There are many lessons to learn from the savings and loan crisis of over 20 years ago, but the federal banking agencies, the Treasury Department and, now, Congress are ignoring one of them.
This week the House of Representatives has an opportunity to reinstate Section 113 of the Small Business Jobs and Credit Act of 2010 (HR 5297).
The House passed the bill on June 16 with Section 113, an amendment proposed by Ed Perlmutter, D-Colo. The amendment allows small banks to amortize losses from impaired real estate loans (and other real estate owned), with the length of the amortization period tied to the level of increase in the bank's small-business lending. The provision should help save hundreds of community banks from failure and encourage increased lending to small businesses and save or create hundreds of thousands of jobs.
The Senate version of the bill, passed last Thursday, did not include Section 113.
Many of the S&Ls that failed could have been saved had there been concerted efforts by the federal banking agencies and Congress. Commercial real estate values recovered from their lows of the 1980s, but the accounting for losses was based on a snapshot of depressed values and appraisals — all temporary, but nonetheless sufficient for more than 1,800 S&Ls and banks to be closed, at a huge cost to the deposit insurance funds.
History is repeating itself. Drastic reductions in current real estate values — in some markets such as Florida and Arizona, declines of more than 60% — are causing numerous banks to either fail or face failure in the near future. Many of these banks were considered financially sound and prudently managed by the federal banking agencies only three years ago.
Community banks in particular are suffering the brunt of these temporary declines in real estate values. They are not large enough to be saved through regulatory actions designed to avoid systemic risks.
Unlike money-center banks and large regional banks, community banks are having great difficulty tapping the capital markets. Community banks are a primary source of small-business loans. Without them, the administration's efforts to help small businesses operate and expand and produce more jobs will be stymied.
Section 113 allows small banks to amortize losses or writedowns on real estate loans over a maximum period of 10 years, but only for calculating bank regulatory requirements. GAAP would remain intact, thus banks will continue to report losses on their balance sheets and income statements under GAAP. Banks would be required to disclose the difference in their capital resulting from the temporary amortization.
Robert Herz, chairman of FASB, has distinguished GAAP rules, which are based on the need for transparency, from regulatory accounting principles. He has stated that regulatory accounting principles should be based on assessment of risk, not transparency. Section 113 is a regulatory accounting change, not a GAAP change.
It is legitimate for Congress to establish regulatory accounting principles that recognize the transient nature of crisis period real estate values for purposes of calculating regulatory capital.
This provision serves two purposes. First, it encourages banks to make more small-business loans, thus increasing the opportunities for small businesses to grow and to hire more employees. Second, it will allow banks to preserve regulatory capital, allowing some institutions to avoid insolvency and a substantial cost to the Deposit Insurance Fund.
Of course, regulatory capital is an important but not the sole factor in determining solvency.
The chartering authorities have broad powers to determine when to declare a bank insolvent. But capital has been a main determinant of insolvency, and once a bank's tangible equity drops to 2% or less of assets, the chartering authority must close the bank within 90 days unless it and the FDIC have made a determination that leaving the bank open longer would be in the best interests of the Deposit Insurance Fund.
Notwithstanding the compelling case for Section 113, the Senate chose to pass HR 5297 without that provision.
The federal banking agencies and the Treasury oppose Section 113. They wrongly believe that a repeat of the forbearance granted to savings and loan associations during the 1980s would add to the costs of closing banks. However, the forbearance for savings and loans preceded the enactment of FDCIA in 1991.
FDCIA required the agencies to adopt safety and soundness regulations and empowered the agencies to substantially limit the activities of banks and savings institutions that become undercapitalized.
The agencies also have general authority to prevent unsafe and unsound banking practices and require changes in management. Any bank that is given a lease on life through the amortization authorized by Section 113 will be subject to the stringent oversight and examination of the appropriate federal banking agency.
The opposition to Section 113 by the federal banking agencies and the Treasury should not stop the House from reinstating Section 113 when it votes on HR 5297 this week.
Passage by the House of a different version of HR 5297 would then require the Senate to vote on the House version for the legislation to be forwarded to President Obama for his signature.
Despite the attitude of some members of the House that the only choice, given the short time before recess, is to vote up or down the Senate version of HR 5297, there is time to do this right.