Memo to the ERC: What led to Dodd Frank?

For the most part, I’ve enjoyed the articles of Mary Owens — a financial services person and  the latest chairperson of the Nevada County Economic Resource Council — in The Union about economic matters. I’ve never met Mary, but she did reach out for me to connect with her on LinkedIn.

Mary’s analysis is more sophisticated than the normal pabulum, unintelligible screeds and podunk reporting that the newspaper typically dishes up to its subscribers.

But I had to scratch my head at Mary’s column in The Union this week. She wrote: “The Dodd Frank bill dramatically limited how small and regional banks can lend money. This limitation hit local and regional real estate developers unusually hard. But that was not the only impact on real estate developers. Dodd Frank also dramatically increased the qualification standards for home loans. Without question, the lending standards that were allowed to exist for the five years prior to the housing bubble had to be improved. But Dodd Frank went too far.”

But nowhere in her article did Mary mention the lending practices of small and regional banks that led to Dodd Frank, including the ones in our region. Hello???!!!

We don’t do a good job of looking in the mirror and holding ourselves accountable for the outcome. That’s unfortunate because it keeps us from coming up with meaningful solutions.

Author: jeffpelline

Jeff Pelline is a veteran editor and award-winning journalist - in print and online. He is publisher of Sierra FoodWineArt magazine and its website Jeff covered business and technology for The San Francisco Chronicle for years, was a founding editor and Editor of CNET News, and was Editor of The Union, a 145-year-old newspaper in Grass Valley. Jeff has a bachelor's degree from UC Berkeley and a master's from Northwestern University. His hobbies include sailing and trout fishing.

9 thoughts on “Memo to the ERC: What led to Dodd Frank?”

  1. Respectfully Jeff, I think there needs to be a distinction between the particular circumstances of some local banks that may have behaved badly in the recent past, and the larger question of what impact Dodd Frank has had on community banks, and what regulatory scheme is best to encourage the flow of capital today while creating appropriate levels of transparency and accountability.

    Let me preface my statement by answering your question, “what led to Dodd-Frank?”

    What led to Dodd-Frank were the abuses encouraged by the increasing connection between commercial banking (or managing deposits to make loans upon which the bank earns a commission) which encourages a conservative culture and investment banking (or the management of funds including deposits to trade financial instruments like stocks, bonds, or more exotic instruments like derivatives, and proprietary trading, or the investment of a banks own assets for its own direct gain) which encourages a risk taking culture.

    This connection was strengthened by the repeal of the Glass-Stegall Act (1933), which limited these activities under its “affiliation” provision that limited the affiliation of commercial and investment banking activities, with the passage of the Graham-Leach Act (1999) that significantly weakened these key provisions.

    In the words of economist Joseph Stiglitz, “repeal of Glass-Steagall brought investment and commercial banks together, the investment-bank culture came out on top.”

    But it is important to note that community banks, or banks managing less that $10B in assets, which is the FED definition, never played a substantial part in the post Graham-Leach rise of the risk taking culture, and remained relatively conservative in their practices and lending profiles. The economic collapse of 2008 was led by larger national banks with investment banking components not community banks. To put this in perspective, according to the Federal Reserve Board 94% of the banks in the US have less than $10B in assets, but they manage less than 20% of the capital, meaning the larger national banks control 80% of the capital.

    And this gets to Mary Owens point, which I believe is spot on: the regulation designed for the big national banks is not necessarily the regulation appropriate for a community bank and imposition of those standards can retard local capital investment.

    The purpose of Dodd-Frank was to reduce risk from trading in exotic financial instruments that places the solvency of larger national banks with both a commercial and investment banking component at risk, and increase transparency and accountability for ALL banks across the board, in order to avoid the near collapse of the system we experienced between 2007-2009.

    I believe it is important to note that almost all of the almost $9 Trillion in “bailout” money spent since 2008 (if you included TARP, AIG, Bear-Stearns, purchases of commercial paper, the Federal Home Loan Guarantee Program, et. al.) the vast majority of it went to a handful of roughly 50 top financial institutions, and almost none of it went to community banks. To be fair community banks benefited greatly from the stabilization of the markets and the gradual improvement of credit availability from the Fed.

    But since 2010 we have seen the role of community banks shrinking in capital markets—in 1994, before Dodd Frank, community banks managed almost 40% of all of the assets held by banks; and after Dodd-Frank, in 2015, that level has gradually fallen to the 20% of assets—and that is a big problem. The primary places community banks have been losing market share is in consumer, real estate and commercial and industrial lending. That means your local small businesses increasingly have to go to the “big” bank, which does not know the community, to get credit, if they can even qualify.

    Community banks are not big banks. They specialize in having a more direct relationship with their customers because at least theoretically they know them from their community. Community banks may manage only 20% of the assets but they make more than 75% of all agricultural loans and more than 50% of all small business loans in the US. Consequently failing to check the decline in market share in community banks will hit rural regions of the country the hardest.

