, Salem, MA

February 28, 2013

Watson: Difficult options for banking regulation

Brian T. Watson
The Salem News

---- — Last week, I wrote about the Dodd-Frank Wall Street reform bill and its slowly unfolding rules and consequences. The original bill, and the ongoing process of writing provisions that guide the details of its implementation, are resulting in thousands of pages of regulations.

Preparing for last week’s column, I had a number of conversations with Mike Wheeler, president of Beverly Cooperative Bank, and William Howard, chairman of the bank’s board. Wheeler pointed out how unnecessary it is for Beverly Coop — a small, community bank with a responsible lending record — to be given additional regulations.

He has a valid point. This week again, Mr. Howard and I discussed that issue and the larger question of how to respond to the specific actions of the very large banks where they contributed to the 2008 financial crisis.

Regarding community banks — banks with less than about $1 billion in assets — Howard acknowledged that some of them got into trouble when the housing bubble burst. But their mistakes were not the machinations of the larger, investment banks. Instead, some community banks simply got overoptimistic about the seemingly ever-rising value of homes, and so lent too aggressively to ordinary subdivision developers — especially in fast-growing regions like Florida, Alabama and California. Their errors may have been primarily errors of judgment. Depending upon the kinds of loans they extended, there may or may not be new regulations that could be applied.

For example, is there a need for additional rules about capital leverage that would further define or limit the ratio of land development loans to risk-based capital? And if so, is this something better done by Dodd-Frank, or the FDIC?

When considering community banks like Beverly Cooperative, however, Howard said that perhaps the regulations can be appropriately tailored to create exceptions and qualifiers that recognize which banks, or bank actions, don’t need additional oversight.

There really are two worlds (at least) in banking: small community banks and giant investment banks. Howard and I agreed that the Wall Street meltdown exposed areas in investment banking that had simply gone out of control.

The creation of all sorts of confusing, barely trackable, financial products — sold privately and entirely unregulated — allowed levels of risk-taking that far exceeded the capacity of the financial system to manage once the house-of-cards arrangements started to fail.

Whether it was credit default swaps, collateralized debt obligations, “synthetic” versions of those, or other hybrid collections of mortgages and loans and insurance policies, they were all increasingly used primarily as constructs with which to speculate unrestrainedly.

What caused that behavior? Was it lying mortgage applicants, the federal government, Fannie Mae, the ratings companies or the investment banks themselves? What actions would eliminate a repeat of the crisis?

Dodd-Frank is one response. It attempts with legislation to write enough wise rules to define the contours of acceptable risk. Because our financial system is so immense and complicated — and interconnected globally — and because the activities of investment banks, hedge funds and insurance companies are so multifaceted and dynamic, it is easy for any attempt at comprehensive regulation to become long and complicated itself. That is the case with the rules being promulgated under Dodd-Frank, and, of course, it makes every thinking person concerned. Will the legislation achieve its intended purposes?

Some observers who look at the power and intractability of the government-banking symbiosis (our “Goldman Sachs government,” some say), and the constant difficulty of regulatory enforcement, are starting to wonder if any set of rules can tame the enormous, global, financial beast. For example, will we newly regulate derivatives only to see the actors develop other counterproductive extremes?

In response to these concerns, more discussion is likely about the value of breaking down the size of the largest banks (globally), and thereby increasing the manageability and accountability of their bureaucracies, and also reducing the vulnerability of the economy when a bank miscalculates.

Another option is to put some bankers in jail. Since 2008, a number of guilty bankers, lenders and inside traders have reached “settlements” with the justice system, paying a fine and avoiding incarceration. Would the sight of scores of the meltdown Wall Streeters in jail be a deterrent to other would-be thieves?

And maybe we shouldn’t even attempt to write voluminous regulations, which can never anticipate every possible development, contingency, circumstance or human duplicity. Maybe we need just one rule that says, “Illegal, unethical, irresponsible, greedy or unsustainable banking practices shall not be permitted.” Would that work?

Howard and I — and many others — understand the problem and understand the goal. We all have possible and partial answers and proposals. But isn’t it possible that any solution — every solution — will be no better than the level of integrity brought to bear by every actor and institution in the system?


Brian T. Watson is a regular Salem News columnist. Contact him at