Bank Crisis: Where Were the Regulators?

Includes: IDMCQ, SOV, WMIH
by: Vernon Hill

As the shadow banking system implodes and core deposit-funded banks prepare to expand to fill the void that’s been created, inquiring minds want to know: where on earth were the regulators?

Answer: they were counting the twigs as the forest burned.

It’s now clear beyond doubt that regulators’ myopic “risk-based capital” program was useless as a way to assess and calculate the risks institutions were taking. Computer-based analysis, epitomized by Basel II, wasn’t any better. Worst of all, the regulators spent most of their efforts obsessing over minutiae—items like ensuring the proper positioning of FDIC signs, and enforcement of CRA giveaways—rather than address the core risk of the cycle just ended: institutions’ chronic lack of stable funding.

As former CEO of $50 billion Commerce Bank, which is totally funded by core deposits, I know first hand that regulators did everything they could to undermine our model rather than help us strengthen it. Now that the cycle has turned down, we see what the regulators’ misplaced priorities have led to. Commerce’s strong deposit franchise enabled it to be one of the few large institutions to weather the storm with hardy a blip. Other institutions didn’t come through as well—but at least their FDIC signs were in the right place.

Meanwhile, the S.E.C., which allegedly regulated the investment banks, did nothing to assure institutions’ safety and soundness. Rather, it focused almost entirely on compliance. You see the results. I’m sure Lehman’s (LEH) and Bear Stearns’s (NYSE:BSC) compliance practices for world-class at the moment the banks became insolvent.

The OTS, in its ongoing struggle for survival, permitted such abominations as IndyMac (IMB), WaMu (NYSE:WM), and Sovereign (SOV) to limp along, supported mainly via unstable wholesale funding.

Yes, we need a new regulatory structure. But this time, the structure should focus on the structural issues that underscore the market, rather than waste resources on endless minutiae.