The author has chosen to use a question-answer format in order to make the often complex subject matter, easier and more enjoyable to read. Q and A is not a dialogue bewteen real people -- the author has provided the dialogue for both Q, standing for Quaero, which is Latin means "I search for" and A, Auctor, which in Latin means "person responsible."
Q: You realize of course that many people blame the costly savings and loan bailouts and the increased number of bank failures on deregulation. There are currently calls for stricter controls and higher capital reserves. What's your stand on this issue?
A: My initial approach is the same in dealing with any public policy issue. Human nature must be taken into account.
First, people are going to do what they want to do . They will find a way around the best laid government obstacles.
Second, people act in their own self-interest and know better than an impersonal government where those interest lie and how to attain them.
Third, a free market, based on the first two premises, functions more efficiently than a bureaucracy.
Q: I think you have just advocated "more of the same"---laissez faire---what might be viewed by some as a prescription for disaster. The current weakness in the economy has been traced to the weakness in the banking system.
A: And the weakness in the banking system may be traced to regulations which distort the market and wreak economic havoc.
Q: I think the real question is whether regulators can protect taxpayers and promote economic growth at the same time. Are they mutually exclusive goals? Will easy credit hurt the banking industry?
A: According to congressman Charles Schumer of New York, the banking system is shell-shocked from too much lending, too many new ventures undertaken in the eighties. Now bankers are cautious and investing in U.S. treasuries for safety. Unfortunately government securities are non-productive liquid type investments that will not provide the shot in the arm that the economy needs at the end of 1991.
Q: Why don't we start our discussion at the beginning with the earliest link between government and banking in this country? Didn't we have a central bank early in our history?
A: You're right. In 1791 Congress created the first Bank of the United States.
Q: What happened?
A: There was the time-honored heated debate involving states rights versus federal rights and as a result when the charter came up for renewal at the end of twenty years it was allowed to elapse. Congress tried again, forming the second Bank of the United States in 1816.
Q: And obviously that didn't last.
A: It was virtually destroyed with the election of its foe, Andrew Jackson, in 1832. The bank had become extremely wealthy and Jackson feared the power its officers could wield in influencing the government. He order his Secretary of the Treasury to withdraw all government funds and instead deposited the government's money in various state banks, referred to as "pet banks". When the charter of the second Bank of the United States expired in 1836 it simply ceased to exist.
Q: So when did today's federally chartered banks come into existence?
A: Congress passed the National Bank Act in 1863 to help finance the Civil War. This was the beginning of our dual banking system with some banks chartered and protected and regulated by the federal government and others by the state.
Q: You know, the Japanese established the Ministry of Finance, their version of our Federal Reserve system, in 1882.
A: That was long before we established our own Federal Reserve System in 1913. Actually the modern structure of our banking system began in 1927 with the passage of the McFadden Act.
Q: I've never heard of the McFadden Act.
A: It denied nationally chartered banks the right to operate branches within a state unless the already existing state chartered banks were given equal rights. The McFadden Act originally permitted national banks to exercise securities powers. It wasn't until 1933 with the passage of the Glass-Steagall Act that banks and savings and loans were forbidden to underwrite securities.
Q: This was New Deal legislation instituted under Franklin Roosevelt. Right?
A: Right. It was an attempt to insulate the various types of banks from competition by commercial enterprises and also to protect consumers from having their deposits used by banks speculating in the stock market.
Q: I guess the crash of 1929 was a fresh and scary memory in 1933.
A: Absolutely. 5,500 banks failed in the 1920s. In just the three years 1926-1929, 125 banks failed in Florida alone, as a result of insider abuses and conscious conspiracies to defraud. The officers of the Palm Beach National Bank should have been indicted in the summer of 1926 for embezzlement and criminal fraud, according to the bank's receiver, but instead an official political statement was issued claiming the bank failed because of the local economy and unforeseen disasters which hit agriculture and industry in South Florida.
Q: A cover up!
A: The officers of a defunct state bank were indicted for making illegal loans by a grand jury in Palm Beach County a few months later.
Q: I bet that was small comfort to depositors who lost their savings.
