Community Banks, Part Three

This morning, Simon asked why community banks seem to be opposing the Consumer Financial Protection Agency. Felix Salmon agrees that community banks should be in favor of the CFPA, for three reasons: (1) the CFPA should increase the cost of complexity, not the “boring banking” that community banks are typically thought to do; (2) the CFPA should level the playing field with predatory lenders, saving community banks from the choice of losing market share or becoming predatory lenders themselves; and (3) the CFPA should shift competition from finding hidden ways to gouge customers to traditional underwriting, which should be a community bank strength. He later adds (4) the big banks’ big advantage is in deceiving customers, which the CFPA should be able to rein in.

Salmon thinks there are still two reasons why community banks may be afraid of the CFPA:

I think it’s a combination of fear of the unknown, on the one hand, and fear of the big banks, on the other. Since every regulator to date has been successfully captured by Wall Street, it’s reasonable to assume that the CFPA might end up being captured by Wall Street too. In which case the burdens of the CFPA might end up being borne disproportionately by smaller community banks.

The commenters on Simon’s post made some similar points, beginning with Bond Girl – “I know several executives at small banks that were flipping subprime mortgages and the like” – and Russ – “it’s not irrational for the smaller banks to fear that in practice regulation would be gamed to further empower the big banks while falling on the backs of the smaller.”

I think it breaks down this way. To the extent that community banks were ripping off customers with mortgages they had no chance of repaying, then that is something that should stop, and the CFPA should be aimed against them. Put another way, if that is the case, then community banks should be ignored on this issue just like Angelo Mozilo should be ignored.

That said, I think there are probably many community banks that do fit the “boring banking” stereotype. When I bought my family’s house, I got a mortgage from Greenfield Savings Bank, based in Greenfield, Massachusetts, which, I believe, did not even reserve the right to resell my mortgage. Looking at their current rate sheet, I see that they offer 15-, 20-, and 30-year fixed-rate mortgages; a 5/1 adjustable-rate mortgage; and 30- and 40-year fixed-rate mortgages for first-time homebuyers. And that’s it.

The first question to ask about these banks is: if size is so important in banking (I’m thinking of all those people who say that breaking up mega-banks would hurt consumers or, worse, the entire country), then why does Greenfield Savings even exist? Community banks must have some source of competitive advantage over Bank of America and Citigroup. There are two obvious possibilities. One is that customers prefer dealing with local banks, and based on my personal experiences, the level of customer service is far superior than what you get with a megabank. The other is that community banks, as Salmon said, are better at underwriting, because they actually know the characteristics of the neighborhoods they are underwriting in and, possibly, the borrowers they are underwriting. The reason I went with Greenfield Savings was that they offered me a lower rate than any national bank, and presumably they were able to do this because they knew something about the local market that the national banks didn’t.

Now, both of these are advantages that should be protected by the CFPA. That is, if your goal is to provide better customer service, you are probably not in the business of screwing your customers. And if your competitive advantage is in underwriting, then you have no need to confuse customers with unnecessarily complex products. You should be happy that Elizabeth Warren is keeping predatory lenders out of your backyard, because even if you refuse to match their mortgages, they are driving up housing prices and making it harder for you to find qualified borrowers.

(On the other hand, if you decide that your strategy is to originate toxic mortgages and flip them to investment banks, then you have no competitive advantage left and no business to go back to when demand for your mortgages craters, and no one will bail you out because you are too small.)

So we are left with Russ’s problem: small banks believe that once the CFPA is created, it will be captured by big banks, who will use it to screw them – not an irrational fear, given the way regulation is often used as a stick with which one set of corporate interests beats on another. But the simple answer there is that Tim Geithner and Michael Barr (and Barney Frank) need to design the CFPA in such a way as to minimize this possibility. Maybe they could have rules requiring the CFPA to allocate auditing resoruces in some proportion to firms’ size. Maybe they could slap special anti-lobbying provisions on the CFPA (high salaries but no ability to work for a company you regulated for a long time) to reduce the risk of capture. Maybe they could put in a tax-and-transfer mechanism to ease the compliance costs for small banks. Maybe something else.

The bottom line is, either community banks are just as guilty as the unregulated mortgage brokers and the investment banks that funded them, in which case Geithner et al. need to make the case that Congress should not listen to them; or community banks are part of the solution, in which case Geithner et al. need to make the case to them that they should support the CFPA. I obviously support what Geithner is trying to achieve with the CFPA. But it’s time to close the deal.

By James Kwak

15 responses to “Community Banks, Part Three

  1. “The reason I went with Greenfield Savings was that they offered me a lower rate than any national bank, and presumably they were able to do this because they knew something about the local market that the national banks didn’t.”

    Doubtful. Probably just that the local loan rep wasn’t as greedy.

  2. Carson Gross

    Maybe something else.

    Really? Maybe something else?

