year. This is one move he could make that would make a real difference for the economy.