A: Now it is taxpayers rather than depositors who pay for the excesses and abuses of management.
Q: You mean because ultimately taxpayers stand behind the government-guaranteed deposits?
A: Exactly. Let me backtrack to 1913 to the establishment of the Federal Reserve Bank which was supposed to ensure the soundness of the banking system.
Q: The number of bank closures during the Great Depression bears testimony to the fact that it didn't do its job.
A: You should know by now that when one agency fails to do its job, the usual government solution is to add another agency and so we got the Federal Depository Insurance Corporation (FDIC) and the Federal Savings and Loan Insurance Corporation (FSLIC).
But just like any safety-net, deposit insurance, introduced in the 1933 Glass-Steagall Act, has encouraged risk and poor management. It has distorted the system.
Q: What do you mean?
A: Originally the Federal Depository Insurance Corporation (FDIC) was supposed to stop runs on banks, but instead it has effectively stopped depositors from keeping an eye on their savings, and bankers from being prudent.
Q: Best selling author and former banker Paul Erdman, on March 5, 1987, told his Commonwealth Club audience that:
But no big deal, he said, even if runs occur--the world's money has no better place to go!
A: FDIC insurance now covers any deposit up to $100,000. As long as a deposit remains under that $100,000 level it is the responsibility of Uncle Sam to monitor bank judgment.
Q: How many people do you know with $100,000 sitting in the bank?
A: You've got a point. But it's worse than you think. Currently an individual or group can be insured beyond the $100,000 limit just by opening another account once the $100,000 insurance limit is reached in one bank. A recent reform limited the number of insured accounts to two in any one bank.
Q: Some reform! The customer could go across the street to open up accounts three and four!
A: Well I know if the Bush administration were to have its way, large pension fund deposits would no longer be insured on the "pass-through" theory.
Q: What in the world is the "pass-through" theory?
A: The theory that says that entities like pension funds, should be considered as so many individual deposits, each below the $100,000 ceiling deposits. The fact that they are lumped together should be overlooked for insurance purposes.
Q: Maybe it's time something was done towards gearing bank premiums to risk and perhaps even trimming the guarantee from $100,000 to a modest sum more in keeping with the average manŐs savings, since he is the one who gets tapped if a bailout is needed. And how about prohibiting one person from having several insured accounts totaling over $100,000?
A: Why not? Pay outs could be lessened by reducing the dollar amount of deposits covered below $100,000 and limiting the pay outs to a per person liability rather than per account. That was supposed to have been done in 1984 when the FDIC and the Federal Home Loan Bank Board supposedly banned new "brokered accounts".
Q: "Brokered accounts"? Is that what they call the really large deposits which are split into $100,000 accounts split to take advantage of FDIC insurance limited to that amount?
A: You've got it!
Another idea is to balance the FDIC's income-outgo ratio by co-insurance.
Q: You mean requiring the depositor to pick up at least some of the tab for insuring his own particular account?
A: Absolutely. In fact why not do away with the FDIC and go back to caveat emptor.
Q: In other words, why not let individual depositors shop for their own deposit insurance?
A: Opponents claim banks would be open to runs, something deposit insurance was supposed to alleviate. Besides, private insurers couldn't begin to assume a $4 trillion liability.
Q: Then why not categorize banks? There could be "safe banks" where deposits are invested in government and agency securities, and home mortgages. These banks could be covered by the FDIC---backed ultimately by taxpayers. "Risky banks" would have more investment latitude but depositors would not be provided with insurance. Of course they could obtain their own.
A: Dream on! Insurance for depositors of a "risky bank" would be sky high. But I see two other problems:
First, most consumers would prefer the risky banks because of the higher possible returns. Americans are optimists! According to Lowell Bryan, author of Bankrupt: Restoring the Health and Profitability Of Our Banking System, most institutional investment, a total of $1 billion in deposits and other borrowed funds, would leave the insured "safe banks"
Secondly, the investments that make "safe banks" safe, like Treasury bills and so forth, are already backed by taxpayer guaranties, making FDIC protection redundant.
