The OCC's Dugan Decides Not to Learn From History

by: Tom Brown

John Dugan, the Comptroller of the Currency, spoke at the Exchequer Club in Washington, D.C on April 16th. I’m glad I wasn’t there. If I’d heard what he said in person, I would have either a) become physically ill, b) turned purple with frustration, or perhaps c) both at once. Based on Dugan’s remarks, the OCC is all set to take the same ham-handed approach to bank regulation during this real estate downturn that it did in the early 1990s that made that downturn worse.

Real estate lending is of course a cyclical business. I believe what the OCC has in mind is a terrible shame that, in the end, will excessively hurt individual bankers and bank shareholders. All I can do is keep writing about it.

Notably, Dugan comments at the beginning of his speech that he is at the end of his third year in office. He then goes on to describe problems he’s seeing at the banks he regulates—but not once does he say that his agency might have stepped in sooner to rein in the lending behavior that has caused the problems. Instead, he explained how the OCC is all set to overreact now. Here are some of the things he had to say, and my take.

Dugan: “Given economics trends, it’s clear that we’re going to see more problem loans and more charge offs, and addressing these problems is never easy for either banks or their supervisors….I think it’s imperative that we as an agency have a consistent, balanced approach to addressing these issues...”

TKB: Since Dugan doesn’t talk to bankers, he has no idea that the “balanced approach” he has in mind is a fantasy. In my opinion, the OCC has not applied a consistent regulatory discipline any time in the last 30 years. It clearly doesn’t use one today. Instead, midsized and community banks are held to much more severe standards than are large banks. In addition, because of the nature of loan review, the application of “standards” has always varied widely by individual loan examiner.

Dugan: “At the OCC, we know that we made some mistakes during the last downturn….One of the most controversial issues associated with the last real estate downturn was the tendency of the OCC examiners to make unilateral adjustments to real estate appraisals that had become outdated due to clear changes in the markets.”

TKB: The OCC has learned its lesson from the last real estate downturn? He’s got to be kidding. If the agency truly understands the harm that “unilateral adjustments to real estate appraisals” can do, it would have fired Tim Long over a decade ago--for forcing the banks he regulates to make unilateral adjustments to real estate appraisals. Instead Dugan has promoted him to run supervision of all mid-sized banks! That’s a truly ominous sign.

Dugan: “In the event that bank management is unable or unwilling to make adjustments that realistically reflect market conditions, examiners will have no choice but to assess the situation themselves and make adjustments in loan classifications and reserves.”

TKB: Translation: in evaluating a bank’s loan portfolio, the OCC will assume the real estate markets, especially the residential market, never, ever recover. So bankers, get ready for some ridiculous downgrades in coming examinations.

Dugan: “Right now, too many community bankers are having too hard a time coming to grips with the problems that have emerged in their commercial real estate portfolios…While resistance to recognizing problems at the beginning of an economic downturn may be human nature, it’s not healthy, because denial is not a strategy.”

TKB: Tough talk from the chief regulator! Here’s what he means: even though the OCC didn’t make a peep when banks wrote these suddenly-allegedly-questionable loans, it suddenly knows more about them now than do the bankers who made them. So it’s the bankers who are in denial, not the OCC, the agency (if you believe its new view of bank credit) basically slept through the bulk of the credit expansion, and is in full-regulatory-panic mode now that credit is contracting.

Dugan: “Our regulation expectations must be clearly articulated, consistently applied, and effectively enforced”

TKB: Translation: not! In fact, the OCC has never clearly articulated its regulatory expectations, nor has it consistently applied any regulatory “principles” it might have concocted over the years. What’s more, the OCC doesn’t have the guts to publish the “standards” that individual examiners apply because it doesn’t want to face the barrage of criticism publication would undoubtedly bring.

Dugan: “I’d like to remind our national banks that they have an avenue available to them to appeal regulatory decisions they think are unfair, the OCC’s Office of the Ombudsman has independent appellate authority that can only be reviewed by me”

TKB: Yep, that’s right! If you’re a banker looking for relief from some lame-brained decision by an overzealous examiner, you can appeal to Ombudsman Larry Hattix, a long-time examiner himself. Only Dugan can overturn his decisions. Good luck! Given OCC’s bring-the-hammer-down culture and examiners’ natural tendency to stick together (not to mention the very real risk of retribution bankers run when they appeal their local examiner’s decisions) I somehow don’t think bankers can expect much in the way of relief from this “independent appellate authority.”

Commercial real estate is a cyclical industry. The downleg of the current cycle has begun, and clearly has a way yet to go. Unfortunately it’s also clear that the OCC will overreact to the deceleration, by taking an unnecessarily harsh view of what constitutes a problem asset. The likely result: excessive chargeoffs and reserve builds to unnecessarily high, exorbitant levels.

The U.S. has a dysfunctional financial regulatory process. (Treasury Secretary Paulson has proposed a dramatic change in it, but don’t hold your breath.) More disturbing to me are the actions of individuals in key roles at some of the key regulatory agencies such as the OCC and the FDIC. They haven’t done much to prevent problems and, now that problems have begun to occur, are overreacting to them. We all deserve better!

Tom Brown is head of