Author
Donald E. Powell took office as chairman of the Federal Deposit Insurance Corp. in late August 2001, a month after one of the nation's costliest bank failures of the past decade, and days before the tragedy of Sept. 11. He took charge of an agency whose staff had been halved as the industry it regulates underwent dramatic consolidation, and as much of the resolutions business of the early 1990s went away. And he assumed control with the nation in recession and as it contemplated the necessity of war.
Powell plunged ahead, logging hundreds of visits with
lawmakers, financial leaders and other agency heads; he appeared before
congressional committees, hosted banking conferences and applied corporate
management at his own agency. In less than a year, Powell had injected
new vigor into discussions of regulatory restructuring, deposit insurance
reform and other controversies, rapidly reestablishing the FDIC as a
national leader in banking policy debate.
Powell has never been one to shrink from difficulty. In the late 1980s, his bank, the First National Bank of Amarillo, nearly failed. Through months of crushingly hard work, he pulled it back from insolvency. "It was like a war mentality," he later told American Banker. "But you had a mission and you attempted to get it accomplished." (In 1994, the Office of the Comptroller of the Currency rewarded his efforts with a bottle of champagne, which Powell displayed in the bank's lobby.)
He brings that same attitude—and a very personal appreciation of the role of bank regulators and deposit insurance—to the challenges now facing the U.S. banking industry and its overseers. In an April conversation with Minneapolis Fed President Gary Stern, the FDIC chairman discussed, among other things, his thoughts on regulatory reform, the value of market data, the future of banking and the ultimate importance of capital. "The very best minds, the very best risk model ... cannot always anticipate the unknown," he said. "And that's the reason you have capital. Capital is the only thing I know that's forgiving. It's blood."
Credit Rating Agencies
Stern: Why don't we start with credit rating agencies since that's high on your agenda at the moment, and I know you have some concerns in that regard.
Powell: My concerns about rating agencies are really threefold. One is the lack of competition. I think we'd all agree that the more competition you have, the better the market works. The second is the way they're funded. If I'm an entity that is going to issue some debt, before the marketplace will accept it they want to know how it's rated. And as you know, rating agencies are funded by fees they assess from those that they rate. That in itself is potentially a conflict of interest. It doesn't have to be. But it's not good.
And the third issue is there's no accountability. You have accountability. I have accountability. Corporate America sure understands accountability. And if rating agencies are wrong, there might be some that would bring that into the open market, but really there are no consequences.
It's like being a college professor or a schoolteacher. There's no advantage to giving everybody an A. So the bias is always if you're going to err, be sure you err on the downside. And I'm not suggesting that's the only way. I've never worked at a rating agency. I'm sure if they were here today they would say we have lots of discipline, lots of checks and balances, we keep everybody apart. But the facts are we can't deny the lack of competition, we can't deny the way they're funded.
I'm not sure they have an appreciation for how much they can move the market. If we were the shareholders of some company, and our stock was downgraded, I can promise you it's an instant click in the market value and our capitalization. We may recover but we don't recover for those who sold the stock.
And another thing that bothers me—if we were on an investment committee for, say, the Minneapolis Foundation, and we go to a meeting tomorrow, the first thing is to look at our investments. We look at the buys and the sells. We look at the sells and say, "Wait a minute, why did we sell 3M, a Minneapolis company?" And they'd say, "Don't you remember, Gary, our policy says that we don't own anything less than triple B or double A." And you say, "Well, where's the judgment?"
Well, the judgment is given over to the rating agencies. Thus, we don't get to participate in the judgment, but we're accountable because if I'm the beneficiary of that trust and you're a board member and our value is not as much as it was last month or the month before, we're not going to call a rating agency. We're going to call you. We'll say, "Gary what are you guys doing here?" And you can't say to me, "Look, it's our policy." I'm going to say I don't care about your policy. All I know is that your returns were not what they were a year ago.
