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The Profligate Versus the Prudent, Again

17 May 2010
Posted by Andrew Samwick

If there were ever an opening to a news article on the financial crisis to get my blood boiling, this is it:

As law enforcement agencies and regulators investigate the likes of Goldman Sachs and Morgan Stanley, and lawmakers debate legislation to revamp financial regulations, it's become conventional wisdom that big investment and commercial banks caused the crisis and small community banks are paying for the sins of others.

That's not true, however. Georgia leads the nation in bank failures since the crisis began, and all of them have been at small banks, most caused by bad loans to builders.

There are two problems.  First, small community banks could fail left, right, and center and not cause anything like the crisis we have endured.  Second, the right way to distinguish between financial institutions is not by size, but by whether they were insured or not and whether they behaved prudently or not.

Institutions that were part of the FDIC insurance system were more heavily regulated in terms of the assets they could purchase or create with their liabilities.  Regulation was far from perfect, but it was clearly relevant to how much of the lending was done in subprime mortgages.  As the article goes on to state (emphasis added):

"I think there was a supply and demand imbalance, but I think that demand was inflated by the nontraditional mortgage activity," said Doreen Eberley, the regional director of the FDIC's New York region, who served as interim regional director in Atlanta last year. "The availability of mortgages drove construction. The Atlanta story wasn't one of speculative construction."

Eberley pointed to the growth in nontraditional mortgages underwritten by entities outside community banking that pooled these loans for sale to investors as complex securities. From 2002 to 2007, subprime mortgages for the riskiest borrowers in the Atlanta area grew in value from $4.6 billion to $15.4 billion, and Alt-A mortgages, given to the next riskiest borrowers, grew from $1.8 billion to $16.6 billion.

I am the Board at one of my community's several outstanding local banks.  We did not originate any of these nontraditional mortgages.  Because of that, during the inflating of the bubble, we lost market share in the mortgage market to entities that behaved less prudently with their lending policies.  After the bubble burst, we were subject to the same immiserizing near-zero interest rate policy as everyone else and now face the prospect of higher costs of operating due to increased regulation.  We didn't wreck the system, and we now have to pay the costs of cleaning it up.  That there may be some community banks that behaved as profligately as the entities outside the insured banking sector does not minimize the real cost to prudent institutions in the wake of the crisis.

Absolutely, but...

GA leads IL by three banks, from what I can tell, in the closings.

But the article's claim that "all of them have been at small banks" is at best disingenuous. By my rough count, just under half of the GA failures have cost the FDIC at least $100MM each. (Illinois is running just over 1/3 at that level.)

They may have had cute names--lots of "Security" and "Community" banks, not to mention "Freedom Bank of Georgia"--but they weren't all that small.

There were certainly banks that were primarily created to facilitate Bad Real Estate Lending (see, e.g., Peter Carbonara's piece in the real BusinessWeek for a discussion of FirstCity and Haven Trust), but many of the dead more likely made "prudent" loans for housing on the Atlanta-Athens corridor and then watched as the area stopped growing.

(NH has no such problem, which is a contributing factor to no bank failures in the state since February of 2001. It is arguably easier to be prudent in the absence of temptation.)


Should have been screaming bloody murder

I am well aware that most community banks didn't really participate in the subprime orgy - *but* why didn't the community bankers scream bloody murder (loud and long) when they could see, month by month, lending standards being driven to non-existence by competitors?

They could have screamed to their lobbying groups, their regulators, and the press.

But to the best of my knowledge they didn't.

Why?

My guess is that it was a combination of fear and avarice.

Fear that ratting out the NYC big boys would someday, somehow lead to commercial retribution.

Avarice, in the sense that the feared retribution would likely take the form of denied business opportunities.

Thoughts?


Generally the FDIC losses are

Generally the FDIC losses are running at abot 1/3 of assets, so if the average cost to the FDIC is $100M, then we aretalking about baks that have assets of around $300 million or so, and yes in the banking world, that is small. The big boys lik JP, C, BC, WFC have asets in the Trillions, many many orders of magnitue larger




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