Q: From what I read, Lowell Bryan would favor categorizing the banking business. He even refers to "core banks", federally insured and in the business of taking deposits and lending to small enterprises. He envisions only ten to twenty of these banks formed via mergers of what are now the 120 largest bank holding companies who have two-thirds of the country's deposits.
My facts differ from yours. In a review of Mr. Bryan's book (Business Week 8-5-91) it was said that:
More risky business would go to money-market investment banks and finance companies which would primarily make loans to real estate investors.
A: What can I say? Co-insurance is something to play with though.
Q: I like the idea of co-insurance too. There are almost unlimited possibilities for funding insurance by combining in one way or another the resources of the government, the banking industry and of individual depositors.
Q: Where does FDIC get its money now?
A: Banks pay premiums into the Bankers' Insurance Fund (BIF). These premiums exceeded disbursements leaving as much as $18.3 billion in the fund as recently as 1987. But by the end of 1991 the insurance fund had dropped pretty near to zero because of the increased number of pay outs.
Q: You mean pay-out caught up to premiums?
A: Exceeded premiums, because of the large number of bank failures.
Q: So you're saying by 1992 the insurance fund will be insolvent?
A: Not so much insolvent, as illiquid.
Q: What's the difference?
A: Insolvency is a permanent inability to meet obligations whereas illiquidity signifies a temporary but rectifiable shortfall. The BIF, which is part of the FDIC and because more people are familiar with the FDIC I will simply use that term for ease of discussion, still has a source of income and good long-term prospects of solvency. It's just that its income is spread out over a long time period and the need for disbursement is concentrated and immediate because of the unprecedented bank failures.
Q: So what's the solution?
A: Adding capital to a reformed system.
A: Yes, adding capital to a reformed system.
Q: Oh, is that all?
A: Let's take it a step at a time. As we said, we can give the FDIC an infusion of capital by borrowing, either from the banking industry, the Federal Reserve Board (Fed) or taxpayers. Which will it be?
Q: I have a sneaky feeling that this is one of those questions, where no matter the answer, it's going to come down on the taxpayers.
A: Let's eliminate the Fed as a potential saviour because of the precedent any bailout of the banking industry by that independent agency would set. There are plenty of other agencies that would soon press the Fed to advance funds to them.
Q: But I thought the Fed was expressly set up to insure the stability of the nation's financial and banking system. Having the Fed ride to the rescue seems to be a legitimate and practical solution.
A: You're right that the Fed can, should, and has inserted funds into the system in emergency situations to insure stability, but we're talking here about long term recapitalization of an insurance fund. Let's examine the other alternatives.
Congress has recently (fall of 1991) been working out the fine points on legislation that would have the Treasury loan $70 billion to recapitalize the FDIC.
Q: The U.S. Treasury? Just as I thought; that's in reality a taxpayer bailout just like the S & L bailout.
A: Not "just like".
Q: Oh sure, the banks will pay back the loan out of premiums---maybe even larger premiums due to higher assessments, but remember the savings and loans were supposed to pay back taxpayers (the Treasury) out of the sale of foreclosed assets.
A: That's different. Those assets were mostly real estate. Due to changes in the tax code and the economy, real estate values have fallen and the cost to foreclose and manage them has gone through the roof.
Q: Not to mention the regulations and restrictions which have hamstrung the liquidation process.
A: There's no doubt that the delays have been extremely expensive. But you must admit that the source of loan repayment by the banks is more easily identified than the source of the S & L loan repayment.
Q: You mean the banking industry reimburses the Treasury via premiums charged to member banks whereas thrifts are forced to depend on the proceeds from asset sales---mainly real estate.
A: Exactly right. Premiums receivable can be calculated, whereas the net income from property sales is inscrutable.
Q: But what is not known is the cost of an undetermined number of bank failures. That cost will ultimately determine the net premiums available to service any Treasury loan to the FDIC.
A: That's why the solution is more than recapitalization. Reforms are needed to reduce the number of bank failures.
Q: Reforms such as?
A: That is the debate that is going on. Some experts favor measures to restrict the range of bank activities, linking deposit insurance premiums with individual bank risk, raising the capital requirements of banks and more frequent examinations of bank records and management.