Stern: So, how do we fix this?
Powell: The Securities and Exchange Commission is looking at it, and I'm convinced that the SEC will come up with some thoughts and some recommendations, and it will give the marketplace an opportunity to respond to their thoughts and recommendations. But I think it's clear we've got to have more competitors. And I think that can happen. And then somehow we've got to make sure that judgment in the marketplace, that responsibility, is not delegated 100 percent to third parties. And that goes back to the marketplace, and so forth. It's just another opinion, an important opinion.
And then I think we've got to look at some ways that we can fund them, maybe through assessments.
Stern: Kind of across-the-board assessments?
Powell: Exactly. And you know, maybe it might be—this would be very radical—that we issue some debt that's not rated. And we find out what the market would do with a debt that's "naked of" rating. If you're a strong company, let's say IBM, and chose to issue some debt that's not going to be rated, what would the market do?
Stern: Well, presumably you'd get some, what I would call, nonrating agency analysis that would take a look at it. It's like a private placement.
Powell: Exactly, and you know, that's okay. I mean, I was CEO of a bank and for one reason or another we chose not to participate with some bank rating agencies.
Stern: I think I would agree that market participants certainly can do some of that.
Powell: Yes. I think it's an issue that has been highlighted by some of the corporate failures we've had. Enron—all of us know about what the rating agency did there, what the ratings were prior to their bankruptcy and the time that had elapsed between the downgrades and the actual bankruptcy filing. It wasn't very long.
And the same thing can be said of HealthSouth. And WorldCom and Tyco. But you know, we should acknowledge that people can make mistakes and acknowledge what the rating agencies would say: "We were dependent upon statements that were fraught with fraud."
But that's part of it, also. I think the rating agencies' role should be to look at management. To look at the governing board. To look at the products. I've visited some corporate CEOs who shared with me that, you know, XYZ rating agency comes in and they spend two days with them. A day and a half. As an old lender, I know that's not good business. You need to look at numbers. But you need to go to the person's place of business, understand their culture, understand what is really behind the numbers.
Stern: Of course, some of this relates pretty directly to bank supervision. We obviously send teams into banks and take a look, and sometimes we come away with a pretty accurate assessment but ...
Powell: Sometimes we're wrong, too.
The Future of Banking
Stern: That's right. Let's talk about banking a little bit: your experiences as a banker, how you found things once you got here in a public policy position, and what you think about the industry going forward.
Powell: I've only been here 19 months, Gary, but I've said it is good for a regulator to have spent some time in the industry that he or she is regulating. I think it's very beneficial. At the same time, I think it would be good for a banker to have to be a regulator, too. I've learned that there are two sides to the story since coming here, and I think that's important.
I've looked at it from one side of the fence and I had my thoughts and my ideas, but I didn't have all the facts. But I think it has served me well coming from the industry to the FDIC in sharing with the folks at the FDIC some practical experiences that have happened to me.
And the same thing is true in policy. I mean, we have some issues as we speak concerning regulatory burden. They're debating today [the interview was conducted in mid-April] in the House about the standards accountants and lawyers should be held to. Should they be held to the same standards that bank insiders and directors are? Or should their standards be different? And I have some thoughts I could add because I've come from the private sector and dealt with accountants and lawyers and understand the relationship between insiders and outsiders.
The industry is in remarkable shape, extraordinary perhaps in that I used to say all the time that the banking industry is just a reflection of the economy. That's not true in the last three years, as you know. Banks in 2002 experienced record profits. And yet we had an economy that was soft. We had lots of disruptions. We had lots of uncertainties. And yet bankers thrived. Why? I'm not sure that's ever happened. And you would have some views about that. Perhaps I would have something to add. I think it's four or five issues.
