A common theme at failed banks: CEOs refused to hear bad news.

A Common Theme at Failed Banks: CEOs Refused to Hear Bad News

What are some of the characteristics that many of our most troubled banks shared in common?

Certainly, one factor was that their territories frequently had economic difficulties - so that a good economy was no longer bailing out poor credit decisions.

On top of this, many of these troubled institutions had concentrated all their lending in their local regions, so they had no chance to avoid trouble when their states' economies slumped.

And this situation was to a large extent the result of our strict state branching laws, which hemmed in banks.

It's Management that Counts

But there's more to the story. After all, many banks have made it despite poor territories.

And the disparity between banks that did well and those that didn't - in both good and bad territories - shows that the key to success is management and the corporate culture that the managers have imposed.

Trying to find the common characteristics of the corporate culture of many of our notorious problem banks, I have been told over and over again by people who worked for these institutions that one of the most common traits of the chief executive officers of these banks is that they didn't want any bad news.

The old practice of killing the bearer of bad news had its effect on subordinates in many institutions, with the result that after a while the CEO felt that everything was wonderful.

Anger Instead of Action

For example, I was told that when the head of one major bank, now the property of the FDIC, was told at a meeting by one officer that there were troubles brewing in the credits in his region, the response of the CEO was to get angry and yell: "Quit moaning and start loaning!"

Far more serious, I talked with a lending officer of a bank that had participated on a loan to finance a resort hotel with a bank run by a "no bad news" CEO.

The hotel got into trouble, and the officer I talked to wanted to take it over before it went bankrupt.

The account officer of the "no bad news" bank responded, however: "We don't foreclose on property if we don't have to, because then we would have to tell the chief, and as long as it is still operating, he doesn't have to know."

But when these CEOs who have wrecked their banks, ruined the careers of so many bank people, and cost the shareholders and taxpayers so much money are asked what went wrong, many report: "It was someone else's fault" or "The loan officers let me down" or "It was the change in the tax act that caused my bank to fail."

Who Was Watching the CEOs?

What about the boards? It is obvious that many knew little or nothing.

We saw in official records, for example, that Bank of New England directors were buying the bank's stock just shortly before the stories of financial disaster hit the press and the stock plummeted. Obviously, they had been given the same optimistic forecasts.

But how are boards picked? They are usually picked by the CEO and remain in place based on his consent.

In too many instances, it is only when the board members see the rising tide of lawsuits, inquiries from the examiners, and other rare notices that they might be held personally responsible for some of the bank's losses that they dig in and try to decide if they have left this institution under proper guidance.

A Know-Nothing Philosophy

Again we have seen too many boards that are composed of people with the same know-nothing philosophy as the CEOs in question.

"Look, I'm just a druggist. What do I know about running a bank?" is the way many respond when questioned on their status.

Would a pharmacist sell pills without knowing what he is selling? No. Yet he sits on a bank board and accepts whatever he is told.

In time we are likely to see the end of the "too big to fail" doctrine. This should result in depositors with more than the insured ceiling taking a haircut on the value of their claim in any bank that fails - large or small.

Such a reform would result in large depositors needing private insurance. And this in turn would involve an investigation of the bank to help the insurer set his actuarial position and evaluate his risk.

One can only hope that when such investigation does take place, we will see emphasis on the corporate culture, the willingness of the CEO to hear the truth and to act on it, and on the board knowing what it is doing and fulfilling its role as the only group that can override a CEO who decides to operate his bank like a feudal lord would.

This is far more important for the future of banking than counting the cash and deciding what the assets would be worth if we evaluated them at market instead of book as interest rates shift.

Mr. Nadler is a contributing editor of the American Banker and professor of finance at the Rutgers University Graduate School of Management.

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