    I dunno, man. I’m gonna have to see something more convincing than that if I’m a small bank. With all the centralization of regulation in New York/DC, why on earth should a local bank assume they’ll have any influence whatever, or that they won’t get crushed by the NY/DC finance cartel?

    I see a future of huge, TBTF NY/DC banks with access to cheap, guaranteed capital dominating the financial future if we keep heading down this path. We’ll keep making it harder to start and run banks at the Federal level, and then wonder why there are a few dominant banks based in the eastern power centers.

    Y’all know my solution.

    Cheers,
    Carson

  3. Many really small banks and credit unions are regulated by their state rather than federal examiners – perhaps there could be special rules created to require CFPA to consult with/defer to state examiners before taking action?

    Also, there’s a pretty good example of setting different rules up for different size banks in the Community Reinvestment Act – really small banks only get examined about once every 5 years, and have much more flexibility in how they meet their CRA requirements.

    Perhaps that system could be adapted to the CFPA?

  4. I guess it seems to me this still leaves us where we started. Since Geithner and Frank and everyone else have, since the start of all this, treated the problem as being “How to save the big banks?” rather than “What is good for America?” (let alone, “What constructive purpose do the big banks even serve? Or are they purely destructive?”), it’s hard to see why anyone should trust them to suddenly have a change of heart.

    “Ask not what the big banks can do for your country, but ask what your country can do for the big banks.”

    I think that sums up Paulson/Bush/Geithner/Obama policy so far.

    That’s just the issue of specific personnel. Structurally, it’s hard to believe that, even given good faith on the part of this official or that congressman, any real reform can be accomplished within the parameters of this system.

    They could enact a nominally rigorous reform with great fanfare, and then the news cycle moves on, electoral campaigns will still allow and depend on private money, lobbyists will still be empowered, and regulatory agencies will still be starved of funds and/or funded by tithes from the very bodies they regulate, and bullied by politicians.

    I guess that criticism goes beyond the original question, and maybe there can be exceptions to the pattern, but offhand I can’t think of any.

  5. ” breaking up mega-banks would hurt consumers or, worse, the entire country)”

    I wonder why I cannot remember having read explanations as to what the breaking down or up of the big banks would mean for international relations
    the only hint I remember is that Deutsche Bank refused German bailout money but took 12 bn TARP but I am still waiting for an explanation what that signifies for political foreign relations, power distribution between countries
    – sorry I do not know a term for it but what I mean is what would a failure of the big banks do to Obama’s clout when he sits down at the negotiation table.

  6. Community banks know the deck is stacked against them. They all saw CIT was abandoned as not big enough to save – and that Merrill lost money trying to be less risky and Goldman is viewed as the salvation of America because it’s “profitable” today.

    And they see that though Goldman became a bank holding company, they cut a deal with the feds that lets Goldman engage in the exact same risky behavior that got us into this mess. (Their spokesman even brags about it – business as usual at Goldman! Why reform when it’s more profitable to risk big and the feds will bail you out no matter what? Even if we don’t need the money – as they keep claiming with the AIG unwind – the biggest recipient keeps claiming they didn’t need the dough.)

    Is Geithner’s schedule open for such negotiations with the little community bank in my neighborhood? Does Geithner care a fig for the little community bank in my ‘hood? No and no.

    They’re not big enough at all for anyone to care about and perhaps they feel if they cast a stone into the lake of bigness, they’ll lose any opportunity to be snapped up by one of the biggies any time soon.

  7. I posted this on Felix’s blog this morning, then saw this and thought I would also add it here. Some of the sentiment is already reflected, but I thought it would be good to elaborate.

    I work in management at a mutual savings bank institution in upstate New York. You are correct in saying that the direction the CFPA would drive regulation is what we are already doing, and I think that is a good thing.

    The challenge that legislators and regulators will face regarding support of smaller institutions is cynicism. Financial regulation is extraordinarily expensive for small institutions, as is the provision of deposit insurance. Community banks work hard to meet the expectations of regulators and examiners, and spend a significant amount of money on auditors, consultants, and other professional services to do so.

    Yet another layer of regulation, which in the perspective of community institutions will be substantively ineffective in regulating – if not completely ignored and bypassed – by industry gorillas, will undoubtedly add to the regulatory cost of doing business. Making it harder and more expensive to be a responsible and prudent vanilla banker.

    Among community banks, there is wide-spread resentment of constantly getting the short end of the stick. In good times, they work hard to make good decisions, sometimes in spite of regulators, and they pay their share for deposit insurance and regulation. In bad times, they are called on to make deposit insurance premiums in multiples of what is ordinarily assessed, and are then burdened with another set of regulatory requirements that will likely end up being a waste of time, energy, and money.

    The real winners here are bureaucrats, consultants, ill-trained government examiners, and other professional services – bankers that ignore the rules and make outsized salaries and bonuses notwithstanding.

    I think I mentioned in a previous comment that economic growth is predicated on investment in productive assets. An important facet of this discussion to realize is -that without some rationalization of regulation, regulating bodies, and regulatory costs – proposal of far reaching regulation is creating further drag and diversion of resources, reducing our systemic ability to invest in worthwhile projects.