I think we learned in the late '80s to early '90s, from our mistakes. We took our medicine. We began to understand that directors should be independent. That we should have independent loan review. That we should have independent auditors. We signed call reports and certified financials long before Sarbanes-Oxley, and we diversified and the marketplace gave us new tools to make our risk profile and balance sheets much different than they used to be. We now rely on noninterest income. We don't want credit risk. We move it outside the banking system. As you know, there's lots of credit outside the banking system. So banks have improved—through new products, through new technology, through better management, through diversification.
And I would say the last thing is, and I feel very strongly about this: Capital is forgiving. Bankers have capital ratios that are at an all-time high so bankers recognize the importance of capital. This is because they can't put in their risk model everything that might happen to them. So I don't have any unique views, but clearly what's wonderful about this is that the industry has escaped the downturn in the economy.
Where is it going in the future? I struggle with that. We at the FDIC are doing a study, as we speak, on the future of banking. I don't have to tell you what's happened to the liability side of the balance sheet. There's been a tremendous amount, $3 trillion-plus now, that is in money market accounts. I think the bankers some time ago said, "You know, we're not going to pay interest on checking accounts," and they kind of lost that product and it went over to another arena. And I don't know if it will ever come back. I visit with a lot of the young people and they say to me, "Why do I need a bank account?" That bothers me. They borrow money, write checks, debit cards, credit cards, home mortgages, equities, securities, with a noninsured financial institution. That's the marketplace at work. I think the industry understands that and they're doing some things about that. And then obviously there's some on the retail side. There's some money that has flowed out of the banking system into the credit unions.
Stern: And yet as you pointed out, it was a record year for profits. My impression is that bricks and mortar hasn't disappeared—in fact, it's continued to grow.
Powell: That's an interesting discussion. I can remember as a young banker going to my first banking convention and this guy stood up and said, "We will be a checkless society by the year 1990." And the same thing was predicted about high tech: No more high touch. Today even the baby boomers want quick transactions. Young people are used to seeing a TV screen that's got four or five things going on it. They're not going to go into the bank, they don't care about a bank. They want to be sure they can do everything with a computer.
Stern: Maybe the answer is you've got to be able to serve the customer with multiple services and multiple vehicles.
Powell: Yes. Which leads me to conclude that bankers today recognize they've got to have the entire wallet. Anything that has to do with money, whether it's securities, annuities, life insurance, any kind of insurance products—they want to keep that customer relationship intact.
Stern: It's easy to imagine Citigroup doing that, but it may not be so easy to imagine a bank in Fergus Falls, Minn., or in Amarillo doing that.
Powell: That's a great point. What's interesting about the bank in Jefferson City, Mo., or in Minnesota or in Amarillo, Texas, is that I think the smart ones recognize they've got to do more than just accept deposits and make loans. And they're dependent upon third-party vendors. I know a guy who chartered a bank four years ago, sold it to a national organization. The customers came to that bank and complained about how the national organization didn't have the same technology that the small independent bank did, such as imaging of checks, e-mail statements. Now the large institution is slowly coming with imaging. You could say customers don't want that. Well, this customer did. And e-mail statements. Real-time stuff. And they were able to buy the same products. The new, big company didn't have any of the products, with the exception of one, that the smaller bank had.
The smaller banks are dependent upon third-party vendors. So they don't go out and spend a lot of money in building their own systems. They get it from the third parties, and third parties have been very competitive in that. You can't build it in-house for what you can pay the third parties. They're making a lot of money, and they're providing a service to the bank. So I think these banks are going to be able to compete.
It's the Wal-Mart story. I think we're always going to have large institutions that are very productive, great, sound, operate in a very businesslike way and return a lot of earnings to the shareholders. At the same time I think there's always going to be a place for the small independent bank that has a certain niche. Some customers still want to look that person in the eye rather than talk over a phone or computer. So I think there's going to be room for everybody. We'll see.
Stern: Sounds pretty optimistic.