Q: I suppose which activities and the degree of restriction would be left to fallible legislators and regulators, many with little expertise in financial fields. This does not sound like something you would favor.
A: You're right. Aside from my philosophical abhorence, I see giant pitfalls and would prefer that the marketplace determine the kind and degree of restrictions. If regulators are too restrictive they could cause, rather than prevent, bank failures.
Q: Don't forget the cost entailed in requiring more frequent examinations and higher capital reserves. P>A: Bank managers will have greater incentive to act prudently once they have more capital on the line and this, by itself, should reduce the probability of bank failures.
Q: What about tapping the reserves of the banking industry?
A: That's on the agenda. For instance, I can't figure out why foreign deposits are by-passed when calculating the premiums banks must pay into the BIF (Bank Insurance Fund).
Q: You mean foreign deposits aren't insured now?
A: They're insured if the bank fails but they are not counted when determining the size of a bank's premium. They get a free ride.
Q: I would think that would make foreign funds a preferred source of capital for banks!
A: You're right. This is a regulatory induced bias.
Q: I've got another idea. In his 1991 book, The S&L Debacle, Professor Lawrence White suggested,
This way the FDIC would get an infusion of approximately $25 billion and banks would receive dividends on their investments. Since they could carry the preferred stock on their balance sheets as an asset, the banks net worth for accounting purposes---assets minus liabilities--would not go down.
A: Excuse me. Wouldn't that amount to double-counting? I can't see letting the FDIC include the $25 billion banking contribution in its resources while also allowing the banks to carry the par value of the preferred stock ($25 billion) on its books.
Q: OK. How about if the preferred stock is publicly held and traded just between banks, and the preferred stock is carried on bank balance sheets at current market values as reflected by that trading?
A: I don't think it is possible to strengthen the FDIC via banks funds, without weakening the banks.
Q: If I'm right, banks place their capital reserves with the Federal Reserve Bank which gets away without paying any interest on those reserves. Why not make the Fed pay interest?
A: Sounds good on the surface, but remember the Fed pays any excess funds into the Treasury, so any interest paid by it would ultimately reduce the Treasury's income and just be one more hit on the taxpayer.
Another suggestion is to lower the legal lending limit of federally insured institutions.
Q: What are the lending limits now?
A: Most banks can lend somewhere between 10 percent and 20 percent of their equity to a single borrower.
Q: Based on the safety in diversity maxim, I suppose.
A: Correct. If banks were held to lower limits---say 2 percent to 5 percent, they would be forced to diversify even more and their lending capacity would be spread more thinly over a broader spectrum.
Q: Wouldn't that hurt the large borrowers?
A: I'm surprised at your concern. Large borrowers generally have many sources of funds. Small and medium size borrowers have fewer alternatives and this policy would actually free up funds for them.
Q: So you would favor this regulation?
A: You're trying to catch me in the inconsistency of favoring regulation. Let me put it this way. If there has to be regulation, then limiting individual bank's exposure to large speculators and opening up capital sources for a greater variety of more modest endeavors, is one of the better regulations.
Q: I've heard it said that if insured banks had the same loss rates that they enjoyed prior to 1980 that they would have suffered only $9 billion in bank loan losses in 1990 instead of $29 billion actually recorded. Is this true?
A: Perhaps there is a clue in the fact that only one Canadian bank failed during the 1920s and 30s. Bert Ely, who has written a book for the Cato Institute which details the banking collapse in America in the early 1930s, attributes the relatively smooth sailing that took place over the same time period in Canada to the fact that ten banks operated 4,000 branches throughout Canada. This gave Canada's banks a broad geographical dispersion for their banking risks.
The independent bank, far from being the strength of small town America was its greatest weakness according to Mr. Ely. He believes the banking collapse in America in the early 1930s was caused, at least in part, by the restrictions on branch-banking which kept U.S. banks unnaturally small.
In 1930 there were 23,700 banks and only three percent of them had any branches at all. In the early thirties the typical bank failure could be traced to fraud or a local economic disaster.
Q: Interesting.
