Article

Stay Calm

By Hannah Wallace August 31, 2008

Most Sarasotans know Bill Isaac from his role as a developer of

Pineapple Square
in downtown Sarasota. But Isaac served as chairman of the Federal Deposit Insurance Corporation, or FDIC, from 1981 to 1985 during the savings and loan crisis and is now chairman of the Secura Group, a financial institutions consulting firm. Isaac says there’s no need to panic about the state of banking in the U.S. 

 

Q. Some people are predicting a widespread financial meltdown, maybe even a depression. How worried are you?

I am not worried about a depression, and I don’t think we’re headed for a widespread financial meltdown. The 1980s were a horrible period for banking. From 1980 to 1991, we had 3,000 banks in failure. At the end of 1991 we still had 1,500 on the problem bank list. That’s 4,500 banks that failed or were headed that way. Currently, the FDIC put 76 banks on the problem list. I do believe we’re going to have more problem banks on that list, and we’re going to have more bank failures, but I’m not expecting anything resembling the 1980s unless the economy craters, and I don’t expect that to happen.

Q. What is the most serious threat to our economy?

If people were to stop spending and put money in a mattress. If the banks stop lending, the economy will worsen. Credit standards have tightened, and that always happens when the economy gets in trouble. Regulators need to work hard that they don’t make it worse. I always believe a regulator should lean against the wind. If everything looks sunny and the economy is booming, the regulator needs to encourage banks to be careful and watch their credit quality. In an economy like this, the natural tendency for banks is to tighten up so regulators need to encourage them.

Q. Should banks have predicted the crisis? Take us inside the heads of lenders two years ago—what were they thinking, and why?

The subprime lending problem is not widespread in the banking system. There are problems that might be developing in a broader range of financial institutions—some auto loan problems because of the softer economy and higher gas prices, credit card problems and problems with commercial loans—but the great bulk of the problems to date are in a handful of very large banks. The banking industry earned $140 billion in 2006. That’s a lot of money, a record. In 2007, it had fallen to $105 billion. You can explain that $40 billion decline by looking at the losses of only five or six banks. So the difference between the record year and the decline in 2007 does not fall on the shoulders of 8,000 U.S. banks. A lot of community and regional banks are doing really well. I don’t think they gave out anywhere near, relatively speaking, the number of bad loans.

Q. But why did some of these problem banks give out so many bad loans?

I don’t think the large banks did it knowingly. It wasn’t their lending. Wachovia made a large acquisition at the wrong time. They bought a big thrift in California at the peak of the market. It was not good due diligence. A lot of the losses taken at some of the bigger banks are due to the fact that they were assembling these mortgage-backed securitizations and selling them in the worldwide markets and they got caught when the music stopped. When the economy gets heated, lending standards start to decline. Everybody gets caught up in the euphoria. I think for the most part banks didn’t relax their standards that much. There were things that happened in the marketplace that were not expected. Let’s take the mortgage-backed securities. There was not a market for them so the banks couldn’t sell them. They took huge write downs, 50 to 60 percent. If they hang onto them I think they’ll mark them back up. I think there will be some recovery.

Q. Then why are bankers sounding so pessimistic?

I honestly think we’ve talked ourselves into a funk as a nation. I know there are problems out there. But I think a lot of this is media-generated. I was in a meeting with CEOs of 40 banks a few months ago, and we asked the bankers, ‘Are we in a recession?’ They all said, ‘Yes.’ Then we asked, ‘How’s your bank doing?’ Almost everybody said their bank was doing well. So we asked, ‘How does it look in 2009?’ They said, ‘We’re going to do well.’ There has been a lot of negative publicity and focus on the financial crisis. Headlines like, ‘This is the worst crisis since the Great Depression.’ It’s simply not true. There are no facts that bear that out. Look at the failures—six last year. Look at the performance of most of the banking industry and you can’t say we’re in a banking crisis of unprecedented proportions. That doesn’t mean we don’t have turmoil. We do. That doesn’t mean things might not get worse. They might. But I think we’re overreacting. IndyMac failed, and it’s trumpeted as the second largest bank failure in history, and that’s technically true. But IndyMac is less than two tenths of one percent of the banking industry’s assets. There was a tremendous negative reaction to IndyMac but it wasn’t a big event in the banking system. It was a thrift that specialized in high-risk lending and the business plan failed. Sen. Chuck Schumer from New York wrote a memo asking ‘What’s going on with IndyMac?’ and when a senator writes a letter it spooks people and they withdraw their money.

Q. What strategies should be in place so this doesn't happen again?

I do think we have some issues we need to address. One serious issue is fair value accounting, which is pro-cyclical. Fair value accounting requires that financial institutions mark assets to market value, rather than carrying them on their books based on cost, as banks have traditionally done. If historic cost is used, it enables banks to get through what we hope are temporary distortions in the market. As we learned with the mortgage securities, fair value accounting doesn’t work when there’s no market. When we require banks to take big writes offs, it reduces their ability to lend. I have seen one estimate that the write offs to date have reduced the ability of the industry to lend by $1 trillion. In the past, we have relied on the bank examination process to determine when bank assets are permanently impaired and must be written down.  We need to consider returning to that system because fair value accounting creates too much volatility and instability.

Q. Do you predict that banks will be doing a lot of short sales to avoid having all the nonperforming loans on the books at the end of the year?

I was just having a conversation about this with some people, and they don’t find many bankers who are in the mood to do that. Right now, nobody seems eager to sell at distressed prices. They’re not that pessimistic. Sarasota is one of the strongest real estate markets in the state right now.

Q. It’s hard to get a loan now. Do you think banks will loosen their credit lines?

I hope the banks will loosen up a little bit.

Q. You’re the chair of the Secura Group. Is that keeping you busy?

With that and

Pineapple Square
, I’m more than busy. I was up at 4 a.m. today.

At

Pineapple Square
, we’re in Phase One and that’s going well. And hopefully near term we’ll be announcing some more stores that are coming. Phase Two is waiting for the condo market to come back.

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