Powell: We'll see. I mean, a lot of the small banks and the de novo banks are created thinking that they're going to sell it three to five years from now. But I don't think the market goes up and down. I've heard some of them say "well, you know, I can't get the multiple I want so I'm just going to keep this bank and operate the thing. And maybe pass it down if it's family-owned or operate it for a certain period of time and pass the management on to someone else." And it depends on where they are in the marketplace. I've watched independent banks thrive well in a market like Chicago, and I've watched large institutions operate extremely well in Canyon, Texas. Population 13,000. It's about people. It's about serving that customer.
Regulatory Restructuring
Stern: A few moments ago you touched on a number of policy issues, and one was regulatory burden. And of course you've also raised the issue of regulatory restructuring, which as we all know is an issue that comes around from time to time. Progress has been slow, to put it most favorably. I'm interested to know why you've chosen now to raise that issue once again and what you think prospects for progress might be.
Powell: I'm new. Everybody that's new comes in, looks at it and says, "Gosh, this thing's upside down. It looks like scrambled eggs. What can we do?" So I've got the benefit of being new. And then reality sets in and people say, "Don't bring that up, don't talk about that. You know it's worked well for 50 years and it may not look good, it may not feel good, but you know at the end of the day it works pretty well. And the political reality is it's impossible to do and you need to worry about something else."
And I acknowledge that. In fact, I will admit to you that this last symposium we had ["The Future of Financial Regulation: Structural Reform or Status Quo?" March 13, 2003; about 10 days before it was scheduled to happen, I said to myself, "I think I'm going to call our guys and say this is not good. It's silly. Nothing's going to happen. We're half-baked. This is not a wise investment of our time or the people that have agreed to participate."
Thank goodness I didn't do that. Because I was in attendance at that symposium and I learned a lot. I learned a lot about why it works the way it does and the benefits of the system that we have. And also learned—thanks to you and others—some ways that we could tweak it within the framework we have where we could do a better job of serving our constituents and also maybe saving some money for our industry and working better together. You had some great thoughts about that. [See "Top of the Ninth."] And then I also learned from some folks that maybe we could tweak it just a little bit and be more productive. Or maybe if we were more patient, we could do certain things.
But in the big picture, I think, nothing will happen unless there's a crisis. Should we continue to talk about it? Yes. I think we're irresponsible if we don't talk about it. I think it's good business for us to debate. I think it's good business for us to raise our hand and say, "Why are we doing this?" I think turf protection, politics, are not good reasons not to talk about it. Because what's happened is that the regulatory structure hasn't changed, and the market has been unbelievably dynamic. It's changed a bunch. I mean, look at the changes that have occurred in the last 15 or 20 years, and yet we haven't changed.
Stern: I think the marketplace generally leads the regulators.
Powell: That's true.
Subprime Lending
Stern: Well, let me raise another couple of policy issues. You talked a little bit earlier about earnings and how the last year was a very good year. But one area where we've seen some problems in recent years is in subprime lending, and we know that that can be a risky business. On the other hand, it's brought the benefits of credit availability to an audience that had more difficulty in getting its credit needs met earlier. So there's obviously tension there, and then you take that one step further, of course, to predatory lending and to the need for consumer education and so forth, something I know the FDIC has been paying a good deal of attention to. So I'd like to get your thoughts and comments on those sets of issues.
Powell: I think it's very important that we distinguish between subprime and predatory lending. I don't think they're one and the same. But sometimes they get lumped together either by consumer groups or regulators or other folks, so I think it's very important that we first of all distinguish that.
As you mentioned, subprime lending is meeting a need. These folks would not get into the subprime business if there wasn't a market out there. And I think it's a market that has been untapped in days past. I think subprime lending calls for certain regulatory oversight. And I think that's what the regulators are attempting to do. By its very nature, when you call it "subprime," it has increased risk, which calls for greater oversight, more capital, charge-off restrictions, rules, more regulation. But that doesn't mean to me that it's bad, that we should outlaw it, or say that insured institutions cannot be in the business of subprime lending. You just manage it differently because of the very nature of the animal.
