The Problems with Regulatory ReformEx-FDIC Head: Regulations and Globalization Hurt Banks
Banks today have a reasonably sound footing, with more capital and liquidity than before. Bank failures and problem bank numbers are going down, all good signs, says Isaac, author of "Senseless Panic: How Washington Failed America," and who now serves as the senior managing director and global head of financial institutions for FTI Consulting.
"The regulatory requirement has just made life miserable for the smaller banks," Isaac says in an interview with BankInfoSecurity's Tracy Kitten [transcript below]. "The regulatory burdens of hundreds of new regulations that are going to be thousands and thousands of pages long, it's just overwhelming for a community bank to try to comply with all of that."
Isaac looks at the Durbin amendment as "pure and simple, special-interest politics," explaining that the government had no business setting interchange fees. "if the fees are too high, trust me, people will find a way around them," he says.
"I think the Durbin amendment is really a terrible precedent," Isaac says. "It weakens the banking industry at a time when we need it strong, and the folks who supported the Durbin amendment should be ashamed of themselves."
During this first part of a two-part interview, Isaac discusses:
- Nuances of the Dodd-Frank Wall Street Reform and Consumer Protection Act that have "politicized the banks' regulatory system";
- How fraud and cyberattacks could impact consumer confidence and affect future reforms; and
- Indicators that will determine if and when the market could expect bank failures.
Be sure to check back for Part 2, when Isaac delves more deeply into the impact of Durbin and how debit interchange cuts will affect domestic card issuers; the growing impact of global fraud threats; and how the international political climate will continue to affect the global financial crisis.
Isaac is the senior managing director and global head of financial institutions for FTI Consulting. He also serves as chairman of Fifth Third Bancorp. Isaac's expertise in the financial sector crosses corporate governance, financial management, forensic and litigation consulting, government liaison and negotiation consulting, lender advisory services, and risk management. Prior to joining FTI Consulting, Isaac founded the Secura Group, a leading financial institutions consulting firm. LECG acquired the Secura Group in 2007 and Isaac remained with the group at LECG through early 2011. Before forming Secura, Isaac headed the FDIC during the banking crisis of the 1980s, serving under Presidents Carter and Reagan from 1978 through 1985.
Health of the U.S. EconomyTRACY KITTEN: How would you characterize the overall health of the U.S. economy and the U.S. financial structure?
WILLIAM ISAAC: Those are separate but related questions. I think that the U.S. economy is really struggling and we could well be on the verge of a double-dip recession. I think it is primarily because we just have a dearth of political leadership in this country right now. There is the fiscal crisis that has really rattled the markets and forced the Fed to announce it's going to maintain a zero interest-rate policy for the next two years. We don't have sound fiscal or monetary policy right now, and that is really hurting the economy. Business people just don't know what to do. Are we going to have more inflation? Are we going to have more taxes? Are we going to have any growth? What's happening? Nobody's quite sure. What's the value of the dollar going to be two years from now? Commodity prices are going through the roof. These levels of uncertainty really cause serious problems in terms of businesses and individuals willing to commit to the future and invest. We've lost confidence and the government is doing nothing to restore it.
The financial system is actually in better shape in the sense that we went through a serious crisis in 2008 and 2009, as you know, and our major banks have strengthened their balance sheets considerably. They have a lot more capital than they did going into that crisis and coming out of that crisis. They also have a lot more liquidity. The banks are a wash in liquidity right now, and they have very strong loan loss reserves. I think the banking system is on a reasonably sound footing, but it can not out-perform the general economy indefinitely. The economy can't be a lot stronger than the banks, and the banks can't be a lot stronger than the economy. They're going to be following a parallel track for the most part. There can be periods when that separates, but not usually. We're in this together and if we're going to have a strong economy we are going to need strong banks. And if we're going to have a strong banking system, we're going to need a strong economy.
KITTEN: My next question was just to ask what your general thoughts were about the market and whether you felt that it had improved, declined or stabilized over the last eighteen months. And it sounds like you're saying maybe a little bit of all three.
ISAAC: Your three words I think were improved and stabilized. What was the third one?
ISAAC: Okay, well we've done all three. I would say that the markets right now are quite volatile, because of this uncertainty. They really don't know what government policy is going to be, not only in the U.S. but in Europe. What are governments going to do to address these major issues we have, which is essentially a fiscal crisis that has spread throughout the world and throughout the United States? I think that is what's creating all this volatility. It makes people very unsure and right now the markets seem to be betting that we are in a recession or headed into recession and generally the markets forecast pretty accurately on that. The markets, I think, are down something like 16 percent in the last few weeks. That is a very strong signal that we could be heading into recession or be there already.
Bank FailuresKITTEN: Now the economy of course has been slower to recover than anyone really anticipated and we continue to see financial institutions struggle. How many more banks do you think the market can expect to see fail between now and the end of the year?
ISAAC: I think we've pretty well run the course on bank failures. This time around we've had about 400. Generally speaking, and it's a very strong correlation, banking problems trail the economy by about 18 months. If you enter a recession, it takes about 18 months for the borrowers to realize they are in trouble, for the banks to realize the borrowers are in trouble and for the regulators to realize the banks are in trouble. Therefore, the problem banks list starts going up significantly about 18 months after a recession has started. In the reverse direction, those numbers start to go down about 18 months after the recession has ended. We are beyond 18 months from when the recession is officially designated as having ended. Bank failures and problem bank numbers should be going down now. That is the pattern over a long period of time. There's a very high correlation, so I'm not expecting to see a lot of bank failures between now and the end of 2012. I would say that if we have gone back into recession that rest will be short lived. We will start seeing bank failures go up again if we are trailing back off into recession right now.
