Ex-FDIC Chair Slams Banking ReformReagan-Era Regulator Calls Measures 'Woefully Inadequate'
William Isaac, who chaired the FDIC during the Reagan Administration in the 1980s, is a recognized authority on banking regulation. He is currently chairman of LECG Global Financial Services, a consulting company, and recently accepted the position of Chairman of the Board at FifthThird Bank, the 11th largest bank in the country, headquartered in Cincinnati, OH.
Isaac was interviewed by Linda McGlasson, Managing Editor at Information Security Media Group, in advance of this legislation's pending Senate vote.
LINDA MCGLASSON: What's your assessment of the regulatory reforms being molded by Congress -- what are they missing?
WILLIAM ISAAC: Almost everything. The current regulatory reform proposals in front of Congress, which I do expect to be enacted, unfortunately, are woefully inadequate. They really don't address any of the major issues that caused the crisis. They would not have prevented the crisis had they evolved five years ago, and they won't prevent the next crisis. This is really a political shake on the part of the Congress to try to convince the voters that they are trying to atone for their votes on the Troubled Asset Relief Program legislation. They should never have approved the TARP legislation -- it was very bad legislation. The public is very angry about it, they are saying to throw people out who voted for it, and these folks are trying to atone for that vote by pretending like they are being really tough on Wall Street when they are not. They haven't done anything except try to move a few boxes around. They did no substantial change in the regulation of banks and other financial institutions as part of this legislation.
MCGLASSON: That's including the consumer financial protection agency being proposed?
ISAAC: Pretty much. Actually, the banking agencies were doing a pretty good job of regulating and handling consumer protection measures. They are very tough, I can tell you that; the banking agencies have a lot of clout over the banks. When they tell you, "You are violating the law," or they think you are violating the law, if you don't respond, you go into the penalty box until you do.
The banking agencies have thousands of examiners. They really have been pretty good about enforcing consumer protection measures. Where they let down was in two areas. I think the Federal Reserve didn't do the best job in the world of promulgating consumer protection regulations. I think we needed probably to strengthen the rule-making process and there was no enforcement to speak of with respect to non-bank financial institutions, and that's where most of the problems occurred in this last time round. The Federal Trade Commission is responsible for non-banking firms, and it didn't have the staff to enforce regulations with respect to those firms. They certainly didn't have the staff, and so they did a lousy job of enforcing the consumer protection measures on the non-banking firms.
Now we have this new law [pending], which I guess is going to create some sort of new consumer protection agency, which could be sort of scary in terms of what they might do, depending on how they are governed. What I am worried about is: There is no consideration of safety and soundness issues. They have been threatening that they might prohibit pre-payment penalties on loans. That's a very important issue. If a bank can't count on a loan that is outstanding, it doesn't know how to fund that loan, and it could really get left holding the bag if people pre-pay loans sort of willy-nilly whenever rates move. This is a pretty fundamental protection of a bank that is needed for safety and soundness reasons. But the consumer protection agency, if all it looks at is what's the best deal for consumers, it could well cause some substantial problems in the banking system. I don't really know how it's going to be run, and I doubt it's going to be an improvement. I doubt they are going to change the non-banks and make them any materially stronger than they did the last time around.
MCGLASSON: You've authored a new book, "Senseless Panic: How Washington failed America." What are some of the key messages?
ISAAC: I am trying to explain in the book that policy mistakes we made. I actually take the readers through the 1980s and this major, major financial crisis we handled without panicking anybody. We actually had economic growth even as we were handling 3,000 bank failures, including a lot of large banks all over the country -- nine out of 10 largest banks in Texas, for example. So we handled it, a major, major economic and banking crisis in the 1980s without creating a panic.
What happened in 2008 was a much less serious banking crisis, much less serious economic situation, and the government heads were inept in their handling of the crisis. They let it get out of control and created a panic and a financial meltdown in which banks were so afraid that they wouldn't even lend money to other banks, let alone you and me. The book is trying to explain how we handled the crisis in the 1980s without panicking the public, and then what policy mistakes we made over the past 20 years that allowed us to get back into another crisis, and then what mistakes we made in handling that crisis, which were legend, and then finally the book talks about the reforms we should be making.
When I finished writing the book in January, the Senate hadn't even begun its work, but we had the Obama Administration proposed legislation, and we had the House bill, and I say in the book "Here is what they are proposing, and note that none of it is addressing the issues that really brought us into the crisis." These people are going to blame the greedy bankers and try to deflect the responsibility that our government has for creating this crisis with flawed policies over the past 20 years and inept handling of the crisis.