Predatory lending, I think, is a different issue. Predatory lending to me is not lending. The way I describe predatory lending is where a lender owns the asset that is pledged and the borrower has the option to purchase it. And he or she exercises that option every time they make a payment. So it's with the intent not to get a return on the principal that you have loaned to someone. The intent is to get the asset that is pledged and make money off of that. And if they pay it, fine, because you're going to get a high rate of return. That in my view should be looked at; it's right on the edge of usury. Sometimes they exceed usury in certain markets. But I think that is not good for insured institutions. I don't think it has a place in insured institutions and in institutions that are regulated. If the marketplace wants it outside, that's it. I think it has some safety and soundness issues. But clearly emphasizing once again, predatory lending is not subprime lending and they should not be in the same bed.
One way the FDIC has chosen to address the predatory lending problem is through our Money Smart financial education curriculum. We designed it specifically to reach low- to moderate-income adults, since we know that learning to manage money and establishing healthy banking relationships is key to gaining financial freedom, building assets and achieving security. Since we introduced Money Smart two years ago, we've partnered with more than 13,000 groups and financial institutions nationwide, and 83,000 copies of the curriculum are now helping people learn everything from how to write a check to what steps they need to take to buy their own home. And I think it's especially important that Money Smart is available not only in English, but also in Spanish and Chinese—with Korean and Vietnamese translations being finalized—to address the needs of large segments of our immigrant population.
Deposit Insurance Reform
Stern: Let me raise another other policy issue that you've also been leading the charge on and that is deposit insurance reform. And in fact, I guess the House has resoundingly passed the legislation.
Powell: Right. Gary, I knew as a former banker that FDIC insurance was important, but I really didn't worry about it or think about it every day. It was just a given. It's like when I get on an airplane I know that the FAA has looked at the mechanics. They have to meet certain standards. And I just take it for granted. It's only when we have an accident that I start worrying about the FAA. So as a banker, deposit insurance was important. People would come in every now and then, and want to make sure that their accounts were insured.
But in about 1988 it became life or death for me as a banker, as it relates to liquidity, because our institution fell upon hard times. And people in Texas, in 1988 to 1991, were really concerned about safety. Those periods come and go. They come when people are really concerned about safety, making sure the institution is solvent. But they really don't focus on the institution being solvent. They focus on "is my money safe?" So the FDIC provides that peace of mind. The FDIC provides that safety. It's a symbol of stability for the American people.
Now having said that, when I got to the FDIC and got outside the industry, there are times that I struggle with issues of free markets and stability. Is FDIC insurance as important and relevant in 2003 as it was in 1933 or 1988 or 1989? Is it relevant in all seasons? Is it as important to the large depositor, the small depositor, the sophisticated depositor, the unsophisticated depositor?
This issue of moral hazard—I didn't know what moral hazard was until I came to Washington. This issue of the savings and loan crisis. Didn't FDIC insurance contribute to the crisis? Absolutely. But let me tell you some other things that contributed to the crisis. I was at a hearing last month with Rep. Leach, who was a member of Congress during the crisis, and I was a banker during the crisis. He spoke about the 1986 tax act and the thrift crisis, when their balance sheets were upside down: They were borrowing short-term, lending long-term. The oil embargo. High interest rates. Was deposit insurance a factor? Absolutely. But was it the only factor? No. And as Congressman Leach mentioned, FDIC insurance was a footnote.
Now there would be those who would argue about that, but that's one person's view. My view is someplace in between. But what was important was that we as bankers were making mistakes and exercising poor judgment. It wasn't the FDIC insurance. It was what we were doing with the money. In Texas, we could have gotten money, I think, if the cap had been $25,000 to $35,000 because we would have paid a good rate to get it in there.
