Don't Destroy Banks on the Mend

We are facing a record $350 billion deficit in fiscal 1992 - a deficit ballooned by spending to "resolve" hundreds of failing banks and thrifts.

The banking bills being shaped by Senate and House committees will unnecessarily cost tens of billions by stripping regulators of their ability to give leeway to improving institutions.

To paraphrase the bill's language, Congress says to the regulator, "Seize capital-short banks and thrifts, then try to sell their enormous asset portfolios sometime, at some price." Private capital is thereby driven away, boards of directors vacated, and the credit crunch just goes on and on. Benito Mussolini would be proud - we're seizing more banks than he did!

Do-or-Die Provisions

The bills that the banking committees have just passed contain mandatory takeover provisions for banks and savings institutions that are below capital requirements.

It is clearly in the public interest for legislation that will change institutions, moving them toward a stronger and more competitive system. Monumental losses from failed thrifts and failed banks have been set before the taxpayer. Now problems have surfaced in insurance companies. Thus, it is certainly appropriate that institutions posing a threat of additional losses to the long-suffering taxpayer be seized.

However, listen to a former regulator with 10 years' experience. I certainly support the prompt action by the regulatory authorities taken in the 1990s, much earlier than we had done in the 1980s.

My record and my support go to corrective action against loss-inducing, high-risk activities, forcing reserves against risky assets, and writing down nonperforming assets. This is being done. Read any thrift or bank's financials.

Too Many Closings

Right now, regulators are removing management and directors whose activities have resulted in declining capital and falling core income. Fine. The problem is, the regulators are closing not dozens but hundreds of thrifts and banks.

Here's the taxpayer trap: the two banking bills would strip the Federal Deposit Insurance Corp., the Office of Thrift Supervision, and the other regulators of their discretion. Already, private capital is being turned away from thrifts and banks by Congressional and regulatory actions and threats.

Failing institutions with billions in assets are thus forced into the Resolution Trust Corp. and away from the workout skills of private investors. The taxpayer is the loser.

Contracts and agreements entered into before August 1989, but revoked by the thrift bailout law or by arbitrary regulatory actions, have cut down or eliminated the accumulation of capital in bailed-out institutions. Thus, the taxpayer is more at risk.

A Crucial Difference

So it is critical that the regulatory takeovers differentiate between those capital-short institutions that are basically improving with new management and new boards, and those that continue with old management and exhibit declining capital and negative core income.

Check the many cases where management is successfully adding to capital and reducing asset risk, liquidity risk, and interest risk, but is doing so along lines proscribed by today's strong examination and supervision standards.

The immediate seizure of such institutions, which meet trend criteria but not the mechanistic capital requirement, will not result in a gain for the FDIC but rather yet another loss for taxpayers. The institution's franchise value would be radically diminished.

My experience as a regulator dealing with the bad guys tells me that it should be recognized that capital position is extremely important, but capital alone does not an institution make.

Not a Useful Yardstick

The bank bills link restrictive regulatory actions to a singular and mechanistic interpretation of capital. Financial institutions are complex creatures; one standard is inadequate for separating the good from the bad.

The banking bills' specifications of "2% capital or drop dead" are an imperfect measure of viability and solvency. How did the institution reach its present level, coming up or coming down? Capital is only an imperfect accounting measurement of past events.

Nor is capital a fool-proof predictor of an institution's viability. Trends in earnings, trends in capital, trends in disposing of problem assets are.

Identifying the Survivors

Yes, there is another way to tell the survivors from the drowning: adequate efforts to raise additional capital from existing investors and from other sources have been made.

You always have a fail-safe. The primary element of control is a notice by supervision to the owners that failure to achieve the goals of an approved business plan, or any evidence of undue risk-taking, will result in a conservatorship.

Congress should instruct regulators at hearings and in "legislative history" language to close declining institutions, but to respond favorably to institutions with increasing capital, increasing core earnings, and decreasing problem assets.

Ending the Brain Drain

Congress should clarify and restrict the application of civil money penalties against officers and directors to stem the flow of director resignations. Congress must restore government's credibility with the capital markets. There must be an effort to honor the transactions that have been done before.

So get involved with this legislation before it is too late to bring real-world experience to the banking mess. These are not just banking bills - they are matters that will affect your tax bill and the need of the United States to go hat in hand with its hundreds of billions in IOUs to the world's capital markets.

Mr. Martin, a former chairman of the Federal Home Loan Bank Board and vice chairman of the Federal Reserve Board, is now managing director of WSGP Partners LP, Los Angeles.

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