How regulators can kick COVID-19’s bank shock into remission
By William M. Isaac and Thomas P. Vartanian
The United States is confronting its most serious pandemic challenge ever.
The longer it lasts and the more severe it becomes, the more likely that the health of financial institutions and their ability to support the economy will suffer as well. If that happens, it could detonate a string of risks already embedded in the system that could ripen into a severe financial crisis marked by shrinking lines of credit and liquidity constraints.
It is time to start thinking about possible antidotes. One such antidote might include releasing financial institutions from at least some of the blizzard of federal and state rules and ratios they’re subject to so that the impact of the coronavirus does not become a longer and more expensive financial event for the American people.
Read more: Complete coverage of the coronavirus impact
Financial regulators have a weapon they can use to address such financial predicaments. It is one of the oldest in their tool kits: good old-fashioned forbearance.
Forbearance waives the normal rules of engagement in extraordinary economic circumstances and suspends extraordinary regulatory actions until things get back to normal.
Federal regulators began laying the foundation for forbearance last week by issuing statements that permit banks to work with borrowers as conditions worsen, and the ability to repay loans is diminished. Loan payments falling into arrears will not automatically be classified as problems and written down, forcing banks to charge off losses.
Similarly, banks that begin to experience capital and liquidity deficiencies should be given time to come back into compliance so they can afford borrowers the time to get back on their feet.
Going even further, if all nonessential regulatory compliance requirements were suspended, it could free up an army of bank employees that handle regulatory compliance on a day-to-day basis so they could address the emergency in a more effective way.
Congress has imposed laws, rules and ratios on financial institutions which in times like this limit the ability of lenders and regulators to do their jobs. The Dodd-Frank Act of 2010 thoughtlessly prohibited the Federal Reserve and the Federal Deposit Insurance Corp. from using the powers that they so successfully employed over the years (like with the failure of Continental Illinois National Bank and elsewhere) to douse financial fires while keeping it from spreading throughout the country and world.
Yes, the banking system has rebuilt capital and liquidity in recent years, but it is foolhardy to limit the powers of the Fed and FDIC to deploy resources wherever needed in the financial system.
There are equally compelling reasons to dull the impact of market-driven accounting conventions that may once again boomerang on financial institutions as it has in the past. The accounting industry, thanks to the standards created by its seven-member Financial Accounting Standards Board, has locked financial institutions into impractical and unintended economic situations.
The 2008 financial crisis was due, in no small part, to the mark-to-market accounting rule known as SFAS 157, which resulted in the senseless destruction of $500 billion of capital in the banking system.
Mark-to-market accounting suffered then as it still does today from obvious limitations. It is implemented only with regard to one part of the balance sheet — assets — and ignores how those assets are funded. When every financial balance sheet reacts the same way, in the same financial circumstances and requires the same fix, it is difficult if not impossible for regulators to manage a crisis.
Today, there are accounting standards that should be modified substantially or eliminated. For example, the FASB is pushing another form of mark-to-market accounting, known as CECL (current expected credit losses), which requires banks to estimate losses over the life of the loans and write down the entire amount up front.
This is almost certainly going to diminish longer-term bank lending at the worst possible time. This represents yet another a powerful reason that seven unelected people should not be able to set accounting rules for the financial system without strong oversight from the Fed, FDIC, SEC and the Treasury Department.
Financial institutions should have the opportunity to survive economic aberrations so they can enable their customers do the same. An inflexible, “take-no-prisoners” approach in the 1980s would have nationalized nearly all of the Savings & Loan associations and largest banks in the country.
Still, there were roughly 3,000 banks and thrifts that failed in the 1980s and without question, thousands more would have failed had the Fed and FDIC not utilized their emergency powers. The country — even the world — would have gone from a serious recession into a depression.
There is no reason for the financial backbone of the country to be crippled by a temporary health crisis. Practical, common-sense action requires a liberal dose of regulatory and accounting forbearance to get everyone through this crisis.
William M. Isaac, a former chairman of the FDIC and Fifth Third Bancorp, is co-chairman of The Isaac-Milstein Group. Thomas P. Vartanian, a former regulator of and lawyer to financial institutions, is executive director and professor of law of the program on Financial Regulation & Technology at George Mason University’s Antonin Scalia Law School.