Tags: GAO | banks | fail | regulators

House Subcommittee Considers GAO Study of Bank Failures

By    |   Wednesday, 03 April 2013 03:14 PM

This third of three articles reviews a study by the Government Accountability Office (GAO) titled “Causes and Consequences of Recent Failures of Community Banks,” one of the studies that were reviewed by the House Financial Services Committee’s Subcommittee on Financial Institutions, chaired by Rep. Shelley Moore Capito, R-W.V., at a March 20 hearing.

Previous articles looked at related reports by the FDIC http://www.moneynews.com/Robert-Feinberg/FDIC-Dodd-Frank-bank-real-estate/2013/04/01/id/497256 and the FDIC’s Inspector General (IG) http://www.moneynews.com/Robert-Feinberg/FDIC-IG-banks-regulators/2013/04/02/id/497465. The reports by the IG and GAO were mandated by legislation sponsored by Rep. Lynn Westmoreland, R-Ga., a homebuilder in Georgia, a state that experienced a wave of real estate speculation from 2008 to 2011.

Lawrence Evans, Jr., director of Financial Markets and Community Investment at the GAO, presented the study on behalf of the GAO and explained that during the four-year period covered by the study, 414 insured banks failed, including 85 percent that had less than the $1 billion asset threshold that generally defines community banks. The study focused especially on factors that contributed to the failures, “including the possible role of local market conditions and the application of fair value accounting under U.S. accounting standards.”

The reader should probably not be reassured by the GAO’s finding that “between 2007 and 2011, fair value losses did not appear to be a major contributor (to bank failures), as over two-thirds of small failed banks’ assets were not subject to fair value accounting.” The findings showed that state banking associations “said,” which means complained, that the magnitude of the credit losses was “exacerbated by federal bank examiners’ classification of collateral-dependent loans and evaluation of appraisals used by banks to support impairment analysis of these loans.”

The reports cited 2009 regulatory guidance to reassure the reader that loans would not have been written down based solely on the basis of a decline in the collateral value. I would observe that maybe if these write downs had been imposed in a timely fashion, the FDIC would not have lost $42.8 billion as of Dec. 31, 2011, through shared-loss agreements when failed banks were put through so-called “least-cost resolution.”

The report offered no recommendations. Perhaps it should have recommended, or someone should recommend, a review of why the FDIC did not apply the philosophy of the legislation that emerged from the crises of the 1980s and 1990s that called for the regulators to intervene to require banks to be recapitalized before losses could become embedded in their books.

Now it appears that these losses have mounted, primarily at the “too big to fail” banks, to the neighborhood of $15 trillion, equivalent to the entire U.S. gross domestic product, due principally to regulatory neglect, and the authorities are engaged in a plethora of opaque extraordinary measures in an effort to move these losses around so they will not have to be realized.

According to the GAO, failures of community banks were concentrated in 10 states and attributable to concentrations in commercial real estate and acquisition, development and construction loans “often correlated with poor risk management. Our analysis showed that small failed banks in the 10 states had often pursued aggressive growth strategies using non-traditional and riskier funding sources such as brokered deposits.”

So this is the scenario from the 1980s and 1990s all over again after a spate of legislation that was supposed to ensure that the then-shocking debacle would “never happen again.” Now, not only has it happened again, on a much larger scale, but it is still going on, still compounding.

Sometime in the future, someone from the GAO will go back and find that, gee, the so-called regulators seem to have followed the same practices of neglect, influenced by the same phenomenon of industry capture, the same concentration in long-term real estate funded by volatile short-term sources, as they enabled a generation ago, just as I predicted at that time.

For a darker, albeit more realistic view, one might grab an adult beverage and read “The Next Real Estate Bubble: Farmland,” by Blake Hurst, a Missouri farmer, on March 29 on the American Enterprise Institute’s website. The article warns: “Farmers have been taking on mounting debt, creating an unsustainable increase in land prices and risking a crash that would ripple through our economy.” Is there any point in asking where the financial regulators, or “irregulators,” have been while all this has happened?

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This third of three articles reviews a study by the Government Accountability Office (GAO) titled “Causes and Consequences of Recent Failures of Community Banks,” one of the studies that were reviewed by the House Financial Services Committee’s Subcommittee on Financial Institutions.
Wednesday, 03 April 2013 03:14 PM
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