GlobalizationKITTEN: That's a great point. We'll just have to wait and see. You've talked a little bit about globalization and I wanted to ask about the impact that you see globalization having on today's financial institutions?
ISAAC: It's had profound impact. We have banks from all over the world now that are competing with each other in each other's markets. We've had significant consolidation in banking, and those trends are likely to continue. I don't see banks pulling back and not trying to compete globally, the bigger banks. I don't see the trend toward consolidation ending. I'm really quite concerned about our community banks. The community banks, I think there are some 7,000 right now, that are below a billion dollars in size. They are quite threatened because of this, mainly because of the Dodd Frank Act. The regulatory requirement has just made life miserable for the smaller banks. The regulatory burdens of hundreds of new regulations that are going to be thousands and thousands of pages long, it's just overwhelming for a community bank to try to comply with all of that. I happen to be chairman of the Fifth Third Bancorp, which is a pretty good size bank and Dodd Frank is a pain in the tail for a bank the size of Fifth Third, but it's not life threatening because you have millions of customer transactions to spread those costs over. At a small bank they can't do that. For a bank the size of Fifth Third or other large banks, Dodd Frank is a nuisance, an expensive nuisance, but not necessarily life threatening.
One of the major flaws in Dodd Frank from the community bank perspective is that it eliminated trust deferred as a source of capital. I really wonder where we think community banks are going to get their capital, if they can't issue trust-preferred stock to institutional investors. That was not well-thought at all, and I think that counts and ought to be repealed for the small banks.
Regulatory ReformKITTEN: When we look at what is happening on the domestic front, and you've rightly noted the impact on community banks, let's talk a little a bit about Dodd Frank and the legislation's failure in your view to correct and prevent future economic crisis. What are some of your general thoughts as they move beyond the impact on community banks and just the economic stability of financial institutions in the U.S. generally?
ISAAC: I believe Dodd Frank is the worst piece of financial legislation in history, but I'm afraid I can't go back to a thousand years. I'm old, but not that old. I can't say in history. I can say it's the worst piece of financial legislation in modern history. It's hard. I can't come up with a law that is as bad as that one is. It didn't address the causes of the current crisis. It wouldn't have prevented it, and it won't prevent the next crisis. In fact, it's making the next crisis more difficult to deal with because it has tied the Fed's hands and the FDIC's hands in dealing with the crisis. It's politicized the bank regulatory system. It has allowed it to remain fragmented with different people looking at different parts of things. This financial stability oversight council that they created was probably a good idea in theory if it had been independent. But what they did is they created this oversight council and they have it being run by the Secretary of the Treasury, Federal Reserve, FDIC, Office of the Comptroller of the Currency and the SEC, all the agencies that it's supposed to be second-guessing. Those agencies are not going to second-guess themselves, and they are not going to think they are doing anything wrong because they wouldn't be doing it if they thought they were doing something wrong. There is no check and balance on this very fragmented system we have.
I can tell you, if I were President one of the first things I would do is I would send up to the Hill legislation to basically start over again on financial reform and do it right. Reform the regulatory structure across the board and really address the issues that led to this crisis. For example housing, we haven't addressed housing at all. Later you're still doing the same stuff that got us here into this problem. There are a lot of issues that we haven't looked at that Frank hasn't looked at and we really need to start over on financial reform.
KITTEN: I want to talk about one piece of the Dodd Frank legislation and that of course is the one that relates to debit interchange and the highly contested Durbin amendment to Dodd Frank. It seems now that banks may have it a bit better than they had initially thought with the Fed's one sentence incentive fraud prevention. What is your overall take on the Durbin bill and how do you see U.S. banking institutions reaping rewards from interchange fee incentives that are being offered by the Fed?
ISAAC: I can't remember but I think the Fed said that you can have an interchange fee of 12 cents, or something like that. And they finally came out with I think it was a 23-cent number, and then they added on a little more for fraud prevention. The final Fed rule was a lot better than what they came out with, but it's still going to have a significant impact on large and small bank earnings at a time when we don't need that at all. It would be one thing if the savings were going to consumers, but it is clearly not. The retailers who are the ones who promoted this Durbin amendment are keeping the money. They are taking it to their bottom lines. They are not passing along to consumers, and they've said that in their securities filings that this is going to increase earnings by "x" amount. ... The Durbin amendment was pure and simple, special-interest politics. The government has no business setting interchange fees. That should be a negotiation in the private sector. Competition should control the fees, not the government. If the fees are too high, trust me, people will find a way around them. Big retailers will say, "Well we're not going to take your cards, we're just not going to do it and we're going to do our own cards or whatever." Walmart has a lot of power. Walmart can take care of itself. It doesn't need Senator Durbin to do its bidding. I think the Durbin amendment is really a terrible precedent. It's very harmful. It weakens the banking industry at a time when we need it strong, and the folks who supported the Durbin amendment should be ashamed of themselves.
Be sure to check back for part two of this interview when we continue our discussion with Isaac, delving more deeply into the impact of Durbin and how debit interchange cuts will affect domestic card issuers. We'll also talk about growing global fraud threats and how the international political climate will continue to affect the global financial crisis.