Now as it relates to deposit insurance reform—that piece of legislation, that policy, is trying to address all the issues that have come up since then. Not everybody pays. I chartered a bank five years ago. We didn't pay one dime of premium. That's wrong. There have been large institutions that have put into the system up to $80 billion, but haven't paid anything in premiums. That's wrong.
Premiums are not based upon risk. I don't know of an insurance product in America or the world where premiums aren't based upon the risk profile. Ours is not. I mean, we have more than 90 percent of the people who don't pay premiums, and we say they're all alike. Well, they're not all alike.
Stern: Right. And we have the information.
Powell: Exactly, we have the supervisory information on their different risk profiles. And the other issue is the cliff effect—when the insurance fund gets to 1.25 percent of insured deposits and stays below for a year, we don't have a choice. We have to assess premiums to the industry. Now as regulators we don't treat our banks that way. Because if you have a bank and I have a bank, and my portfolio is loaned against traders, speculative traders, while yours is loaned against Treasury bills, who should have the largest insurance premium? And so, we at the FDIC ought to be able to assess and manage that within a range, with accountability and responsibility back to Congress and to the industry, but the range should be broader where we can use some judgment about when, in fact, premiums should be assessed.
Another thing is that there should be some credit to those who have
paid into the fund while others haven't. So FDIC insurance reform speaks
to assessment credit to those who have been paying into it.
Then there's the issue of merging the Bank Insurance Fund and the Savings
Association Insurance Fund. Nobody debates that we shouldn't merge them.
And the last issue gets back to coverage. And it's the whole issue of moral hazard. We at the FDIC don't know what that number should be. I haven't seen any empirical evidence that it should be $100,000 or $75,000, et cetera. But I do know that Congress, 20 some odd years ago set it at $100,000. I do know that's a fact. The second fact is in real dollars that's $47,000, so it's eroded. Is that good? Is it bad? Depends on your view. But those are two facts. So what we said at the FDIC is let's get it out of the political arena. Let's not react when there's a crisis and raise it higher than perhaps it should be. Let's just index it. And put that issue, that question, to bed.
Stern: Of course, indexing it could take it off the political agenda but not necessarily forever, so we could always come back and revisit it.
Powell: Absolutely. And I don't know what the overall coverage levels should be. I struggle with that, Gary.
Stern: There are a number of ways of analyzing what it might be, of course. But fundamentally I think you're making—at least for the deposit insurance side of it—a stability argument, which I think is an argument that many people would agree with.
Powell: You know, I'm a free market guy. But what happens most of the time is sophisticated folks get their money out and unsophisticated folks don't get it out. I was having lunch today with a very sophisticated academic fellow who has served in one of America's distinguished universities and also has served in a high position within the government. And he said, "I called my brother last week, a well-educated, small businessman in California. I said, 'Where are you banking?' He told me. I said, 'Tell me about the condition of the bank.' And he said he didn't have a clue. And I said, 'If I send you the financials could you tell me about it?' He said, 'No.'"
Stern: I think people, because they know their money market mutual fund accounts are uninsured, they at least take a look, from time to time, at whose commercial paper the fund owns. But where they think they have insurance, they basically say, "What do I care?"
Powell: Exactly. And we don't care about insurance in good times. In fact if you ask me today, "who has your insurance?" I couldn't tell you. I don't know who my insurance carrier is. I could tell you who my agent is. But if I go home tonight and Virginia's flooded and my next door neighbor is flooded, you know what the first thing I ask my wife is? "Would you get me the insurance policy? Do we have flood insurance or not?" Well, why did I ask that question? Because there was a flood. So we don't care about it when times are good.
Too-Big-To-Fail
Stern: Let me move on to another topic, one that I know came up in your confirmation hearing, namely "too-big-to-fail." That's something that we spend a lot of time thinking about at the Minneapolis Fed, and I know that you have some thoughts as well.