Unfortunately, the predictions I made in January are coming to pass. I believe that anybody who voted for the TARP (I thought that legislation was very bad legislation) and votes for this reform legislation, anywhere close to the form it is in right now ought to be booted out in the fall. I can allow you one big mistake on economic policy, not two. If people are voting for this reform legislation - it's inept and woefully inadequate -- and they voted for TARP, I think that means two mistakes, which is at least one too many.
MCGLASSON: Is there any institution today that you see is too-big-to-fail?
ISAAC: The top five banks are never going to be allowed to fail, not when they are as dominant in the economy as they are currently. The politicians are lying, of course; they are ignorant when they say that this bill is going to eliminate too-big-to-fail. This bill could say in very, very clear terms, which it doesn't, but it could say in very clear terms, "No financial institution shall be provided any financial assistance of any kind whatsoever by the federal government, or any of its agencies, no how, nowhere, any time." They could have said that -- that would be a very clear mandate to end too-big-to-fail. As soon as we got into trouble, the next time Henry Paulson the third or fourth will rush up to the hill and demand $1 trillion dollars of taxpayers' money to rescue the system, and he will get it because the simple truth is, you cannot allow your major banks to fail. No country can allow its major banks to collapse. Because if the banking system collapses, everything collapses. It is chaos; it is anarchy, and we are not ever going to go there.
If a large institution gets in trouble in isolation, you maybe able to figure out how to deal with it in a way that sort of looks like a failure. But rarely are these large institutions, if ever, going to get in trouble on an individual basis. When one of them is in trouble, they are so big, they are so diversified, they are so much a part of the economy ... they are all in trouble. You are going to have to deal with them as a unit, and you can't allow them all to go down. I don't think you can allow one of them to go down because I think it would create a panic. Look at Lehman. They let Lehman fail. Lehman was a pretty small firm in the scheme of things, and look at the chaos it unleashed throughout the world. They grossly underestimated the amount of panic that would ensue from the failure of Lehman, and that's a principle mistakes these folks made in their crisis management.
Their failure resolution process was schizophrenic. It bailed out Bear Stearns; they let Lehman go down. They were claiming for months that Fannie and Freddie were just fine, and one weekend they nationalized them and they wiped out the Fed stockholders and the common shareholders. Then AIG comes along, and they bailed it out, including all the large banks that were involved in AIG and helped make it happen.
Then WaMu comes along; they protected the depositors, but they wiped out $20 billion of bondholders, and they wiped out the $7 billion of brand new equity ... This schizophrenic failure resolution process or lack of strategy panicked everyone, and it shut down the economy and the financial markets. Then they went up to the hill and demanded, using the most inflammatory of language to force Congress to put this $700 billion TARP legislation through.
I fought it hard. I offered better alternatives, and they went ahead and did it anyway, and then they didn't even use it for the purpose it was intended. They were supposed to buy $700 billion dollar of toxic assets, which would have been a complete waste of taxpayer money, and that's what Congress authorized. Then two weeks after the bill was passed, Paulson said that was sort of a dumb idea, let's do something else with the money. I mean it was scary that the fact that nobody was in control of the government, with any kind of coherent plan. This is why my book is entitled "Senseless Panic: How Washington failed America." Indeed, Washington failed America, and the voters really need to hold some people accountable because that's the only way things are going to change.
MCGLASSON: Your advice to the current set of regulators?
ISAAC: The immediate need is to get the banking system healed and get banks lending again. But that's going to be tough; that's going to be really difficult. The FDIC is essentially tied down. It can't provide capital to banks; it has to let these small banks continue to fail all over the country, and you know it breaks my heart to see that happening. We declared this when they tested the 19 stress-test banks. We told everybody else in the country "You are too small to save," and nobody, nobody is willing to do anything about it. All these small banks don't need to be failing. We could instead do programs to try to ease the burdens on them and give them some capital system. We could be doing that now, but the FDIC has no power to do that -- the Congress took it away in the early 90s, which was a terrible mistake. The Treasury could authorize the FDIC to do it, but the Treasury isn't interested in doing that. They don't seem to have an interest in these small banks at all.
I think that's a real problem: We are leaving community banks all over the country, and this is the shame. I am well aware of the damage it does to communities around the country when they lose their banks, but nobody in Washington seems to care about that any more.
I would say the other things that the regulators ought to be doing is trying to make sure the examiners are not over-reacting and requiring too much capital too fast in banks.
I do think we have got to give people some breathing room to get through this crisis, and we should be encouraging banks to work with borrowers rather than just dropping the hammer on them and foreclosing on loans. I am sure the regulators are trying to do all those things; it's just that they need to be vigilant because the examiners in the field will tend to try to protect themselves, and that will be pretty tough. The people need to be saying to the examiners over and over again during the crisis period, "Give the good banks that are well intended a chance to work through these issues, and let them work with their borrowers to try to solve problems, not just drop a hammer on them."
See Also: Regulatory Reform Clears Senate.