Former Colorado Bank Regulator Discusses Dodd-Frank, Pot, Bitcoin

DENVER — Fred Joseph, a longtime regulator to Colorado's financial services industry, started 2014 as a free agent.

On Dec. 31, Joseph retired as the banking and securities commissioner for the state's Department of Regulatory Agencies. He had overseen the securities industry since 1999 and banking since 2011. During his short stint supervising banks, he made headlines in 2011 when the Federal Reserve Board had to step in to fail a state-charted bank.

Banking in Colorado is bound to be a hot topic in coming months as recreational marijuana aims to become a legitimate business here.

Joseph recently shared his views on banking and marijuana, the showdown with the Fed and other key industry topics. Here is an edited transcript.

You are retiring on the eve of legalized recreational marijuana in Colorado. It is illegal at the federal level and there doesn't seem to be a clear way for banks to work with the pot shops. How do you see this playing out?

JOSEPH: It always comes down to the same answer: marijuana at the federal level is still a controlled substance, therefore federally insured institutions don't want these accounts. I'm agnostic personally. As long as the specter is there at the federal level, I'd be shocked if banks want to take in accounts. Like a lot of people, I'm concerned that they are dealing with all this cash now and, with that much cash, bad things can happen, from armed robbery to money laundering.

Do you believe there are banks that are working with these businesses unknowingly or by turning a blind eye?

I haven't heard of any knowingly doing it. But obviously some of these people are being banked through either accounts they had previously under another business name or personal accounts. But a lot of it is still cash.

It seems like the law may not have been fully thought out.

Yeah, to be able to have access to banking is a big, big thing. It went through, voters approved it, there was this belief that it would create revenue for the state, but they forgot a few things in their effort to get there. I can't fathom how they pay their bills or employees unless they are walking around with a suitcase full of cash. I hope Washington does something.

How are Colorado's banks performing right now?

Vastly improved from five years ago and even three years ago. The Colorado economy has improved. The real estate industry is making a comeback, the construction industry is making a comeback and the energy sector is vibrant. All of those are impacting the bottom line of the state-chartered banks.

In 2011, the Fed stepped in and failed Community Banks of Colorado, a state-regulated bank, because your office wouldn't close it. How do you feel about that?

The FDIC and the Fed are bound by the prompt corrective action of 2%. Our law is different. For us, the guideline is insolvency. Obviously, I can only act according to state law, which says 0%.

They did what they had to do. At the time, the reports sounded like I disagreed with them. I didn't disagree. They consulted with us, but it came out that I thought it was premature. My board, my staff and I were in agreement that if that is what you need to do pursuant to PCA, OK. But our insolvency definition is zero.

It seemed like a disagreement.

Yeah, that's because it was the only one where the Fed closed a bank. But I didn't plant a flag in the ground.

Is there a natural tug-of-war between state regulators and your national counterparts?

Over my 30 years as a regulator, I've dealt with a lot of regulators. My relationship with the FDIC and the Fed has been as good as it has been with any other federal regulator. I could pick up my phone and call my federal counterparts and they will answer.

Have banks learned their lesson from the 2008 downturn?

For now, yes. But you'll see the next generation of bankers come in and say, 'Let's do this, no one has ever thought of that before.' And, yeah, they have.

What's the next big risk?

Interest rate risk. Banks are so liquid that they've tied it up in securities. When rates go up, the value of the bonds will go down. We are telling our banks to be careful with that risk.

On a global perspective, it is derivatives. I'm not sure I know what $700 trillion of notational value derivatives means. All I know is that it sounds like a hell of a lot of money. It is hard to get my arms around that. Is it going to cause financial Armageddon?

What's your take on M&A?

I don't think we are headed to 25 megabanks. That's not going to happen. There is consolidation in all industries. Every company has its own reasons to sell, too.

Are there too many banks?

I like to think the market controls that. It all depends on where you are. In a small town that doesn't have a bank, you don't think we have too many banks.

Should de novo activity resume in earnest?

I can't argue against bringing new capital into the system. I think the FDIC will look at it. Once upon a time we gave out new charters and maybe there were too many. Now, let's look at need and let's look at capital. If someone wants to come to the table now, they are going to have to show need, a good business plan and capital.

What's your take on the regulatory pendulum? Has it swung too far with Dodd-Frank Act or not enough?

The pendulum has swung pretty far toward the regulation side. This is what happened with the savings and loan crisis. It isn't just the rules promulgated by Dodd-Frank. You have the Fair Lending Act, Fair Housing Act, the Safe Act, et cetera. All this accumulation of regulation makes it real difficult for community banks, in particular, to make it.

Regulation is why some of the boards and management are thinking it is no longer worth it [to stay independent]. I forgot about Basel III, didn't I? It is all so complicated. Yes, I'm a regulator and, yes, I'm saying the pendulum has swung pretty far in that direction.

I'd like to think the policy makers and federal and state regulators could get together and come up with a different set of rules for banks that are not the Wells Fargo or Bank of America of the world.

There are delineations in place, such as the $10 billion-asset threshold.

That's true, but if you're $75 million in assets, the compliance is really a big burden. I went around the state and met with a couple dozen banks over the summer and pretty much once you get past specific issues every single banker brought up regulation. It either came first or second.

Many regulations are intended to protect consumers. What's the right way to protect the consumer without being overburdensome to banks?

That's subjective and hypothetical, but, as a regulator, I go out and speak to many groups and have a monthly column about investor education. Sometimes you wonder if anyone is listening. You can tell somebody 'don't do this' and they go out and do it. Sometimes it is hard to protect people from themselves.

As the securities regulator, what's your take on the widening of investing rules from the JOBS Act?

I have a concern that some of it will lead to fraudulent investments just because of the open nature of it. In the desire to increase capital formation and jobs, sometimes the policy makers are willing to let the investor be exposed.

On one side, the policy makers want to make sure the borrower is protected, but not necessarily over on the investing side. If they want to invest in this, they should be OK because they are only going to be able to put in $2,000 or something. Well, in some cases they can't afford to lose $2,000.

What are your thoughts on virtual currencies like Bitcoin?

Everyone believes Bitcoin is the next money. I don't think it will be. It is a medium of exchange, sure, but the store value can fluctuate 50% in a given day.

At best, it is a security. At worst, it is a trading error. It is not backed up by any government and, at the end of the day, it needs to be converted to dollars. Why not just start out with dollars? As a merchant, I don't think you can hedge enough in order to accept it.

Former regulators are in high demand these days for bank management and boards. Do you think something like that is in your future?

Although I had not given it much thought, I would entertain the idea. The only things I have excluded at this point are day trading and joining the circus.