Powell: I'm anxious to read your forthcoming book. [Too Big to Fail: The Hazards of Big Bank Bailouts, to be published by Brookings Institution Press, December 2003.] In fact, I wish I knew what your thesis was so I could respond to it.
Stern: Well, basically, it's that too-big-to-fail is a serious potential problem that people haven't thought enough about and that we should try to address it in these relatively tranquil times before we come to another crisis. It's very hard in the midst of a crisis to worry about longer-term steps. And ultimately, we offer proposals for steps that we think ought to be taken now.
Powell: I'm glad you're writing that. As you know, there are relevant laws on the books, so I think the Congress has spoken to that particular issue. I will tell you that we at the FDIC have some folks who are modeling and going through a simulation process of an institution of $200 billion, and what will happen if in fact that institution should fail, because in today's marketplace these institutions are very complex. And so we're doing that, having that fire drill to make sure that we can speak to that issue.
My personal view on too-big-to-fail is that there should not be such a thing. All institutions should be held to the same standards. Shareholders lose their money, creditors lose their money, management loses their jobs. But I also recognize the importance of the systemic risk. Is it in the best interest of America that these be managed somewhat differently? It's a complex issue. And again Congress has spoken about it because they recognize it's a complex issue. But even since that law was put on the books, I think the balance sheets of these institutions have become more complex than they were.
We had an interesting example of that at not a large institution but a unique institution, a credit card bank that failed. It led us to the question: How do you deal with the securitizations? How do you deal with closing the book on those cardholders? What's the systemic risk associated with that? And we learned some things. Most of the things we did were good, but we stubbed our toe on others. And it has a ripple effect. Let's say you have a credit card bank that fails in November. It's Christmas. Do you shut down those cardholders? What happens to the securitization? Do you trigger something there?
That's just an example of how complex these things are, and I don't think anybody in America wants anything that would cause any unintended consequence that may happen. Having said that, I'm eager to read your book. Because I think there are some things that we could probably do better in speaking to these institutions. Plus, these institutions are not only complex, they're large. The largest bank to fail during the 1980s was $34 billion.
Stern: What makes the too-big-to-fail issue difficult is the "big" part. Those are large institutions and some of them clearly would have systemic implications.
Powell: No question.
Stern: For the vast majority of banks in the country that are relatively small, failure may be difficult for some of the customers, for the community, obviously for the equity holders, but it's very contained. And in many ways, it's like any other business that fails: It's unfortunate but it doesn't threaten the economy.
Powell: Which is another question I could ask you—though you're doing the interview—how big is "too big"? Is there such a thing, in a free market? We've got through 6 percent and 10 percent of deposits now, but organically you can have 80 percent, or 100. I'm looking forward to reading your book.
Market Data
Stern: One of the things we advocate in the book—and I'm going to ask you about it—is more use of market data in both the examination process but also possibly in setting deposit insurance premiums and so forth.
Powell: That's part of our model on the risk-based premiums. I think we're going to look at lots of things—the traditional, the CAMEL ratings, the bank regulatory ratings, but then we're going to look at third parties. I mean, look at their market capitalization, at their stock. Is their price/earnings ratio out of line? Is their volume out of line? All the things that you would look at as an investor. Something's kicking out here. What's going on here at this particular institution? Obviously, look at their ratings by the third party. But get inside those other things, you know. Why is the market treating them differently?
Stern: Yes, I don't want to make this too much of an editorial comment, but obviously investors have real money at risk; we might be able to learn something from the judgments they make.
Powell: Absolutely. In fact, we ought to piggyback that.
Stern: So I gather you would be favorable to greater use of market data as it relates both to your premiums and to using it in the supervisory process?
Powell: Absolutely. Absolutely.
Basel II
Stern: The last question I would pose, at least for the moment, is about the Basel II Accord. Obviously that train appears to be moving, and yet it is a very complex proposal. How do you feel about the merits of Basel II? Do you have any concerns about it?