A: Of the 4,800 bank failures during the Great Depression era, most banks were too small to carry on investment-banking activities and therefore there was really no justification, Mr. Ely points out, for enactment of the 1933 Glass-Steagall Act.
Q: That's the law mandating separation of commercial from investment banking. Are other countries having banking problems or is this unique to the United States in the 1990s?
A: Bank regulators from around the world met in Amsterdam at the end of 1986 and expressed their concern about the dangerous banking practices which they feared might have the potential to touch off a global banking crisis.
According to L. William Seidman, Chairman of the Federal Depository Insurance Corporation (FDIC), bank failures increased from 49 in 1983 to 138 in 1986; 80 percent taken over by healthy banks and 20 percent liquidated. A report issued by the House Government Operations Committee in Washington DC, claimed of all the banks that failed between January 1980 and June 1983, 61 percent were involved in actual or probable criminal conduct.
Q: "Probable criminal conduct"? That means a prosecution and sometimes a trial must take place in order to determine if the conduct was criminal.
I'd also like to point out that 1,700 new banks were founded between 1981 and 1985.
A: Many experts believe the nationŐs banking system is resting on quicksand. There is a scary scenario that must be considered: the collapse of one large bank could lead to the failure of many more interconnected banks; business credit would then be constricted and surviving banks would be unable to purchase the bonds that major corporations depend on to finance their operations and expansions. It is possible that as desperate bankers try to stave off collapse, loans would be called, causing defaults and bankruptcies throughout the economy.
Q: Not a pretty scene to contemplate. Listening to the dangers, one wonders how our banking system has survived as long as it has.
A: The fact that it has survived should tell you something about the scare mongers. Between 1865 and 1933, before the government insured deposits, depositor-losses averaged only 0.78% of the total deposits in all commercial banks.
Q: Before the FDIC? I thought there were all kinds of bank runs.
A: In a study published by MIT Press in 1986, titled Perspectives on Safe and Sound Banking: Past, Present and Future, it was argued that costs imposed by bank failures and associated runs, were no greater than costs imposed by the failure of non-banking firms. Runs were examples of depositor discipline that shut down poorly managed and insolvent institutions.
Q: You mean the market at work.
A: I guess you might say that. But even though these losses were small, they nevertheless exceeded the losses of the FDIC between 1988 and 1989. According to the report:
Q: If insurance cut the loss rate by two-thirds, you don't think anybody is going to want to do away with it do you? Besides, bank panics are contagious.
A: The study showed that only two or three episodes before 1930 suggested any contagion as
Jonathan Neuberger maintains that "research suggests that banking markets are fundamentally stable and not prone to contagious runs."
Q: What did currency have to do with it?
A: In the early 1930s, frightened depositors irrationally converted their bank accounts into currency. U.S. currency is still the most widely used medium of exchange. Today there is more than $250 billion worth of currency in circulation and those who hold it don't have to worry about risk of default.
Q: They do have to worry about theft or losing it. Credit cards and checking accounts are much more convenient and favored, I'm sure, by most people.
A: In their 1963 study of monetary history, economists Milton Friedman and Anna Schwartz claimed that the monetary contraction of the thirties intensified the economic depression. They blamed the Fed for failing to pour reserves into the banking system.
Q: I would imagine the lack of funds, led to the bank runs which in turn produced a credit crunch which acted as an additional drag on the economy. A domino effect---right?
A: That's one theory. In 1987 the FDIC insured 14,822 institutions with over $2 trillion in deposits, and for the first time since its founding, FDIC reserves of slightly more than $18 billion were in danger of running out. The FSLIC (Federal Savings & Loan Insurance Corporation) which then insured 3,200 savings and loans, was technically bankrupt as 1987 began.
Q: Experts tell us that reforming the deposit insurance system is necessary for the health and long term profitability of the banking system. But I want to know how this is going to be done?
A: Interstate banking and branch reform would help. Cost savings from mergers has been estimated at $10 billion in pre-tax savings. Remember the industry earned only $24.5 billion before taxes in 1990---less than an 8 percent return on equity overall. Consolidation and interstate branching would help banks raise the capital they need. Over a 5-year period, the capital created from these savings could support more than $600 billion in new lending.
