Bankers’ Hours column: Regulations won’t prevent the next financial crisis
The nation has seen two banking crises since the Great Depression of the 1930s: the Savings and Loan implosion of the 1980s and the Great Meltdown, which hit fast and hard in 2008.
In each case, Congress, as well as state and federal regulators responded with new laws and regs to correct the perceived causes. Whereupon all heaved a sigh of relief, grateful that the nightmare was over, and everybody could go back to making money, getting elected, or writing up banks at examinations for various violations.
Yet the two recent debacles occurred only about 23 years apart. In the wake of both events, one major piece of legislation, as well as a few minor statutes, were enacted. The big dog law in response to the S&L mess was the Financial Institutions Reform and Recovery Act (FIRREA). The Great Meltdown triggered the passage of the so-called Dodd-Frank Act.
Will Dodd-Frank prevent a future spate of bank failures following on, or followed by, a severely retracting economy? Probably not.
Here’s why: No law or regulation can eliminate, or even obviate, two indelible elements of the fabric of financial activity: human nature and the law of supply and demand. Both are hard-wired into our particular cosmos. Bank failures will inevitably be a byproduct of a lot of money on the table and the banking business model is quite simply making a profit on the movement of that money, and you can make a lot of money when you convert moving cash into loan assets.
When there’s a lot of money on the table, as in the ’80s with the deregulation of the nation’s S&Ls, or in 2008, when the planetary demand for mortgage backed securities (MBS) created a housing bubble, then supply outstrips demand, and the value of the assets backing the loans decreases. Good loans become questionable quickly, average ones become bad assets almost overnight, and the risky deals that looked like good bets morph into losses immediately. When the money’s on the table, everybody jostles for a seat. Most are good borrowers, some aren’t, and then there’s the sprinkling of crooks, just to spice up the fare. That’s the human nature side of the equation.
As for regulation, it’s actually done a better job of insulating Americans from bank failures than many of us bankers would like to admit. During the S&L crisis, some 550 thrifts went bust. Between 2008 and 2014, 509 banks were closed, although the dollar amount involved was much greater. Compare that to the years of the Great Depression, before federal deposit insurance and supervision: Some 9,000 financial institutions closed their doors.
But neither the federal or state governments can write a statute or regulation to repeal the law of supply and demand. Like COVID-19, it doesn’t care what politicians or conspiracy theorists say. And when an economic train wreck approaches, banks are standing smack in the middle of the track.
We don’t know where and when there’ll be enough money on the table to trip the supply/demand balance ratio in the wrong direction: Will it be the stock market? Commercial real estate? Once again, residential real estate? Junk bonds? Or Jeff Bezos subdividing Mars and selling lots?
I’ll go back to a lesson I was privileged to receive way back in the last century. In 1973 a group in Aspen was seeking an S&L charter for the community. They realized they needed to name a managing officer as the last piece in the application for deposit insurance at about the same time I walked into the bus station. They grabbed me, said you’re it and got the charter approved.
The chairman of Aspen Savings was a gentleman named Mike Conviser, a graduate of the Wharton School, who taught me a lot, a little of which I retained.
Mike told how, after he graduated from the University of Pennsylvania, he went to work in Manhattan for James Talcott and Co., at that time one of the largest factoring operations in the world. Since he was single and the new guy, his job was to be first on the scene when a deal went bad. He’d get the file from his boss on a Friday and be on a plane Sunday or early Monday to the site of the disaster. Over the weekend, and on the way, he would pore over the file and wonder, “How could this deal ever have gone bad. It looks like every contingency was considered and covered.”
But, he explained, “It was always what nobody thought of or everybody figured couldn’t possibly happen.”
So, I suspect, it will be with the next bank crisis.
But we’ll know it when we see it.
Pat Dalrymple is a western Colorado native and has spent more than 50 years in mortgage lending and banking in the Roaring Fork Valley. He’ll be happy to answer your questions or hear your comments. His email is email@example.com.
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