Powell: Gary, I came into that game a little bit late, so I am hesitant to make a lot of comments about something that was going on way before my time, and a lot of good people worked very hard on that. I think the leadership of the Fed and our friend in New York, [President] Bill McDonough, has been extraordinary. I think a lot of good people worked very, very hard on that. So I hesitate to offer any views—except the following [laughs].
There is nothing that replaces capital. Anytime we have a system that doesn't have minimum capital standards, I don't think that's good. I don't know what minimum that should be. We have minimum capital standards today and I recognize that the marketplace has moved, and the way in which we measure capital and call for capital is outdated, and I applaud changes to reflect that. Not all assets are created equal. But the very best minds, the very best risk model, the very best management cannot always anticipate the unknown. And that's the reason you have capital. Capital is the only thing I know that's forgiving. It's blood. So we've got to be very careful that we don't do anything to diminish at least some type of minimum capital.
The second thing I would say is there's nothing like good old common sense and judgment. And the more we rely on models and get away from culture, get away from judgment, experiences, we've got to be very careful. Should we have models? You bet. Should they be sophisticated? You bet. Should we tweak them? You bet. Should we always turn them over? You bet. Should we look at them? Should we discipline ourselves when they kick out certain things? We got to do it. And those that don't will get in trouble.
But I think it's all a blend of those things, and you got to put common sense and judgment and experience into that, as well as making sure you have some minimum capital standards.
Stern: Presumably these models, especially the very sophisticated versions, are only going to be applied and/or utilized by the top 10 or 20 holding companies, so the vast majority of banks—if it plays out that way—won't be affected.
Powell: That's the hope. That it's competitive, that it doesn't hurt medium-sized, regional institutions, large institutions, or it doesn't favor one over the other. Obviously, at the FDIC, we're big fans of small institutions, large institutions and those in between. But I don't think we as regulators should do anything to favor one or another. But there is concern about that. We need to be disciplined and answer those concerns.
Mark-to-Market Accounting
Stern: One further question on capital and that is market value or mark-to-market accounting. Obviously that's another issue that's been around for a good long time. Bankers, in general, have not been in favor of that, and yet the economic basis for something like that is pretty strong. And it's my impression anyway that at least some of the big banks attempt to manage their business that way. Do you have any thoughts on that issue?
Powell: That's a tough issue. If I put on a nonregulator hat or if I put on a regulator hat, I may have two different views. You know, once you go down that path—putting everything mark-to-market—then what's the criteria for market?
If you and I had a loan portfolio and we want to mark it to market, we could pretty well do that with interest rates. But as it relates to the value of the principal, we'd have a difference of views about the collectability of those, and should we discount them, should we not discount them. And as you know now, mergers are accounting for that. I think the accounting profession, I think the SEC and I think we as bank regulators all have some views about that. My instincts are, Gary, we'll leave that alone right now. The current system has served us pretty well, and I think we ought to leave it alone in a traditional bank. I agree with you that the large institutions pretty well do that now. And according to generally accepted accounting principles for corporations, they mark them down to market all the time. I think there's an article in today's Wall Street Journal about Boeing writing down their assets. We do that already in many firms.
With banks, it's a little bit more difficult if you go on a cash basis, or moving everything to mark-to-market. It especially becomes very tricky in the securitization issues and it becomes very tricky in some other assets that bankers hold, but you know at the end of the day if I were running an institution, especially a large institution, I'd want to know how my assets were perceived by the marketplace.
I can remember for some of the assets of failed institutions, we'd have someone come in and value the assets. And you know what? The marketplace didn't believe that. They went a different way. And these were experts. So we have real proof of that. You know, these were loans and we'd say, "Well, we've got a third party that's an expert who said they're worth this," but when we put them out for bids sometimes we got more, sometimes we got less. That's the reason it can be so difficult to put those things mark-to-market.
Stern: Thank you, Don.
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