    Believe me, I am certain that more stringent controls are necessary to restrain irresponsible behavior in the marketplace. Ordinarily, one would argue that the market should provide those controls – let the imprudent fail. In this case, however, we have allowed for institutions to build to a level at which their failure poses a systemic risk. Further, the document on financial regulation released by the Obama administration calls for deconstructing all remaining barriers to interstate banking, which to me would not address the systemic issue of institution size – it would appear to exacerbate it. Herein lies a problem, regulators propose to regulate actions more stringently, especially for large institutions, but at the same time remove other barriers for these institutions to continue their wild and ill-conceived growth. You can’t have it both ways.

    For community bankers to get on board, they need to be convinced that it will be in their interest to do so. It can’t pose higher requirements, increased cost, and restrain them further. It must have the strength to reign in the industry gorillas effectively and substantively.

    It seems like a difficult task to me. Especially with the strength of the industry lobby.

  8. Felix Salmon: “Every regulator to date has been captured by Wall Street.”

    Really? What about William O. Douglas? Actually, I think we could cite more recent examples of people who were not captured, including Alan Greenspan, but we might regard more dispassionately someone who is dead.

    This defeatism about regulation is a malaise.

  9. Ken: “Further, the document on financial regulation released by the Obama administration calls for deconstructing all remaining barriers to interstate banking, which to me would not address the systemic issue of institution size – it would appear to exacerbate it. Herein lies a problem, regulators propose to regulate actions more stringently, especially for large institutions, but at the same time remove other barriers for these institutions to continue their wild and ill-conceived growth. You can’t have it both ways.”

    Many thanks for your informative and enlightening post. :)

    Yes, the regulation of actions imposes high cost on enforcement and compliance both. Furthermore, making it easier for Too Big to Fail institutions to become even bigger is crazy. It is better, and cheaper, to build safeguards into the system. In the Wired Age, restrictions on interstate banking may seem outmoded, even quaint, but such structural constraints help to keep the interconnectedness of the financial system within safe bounds.

    BTW, in the deconstruction of barriers to interstate banking, do we see the hand of Larry Summers? If so, would he not be a disastrous Fed chairman?

  10. All of this speculation seems unnecessary. The community bankers have clearly stated their concerns about the CFPA.

    For example,

    Fred Becker of the National Association of Federal Credit Unions

    Camden Fine of the Independent Community Bankers of America

    http://www.nafcunet.org/Template.cfm?Section=News&template=/ContentManagement/ContentDisplay.cfm&

    http://www.icba.org/files/ICBASites/PDFs/ltr062409.pdfContentID=41465

  11. I’ll somewhat repeat what I said to the original article. CB’s are still a part of the banking community. Many are beholden to larger corporate “partners” from whom they receive lots of referrals (and vice versa) because neither party has identical programs, nor are they interested in having them. The CFPA is a great unknown as to its cost and effect(iveness), and may stand as one more barrier to commerce (albeit probably small from the CB’s perspective). The CB’s will need a lot of reassurance from the Geithner/Frank reformers to feel comfortable with new regulation of any kind. After all, hasn’t everything, and I mean everything, been done to favor the big players? Yes, it has!! Why have 60 small banks failed this year and NO big banks? This is the kind of thing they ask themselves as they confront higher audit volume, new forms and fromats, new disclaimers and consumer education requirements. Much of the new regulation will fall on all equally, but the little guys don’t have huge legal departments to cushion their regulatory futures.

  12. Please forgive the naivete of my question, but, why does the CFPA have to apply the same way to community banks as it would to big banks? Why must this CFPA be a “one size fits all” when obviously, that will unbalance the playing field…?

  13. It doesn’t have to. Real reform for almost any sector would not be one-size-fits-all.

    That in practice proposed “reforms” usually are is because the real goal is not reform, but to further the disaster capitalist agenda of using (self-created) problems and crises to further entrench big-business privilege and power, and to drive out smaller competitiors.

    So the question in this case is whether proposed banking reforms (pathetically meager as they are) would be real reforms, in which case small banks should in theory benefit from them, or whether they’d fall into the normal pattern which ends up advantaging monopoly in the name of restricting it.

  14. If we’re left with the hope that Tim Geithner and Barney Frank will design anything that is not in the interest of the big banks, I can see why the community banks would be worried.

  15. There is odviously many concerns about community banks being ignored, and even directly harmed, by larger banking interests with new regulation.

    However, many people would agree that additional regulation is needed at this time to deal with harmful banking activities. Beyond any anti lobbiest measures, influences from larger banks is inherent. Even if we compare a situation of no new regulations to avoid larger bank influences or having the CFPA, I believe that most would agree that regulation is required.

    So in effect, the community banking concerns are important in crafting legislation, but irrelevant in if there should be a CFPA plan. (just saying, even though no one seems to be opposed to new regulation here)