Breaking the banks - Bill Clinton's economic policies

National Review, April 12, 1993 by Robert Stowe England

Bill clinton embraced at

least one Reaganesque idea at the Little Rock economic summit: banking deregulation. In a small way. Briefly. The tale of his retreat is instructive both about the depth of the banking system's problems and about the Clinton modus operandi.

The idea of banking deregulation came from William H. Brandon, the president and CEO of an Arkansas bank, and a longtime acquaintance of Bill Clinton. In Brandon's view, duplicative and contradictory regulations passed in the wake of the savings & loan crisis were the source of a major credit crunch. He estimated that these regulations were cutting lending by some 4 per cent despite generally low interest rates. Four per cent of the $2.15 trillion in total bank lending amounts to $86 billion--a not inconsiderable sum. A prudent streamlining of these regulations would, Brandon reasoned, repair banks' ability to lend to business and thus give the U.S. economy a significant stimulus without increasing the deficit--a factor that made the proposal particularly appealing to President-elect Clinton.

The chiefs of the country's six major banking 'associations followed up Brandon's foot in the White House door with a long letter to the President-elect in December advocating nine substantive reforms. The bankers told President-elect Clinton that the problem could not be solved without new legislation to undo the accumulated damage done by Congress since 1989. The Financial Institutions Reform and Regulatory Enforcement Act of 1989, the crime bill of 1990, and the FDIC Improvement Act of 1991 had, among them, imposed a formal and inflexible lending process on banks that has had dire effects on their ability to make loans to small business. Since small business is the main source of job creation, this would help explain why the recovery is producing so few jobs.

How exactly have the new regulations had this malign effect? First, explains Diane Casey, executive director of the Independent Bankers Association of America, old-fashioned "character" lending "has to a large extent disappeared." Bank examiners have interpreted the laws as requiring full and multiple appraisals of collateral, as opposed to allowing bankers, particularly at small local banks, to make risk assessment based on years of experience in the community. The cost of appraisals, and indirect costs of the time and paperwork, are proportionately greater for small loans, which are therefore less likely to be made.

The new regulations also wreak havoc with existing loans: because the rules concerning collateral are so strict, banks have been forced to declare loans non-performing even though no payments have been missed, simply because the market price of the asset securing the loan has temporarily dropped. Again, this affects small-business loans disproportionately, because they are disproportionately secured by homes and other real estate, whose value is depressed in today's economy.

Finally, the regulations have forced banks to increase their capital ratios drastically. This obviously reduces their ability to lend, and loans to small businesses are among the first areas bankers have cut back on, both because a banker must take care of his larger customers first and because it has become so hard to defend small-business loans to examiners.

Indeed, the new regulations and the change in the Washington Zeitgeist have turned bank examiners into unforgiving villains in the minds of bankers. "Every loan you make, you know the regulators are looking over your shoulder," says Kenneth Guenther, a lobbyist for the Independent Bankers Association of America. Bankers face fines at rates up to $1 million per day and the freezing of their personal and business assets if they are found to have violated an intricate set of rules and procedures.

Depressed Area

It should come as no surprise, then, that since last June bank lending to business, traditionally the profit center of the banking industry, has fallen below bank lending to the government. This gives America a Third World lending profile.

The trend has been under way since 1990, as bank lending to the government has grown at 25 per cent a year, while lending to business has stagnated. By last June, investment in government securities (at $610.7 billion) had surpassed loans to business, which then stood at $604.6 billion. As of this January, bank lending to business had slipped slightly, to $601.3 billion, while bank investment in U.S. Government securities had reached $657.4 billion, according to the Federal Reserve.

The current profile is also remarkably similar to that of the latter years of the Great Depression, according to Bert Ely, a banking consultant in Alexandria, Virginia. Then as now the banking industry was overcapitalized, loaded with excess liquidity, and not lending. In the late 1930s bankers were "scared stiff of bank runs," Ely says. Today they are scared stiff of bank examiners.

The reign of regulatory terror could have been halted almost as soon as it began: as of 1991, the Bush Administration and majorities in Congress favored true bank reform--the opposite of the regulations cited above. Three men have been standing in the way: House Banking Chairman Henry Gonzalez (D., Tex.), a populist throwback to the Thirties who believes bankers are by definition out to exploit the "little guy"; Senate Banking Chairman Don Riegle (D., Mich.), who has made a point of supporting regulators to the hilt ever since his role in the Keating Five scandal became public; and House Energy and Commerce Chairman John Dingell (D., Mich.), who holds a quasi-religious belief that banks caused the Great Depression and must be tightly regulated. (Dingell's father was a principal author of the Glass-Steagall Act of 1933, which forcibly separated investment banking from commercial banking.)