    Community banking plays a particularly important role in residential real estate lending—largely because assessing risk requires and intimate knowledge of the community, mortgage availability, local markets, and political conditions—and these are precisely the types of loans that are most important in a market like Nevada County, where almost all development is on the small scale thus few of the loans are going to be in the large amounts needed to attract REIT’s or big lenders.

    I am a strong supporter of Dodd-Frank—in many ways I don’t think it went far enough on investment baking or created enough protection in the consumer credit markets—but the idea that ONE regulatory scheme works for every size market is just unrealistic.

    Community banks by and large have done an excellent job managing their risk (even if there may have been a particular bank once managed by the opaque boys network that did not) and are still losing market share. If that continues it will make credit much more difficult to get at the local level and only exacerbate the Main Street decline in favor of Wall Street that we have been seeing accelerate since 1999. It is entirely reasonable to be looking at different scales of regulatory schemes for different scales of risk, which is essentially what Ms. Owens was saying.

    Should we have had more local transparency in the past, sure, but the real issue is how do we make credit available in our community now while learning from our lack of transparency in the past?

    I say sock it to the big boy banks who can afford it while creating a rational transparent system at the local level for community banks, and we will see Main Street taking back market share from Wall Street, which is a very good thing.

    1. Hi Steve,

      I guess I should have been more direct, but I wanted to be more genteel. The failure of smaller, local banks such as Citizens Bank also helped lead to tighter regulations, not just the big banks. We can’t escape that and have to be accountable for it. I’m still not sure we learned from it.

      As this GAO report states, “The (local) failed banks had often pursued aggressive growth strategies using nontraditional, riskier funding sources and exhibited weak underwriting and credit administration practices.”

      I think there’s enough blame to go around, and we have to own our end of it.

      In more recent times, local banks have indeed benefited from the stabilization of credit. In fact, their stocks have been outpacing the gains in big bank stocks in a lot of instances.

      Having said all this, I would like small banks to prosper, just like big banks, and Dodd Frank is a problem. But it chaps me when the finger pointing doesn’t include a look in the mirror. We can learn from that.

  2. Steve,
    That was a very clear summary that will help understand what Mary has been saying for quite some time. Locally, it does affect our ability to finance housing projects which are needed for our population. In the valley or the Bay Area, there is a lot of residential building, but it is mainly large apartment complexes for moderate to higher income families. That is what I saw in Mountain View a couple weeks ago. Anyway, nice information to have.

  3. Perhaps we need to get beyond the past and work a little more effectively together on the future?

    Both housing and jobs are important. I would identify 3-4 issues as intrinsically linked together–jobs, housing, transportation, broadband access, access to capital and access to a trained labor force–and working on each is important in crafting a new economy in our region that goes beyond legacy resource management, recreation and tourism, which are lower wage service sector jobs.

    One thing that always fascinates me is that we have a tendency to identify the “thing” we think is the key–“solve housing and everything else flows”– and then fail to see the whole system.

    Although these issues comprise a system no individual intervention is going to get us what we want–prosperity, social mobility, community character–so dozens of people working on the issue from a dozen angles is what is really necessary. Getting them to see each other as collaborators in achieving the future vision is critical.

    Dan, I appreciate your comment, What Mary Owen is working on is incredibly important. The less capital rural regions have access to the more difficult it is going to be to achieve our goals. This is particularly important as other sources of public funds like USDA are diminishing. One way to do that is to create a more approachable regulatory scheme for community banks, but another, and I would argue more important way, would be to create local community investment funds that can be used to leverage public financing for housing.

  4. Thanks Steve.
    We need to learn from the past.
    “Those who fail to learn from history are doomed to repeat it.” — Sir Winston Churchill

    Otherwise, glad this blog could help bring Steve Frisch, Dan Miller and Mary Owens together in a dialogue! Our family’s life is in both ends of the county, not just one, and I never understood why it was so one-sided — except for that pass. Have a great day everyone!

  5. George Santayana would be please with the alleged Churchillian appropriation of his advice that, “Those who cannot remember the past are condemned to repeat it.” I think he would also agree with Shakespeare’s original meaning saying in The Tempest that, “What is past is prologue.” The purpose of the past as Jeff points out is that our lives up to this point — are merely a prologue — an introduction — to the opportunity that can be embarked upon. It guides the future. We can learn from the ‘irrational exuberance’ of an event like embracing a high risk profile like Citizen’s Bank did in the go-go real estate days of the early 2000’s–so be it–but our eyes should be on the future. Living in the past is a millstone.

  6. Yes, embracing “smart” housing projects is the way to go. In fact, both Grass Valley and Nevada City have been approving some housing projects — facts that are getting buried in the broader rhetoric.

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