Q: This is the way I see it:
Since not all banks acted irresponsibly, it only makes sense to determine capital requirements and insurance premiums according to the actual risks assumed by individual banks.
A: The catch is not all risks are known or knowable.
Q: But if they could be identified you can see how capital requirements at the higher-risk banks would encourage those banks to be more careful. Right?
A: "If" is a tiny word but a powerful obstacle. This is not a simple problem. Off-balance-sheet items are involved and then there's the interdependency of foreign banks, many unregulated, with U.S. regulated ones. To tell you the truth, I'd rather save a discussion of our interaction with foreign banks until a little later, if you don't mind.
Q: OK. I'll backtrack. We talked about the FDIC--bank insurer. Would the same discussion apply essentially to the FSLIC---the insurer of the savings and loan industry?
A: Essentially. Since its beginnings in 1933, the FSLIC had supported itself with premiums from institutions it insured and with income from investments. Even though it had the authority to borrow up to $750 million (that used to be a large amount) from the Treasury, it never needed to do so before 1987.
Q: That sounds like the taxpayers would be left holding the bag if the losses resulted in the institution's collapse.
A: It is this open-ended liability with no limits to future costs which needs to be reconsidered.
Q: Who had oversight? Any institution besides congress?
A: The FSLIC was controlled by the Federal Home Loan Bank Board which admitted that $6 million a day was going down the drain because of the sick institutions it was keeping alive in early 1987.
Q: Why in the world was it keeping sick institutions alive?
A: The 99th Congress was unable to pass legislation which would have pumped $15 billion into the ailing FSLIC and would also have permitted regulators to sell failing institutions. Opponents argued that additional legislation wasn't necessary since many state laws already allow such sales. On top of that, the U.S. League of Savings Institutions incorrectly estimated the FSLIC would have $17.42 billion to cover pay outs over a five year period.
Q: But if I remember correctly, the money requested was in the neighborhood of $25 billion.
A: Right. Legislation to raise that amount over a five year period was put before the 100th Congress. Under the TreasuryŐs plan the Federal Home Loan Banks would have sold debt, backed by zero-coupon bonds, for about $15 billion over a five year period with an additional $10 billion to come from income from other investments and special assessments on federally insured thrifts.
What Congress actually passed in the summer of 1987 was considerably less ambitious. The banking-reform bill provided a $10.8 billion industry-financed package for the ailing Federal Savings and Loan Insurance Corporation, banned the creation of any more limited-service banks and prohibited banks from entering any securities businesses until March, 1988.
Q: Why didn't they just combine the two insurers---FDIC with FSLIC?
A: Some people did suggest that merging the FSLIC with the FDIC would, back in 1987, have provided nearly $29 billion to handle bank and savings and loan failures over the next five years without dipping into the corpus of the FDIC fund. Former head of the FDIC, William Issac, was not one of them, nor was his successor, William Seidman. Both men were against a merger.
Q: How did bankers and savings and loan officers feel about a merger?
A: Of course there were a variety of individual opinions but in general the commercial banks were afraid a merger might mean an increase in their deposit insurance premiums and would amount to the bankers' bailing out the thrifts. The savings and loans were not exactly overjoyed, fearing a merger might mean their ultimate extinction, or at least stricter controls.
Q: That's chutzpah! It's not as if they were doing such a great job regulating themselves.
A: I read in California Lawyer (August 1984) that loopholes were tightened so it was harder for non-banking companies to acquire banks and run them as strictly consumer-banking organizations. In December 1983, non-banks were brought under the jurisdiction of the SEC by attempts to broaden the definition of 'lending' to include the purchase of commercial paper, and the definition of 'deposits' to include NOW accounts.
Q: I remember some people questioned the idea that purchasing certificates of deposit should be equivalent to making a loan.
A: In 1984, despite protests from the Florida Bankers Association, the Fed gave United States Trust Co. of New York, the go-ahead to convert a state-chartered trust company to a nationally chartered consumer bank. This was a first.
Q: Why did the Florida group object?
A: They felt the Fed's action violated the section of the Bank Holding Company Act which prohibits banks from owning non-banking entities. They exaggerated a bit and suggested that a local car wash or local bordello could now own a bank.
Q: I've never heard of the Bank Holding Company Act?
A: The Bank Holding Company Act of 1956 forbade holding companies owning more than one bank from operating in various states without express approval from the states themselves. In 1970 even one-bank holding companies were brought under the jurisdiction of the Federal Reserve Board. These regulations were a response to the rapid expansion of financial conglomerates, mostly based in New York. Legislation was pushed by members of congress from states such as Texas and Illinois where state banks weren't even allowed to open branch offices intrastate.
Q: I remember when Bank of America was the largest bank in the world.
A: In 1970 the ten largest banks in the world in terms of assets, were American. Now none are.
Q: What do you think about the merger of BankAmerica and Security Pacific, two of California's largest banks, which took place in August 1991?
A: For one thing it shows the pressure banks are under to expand in order to cut costs and counter the bad loans accumulated over the years. Expansion is their ticket to competition with the larger foreign banks.
Q: Does that mean BankAmerica is now the largest bank, at least in this country?
A: In terms of branches, 2,400 and ATMs, 4,000 you're right. But even with the merger, its assets are $190 billion versus almost $217 billion at New York based Citicorp. But although Citicorp has more assets than BankAmerica, BankAmerica is ahead in profits and is controlling its expenses The BankAmerica-Security Pacific merger is supposed to save about $1 billion in annual operating costs over a five year period. Besides, BankAmerica has more equity capital than Citicorp.
Q: And with its equity capital it can expand beyond the ten states in which it presently operates.
A: Not only "can", but BankAmerica's CEO, Richard Rosenberg intends to expand his operation. In fact earlier in 1991 he was foiled in his attempt to purchase the Bank of New England (acquired by Fleet/Norstar Financial Group) which was especially attractive to Mr. Rosenberg who is himself a native of the Boston area.
Q: Surprisingly it wasn't that long ago (1986) that Bank of America was itself almost swallowed by First Interstate bank.
A: Just to show how life is unpredictable, on August 16, 1991 Richard Rosenberg addressed the San Francisco-based Commonwealth Club. This was only a few days after his bank's merger with Security Pacific.
Q: Isn't Security Pacific the bank that sold some of its consumer and commercial service groups to Japan's Mitsui Bank in the summer of 1989?
A: You're right. Mitsui reportedly paid Security Pacific $100 million for a 5 percent share, valuing the financial services businesses at 15 times operating earnings.
Q: That's unbelievably high. I suppose that's because banking analysts preferred regional banks like Security Pacific to money-center banks like BankAmerica and Citicorp.
A: Possibly, and perhaps with good reason. Money-center banks were involved with bad loans to LDCs--lesser developed countries--- an issue that was newsworthy and damaging a few years ago. In fact in the summer of 1989 federal regulators required a write down of some of those LDC loans which made the regional banks like Security Pacific, look good in comparison.
Q: But that was then and this is now.
A: That's astute! Mr. Rosenberg talked about the overcapacity of the American banking industry and predicted more mergers in the future between the larger banks. He pointed to his own just completed merger and to the Chemical Bank and Manufacturers Hanover merger which had taken place in July 1991 as examples.
Q: Did he think mergers were a good sign?
A: Yes, in as much as he saw overcapacity, along with restrictive legislation, as significant contributors to the competitive disadvantage American banks have been suffering in the global market.
Q: If I recall, Richard Rosenberg took over the retail division at BankAmerica back in 1987?
A: That's right. He had been the President of Seafirst in the state of Washington. He had turned down the BankAmerica job twice before.
Q: He apparently has a reputation as a great marketeer.
A: Absolutely. He encouraged customers to use services beyond checking and savings accounts---safe deposit boxes, IRAs, CDs, credit cards---which all earn separate profits.
Q: Many experts think Mr. Rosenberg was primarily responsible for turning around BankAmerica's fortunes.
A: As you said, he is a great marketeer. He used gimmicks such as giving away 3 years of free checking accounts to anyone who walked in the door of any Bank of America branch on a certain day, or if a new checking account was opened before a certain date the customer received coupons worth up to $1,200 at American Airlines, Hertz, Hilton and Carnival Cruises.
Q: Aggressive marketing of banking products may be the key to the future success of banks.
A: It's here today. Already consumers use banks not only as a place to deposit their money or for the convenience of checking accounts, but they purchase certificates of deposit, have payroll checks direct-deposited and can get cash through interbank ATM networks
Q: You forgot to mention loans. Credit cards often make it possible to draw loans from a variety of institutions across the country. With a little work, consumers can find competitive rates.
A: Not only that, competition has meant more convenience for consumers. Many banks now stay open 45 hours a week instead of 27 as was the norm just a couple years ago. Some are even open Saturday and a few hours on Sunday and others offer 24-hour phone information.
Q: These services must be costly to provide.
A: The costs are passed on to consumers who don't seem to mind as long as volume allows the banks to keep individual charges low.
Q: The "something for everybody" principle. I understand that BankAmerica serves over 5 million households and has been earning over a billion dollars a year.
A: That's right. It is reportedly the most profitable bank in the nation. In 1990 it purchased banks in Oregon, Arizona and New Mexico and now owns the largest in bank in California, Bank of America, and in Washington, Seafirst.
Q: I heard that between 1987-1990 its consumer lending more than doubled from $19 billion to $39 billion.
A: I know, it's amazing. Mr. Rosenberg had the 31 bank districts in California hold recognition dinners and sales rallies. The morale was high to the extent that each branch office had its own colors and unique branch cheers.
Q: Sounds like high school sports or Amway sales rallies.
A: The bank instituted incentive pay and recruited many of their current top management personnel from Wells Fargo bank. They managed to pare problem loans from $5 billion to $3 billion over only 3 years.
Q: Is it true that most California banks pay less on consumer deposits than competitors pay in other states?
A: I guess it is. In 1990 BankAmerica, for instance, paid consumers only 6.7 percent---the consumers then paid the bank 18 percent on credit cards and 10 percent plus to borrow on the equity on their homes. Meanwhile Citicorp in New York paid 8 percent. That saved BankAmerica $700 million and accounted for half its pretax profits. As we said at the beginning, consumer banking can be very profitable.
Q: Not to mention the loss carry-forwards the bank had from its years of enormous losses.
A: But these tax breaks, which are said to have added $240 million to 1990 net income, disappear in 1991. This, plus the recession may mean 1991 is a learner year.
Q: I heard something about BankAmerica buying at least a dozen failed savings and loans from the Resolution Trust Corporation. (RTC is the government agency set up in 1989 to dispose of the assets foreclosed during the S & L fiasco of the late 1980s.)
A: That may be. If you are worried about the possibility of a future monopoly, remember the numerous new nonbank companies.
Q: It's hard to determine what institution is and is not a bank now days.
A: It's interesting to see how that came about. Congress had defined a bank as an institution that accepts demand deposits and makes commercial loans. In a 1980 case, Gulf & Western Corporation substituted personal loans for commercial loans and viola, the first consumer bank was recognized.
Q: Some people say we have too many banks for our population in this country anyway. Do you agree?
A: I'd like to see the market place take care of that possibility. Mr. Rosenberg pointed out that American consumers are served by 12,600 commercial banks, 2,000 savings and loans and 16,000 credit unions. For instance Canada has 65 commercial banks, Japan has less than 150 commercial banks for a population of about 120 million people and Europe, with a population close to 320 million has about 3,000 commercial, savings and mutual banking companies. Our own. . .commercial banks have been limited to school-zone speeds while their competitors have been allowed to race unhandicapped around the course.
General Electric . . .General Motors . . .Sears . . .none of these firms, or others like them, that offer bank or bank-like products and services has to adhere to bank regulations or meet capital standards that banks must meet, or hold reserves at the Federal Reserve Bank, or most importantly, meet stringent Community Reinvestment Act requirements---all this despite the fact that these competitors are extending credit in direct competition with the banks.