The participants have been discussing that much government regulation (e.g. of bank failures and insurance companies) seems to have negative consequences, and are discussing some regulation aimed at ensuring fairness in banking practices.
A: Equally disturbing is the inability of parties to make binding contracts in this day and age.
Q: What do you mean by the "inability to make contracts"?
A: The Uniform Commercial Code, as you probably know, is law adopted by states to give some uniformity to commercial transactions throughout the nation. Under its code there is a covenant of good faith and fair dealing in commercial transactions and a recognized tort---"bad faith breach".
Q: In California the tort is independent of the UCC.
A: Exactly. Anyway banks must treat their customers "fair and reasonably" no matter if the signed written documents (contract) between the parties says otherwise. This determination of fairness is, by law, to be left to third party judges or juries and can not be settled by the contracting parties. This leaves the parties with a potential liability over their heads and is definitely an unhealthy climate for business.
Q: Are you serious? Having a stipulation that parties deal fairly with one another is bad for business ?!
A: Fairness is one of those illusory concepts, like beauty, and is often in the subjective eyes of the beholder. What is fair at one moment in history may not be in another. Those best able to determine what is "fair" in any given situation are the parties to the contract. Would you be as likely to enter a contract if you knew someone could not only wriggle out of it later but also obtain punitive damages against you? I'd find another business, or charge every customer enough to make it lucrative enough for me to cover the possibility of being sued.
Q: That's not good for anybody.
A: You're getting my point. Banks have been found guilty of breaching the covenant of food faith and fair dealing when they stop advancing funds or switch formulas for advances under an established line of credit.
Q: Even if they are given the right to do those things in the written agreement signed by the customers?
A: Even then. But don't get me wrong. I'm not against holding a lender liable where, for instance, a loan office cuts a customer off out of a personal vendetta or fails to stick by the reasonable notice provisions in agreements.
Q: Even if the insufficient time is what has been previously agreed to in the written document?
A: That's something different. I realize the unequal power of the parties has long been considered in courts of law, but I am still unhappy with the rewriting of a legal document. The only reason one would sign a subjectively speaking "unreasonable" document is to better his or her situation. Only the signer can determine the reasonableness of any action in the light of the choices he or she is facing at the time.
Q: Nonsense! Many people who get roped into unconscionable one-sided contracts don't read the documentation or if they do they don't really understand it.
A: You want to think of them as children and remove all responsibility for their own welfare from them. I believe you are well intention but dead wrong to encourage people to throw themselves on the mercy of others. If you go on the premise that the majority of people are basically good and want to help one another than you will not scoff at the idea that even an illegal immigrant who doesn't speak the language in which the contract is written, can go to a priest or friend of a friend for help.
Q: I can't believe you! He or she doesn't, or in all probability wouldn't, because of fear.
A: That is a trade off. Not facing up to their fear may subject them to a one-sided loan. Easy prey. I realize that just as there are a majority of good eager to help people in any community, there are also the sharks and scavengers with no qualms about taking advantage of the weakness in others.
Q: I'll give you that. No matter your weakness there is always someone hanging around to exploit it. It could be the drug dealer, liquor salesman, race track or even the state lottery. I suppose you would put the government in the category of a "shark" in promoting gambling, which is so often the weakness of those who can least afford it.
A: That is a subject too far afield for our present discussion, but I will say in passing, that lotteries are not per se good or evil in my mind. I can see that a person is purchasing hope, excitement and in many cases is contributing to worthwhile public endeavors. Nevertheless, I do not favor them because of the temptation they present to some players.
Q: Getting back to the loan documents; the covenant of good faith and fair dealing requires a bank to be reasonable in dealing with a borrower. Right?
A: You're getting us right back to where we started. "Reasonable" is just as ambiguous as "fair" and is best determined by contracting parties.
Q: "Equal" contracting parties.
A: There you go. And you wonder why institutions hesitate to lend to anyone but sophisticated borrowers who don't really need the money. Don't you see what all the good intentions are doing to the people they purport to help?
Q: I don't suppose you have any trouble with holding banks and other lending institutions liable when it comes to old fashioned fraud; suppressing facts which should have been disclosed, making misrepresentations to the borrower or third parties, making promises with no intention of keeping them and so forth?
A: Fraud doesn't interfere with the parties ability to contract.
Q: What about finding liability via the fiduciary relationship---the duty the professional lender owes to the borrower through their special relationship?
A: A fiduciary relationship is a special relationship where the advising party must place the advisee's interests above his own and is not normally found in a lending situation.
Q: It was found to be at least a "quasi-fiduciary" relationship in 1985 in California. The lender must do nothing which could hurt the borrower's interests. Liability has also been established in California where excessive control by the lending institution over the borrower can be shown. Also a joint venture can be found if an institution becomes too involved in a borrower's business and liability has been established for breach of an implied joint venture agreement.
I read in the October, 1986 issue of Case & Comment :
A: The RTC and FDIC spent close to $900 million on legal services in 1991 with about $700 million going to private law firms. That's a hefty price even for competent service, but Richard Schmitt, reporter for the Wall Street Journal told of hiring a private firm that "not only appealed the wrong case, it filed its appeal the day after the filing deadline expired." It was a $1.2 million mistake, but was easily absorbed in the budgetary item labeled "waste" and passed on to patient, accepting tax payers.
Q: Isn't anything being done to minimize legal costs?
A: The FDIC beefed up the auditing section which kept an eye on the 1,600 or so law firms that were expected to receive fees from the FDIC and RTC in 1991. Auditors found overstaffing, unauthorized research and inflated clerical expenses and are getting law firms to make refunds of an average 3 percent of fees previously paid.
Q: Physicians have endured this type of oversight for years.
A: The ABA Journal (Nov 1991) listed twenty law firms whose 1990 receipts from the FDIC topped $2.5 million. Fees up to $600 an hour have been authorized. Henry Gonzalez, chairman of the House Banking Committee finds the fees of outside law firms often "excessive". Hokpins & Sutter of Chicago headed the list with receipts totaling $22.3 million. In February 1991 a cap of $2.5 million was put on the fees that the FDIC or RTC can award any single law firm in any one year.
Q: It seems like this would spread the agency business around, if nothing else.
A: In 1990, regulators, on the advice of outside counsel given by a private San Francisco law firm and paid for by taxpayers, turned down a $78 million settlement and won a $68 million suit.
Q: It wouldn't be so bad if taxpayers got their money's worth. But a loss of $10 million!
A: In that particular case the federal judge had warned that for the FDIC to go to trial would be "playing Russian roulette with taxpayer dollars." Despite these incidents the FDIC maintains that it gets back an average of $29 in recoveries for every dollar spent.
Q: That figure has been disputed, but let's leave it at that.
Q: Have you heard of something called FASB and if so what is it?
A: FASB is an acronym for the Financial Accounting Standards Board which is the chief rule-making body for accountants. Fasb has a proposal requiring footnote disclosure in all financial statements of more-current values of assets and wants banks to hold larger reserves for bad loans, beginning sometime in 1992. These two items will be costly for banks. Just to estimate the fair value of loans will be demanding.
Q: So what's the point?
A: It is supposed to give analysts a clearer idea of a bank's soundness.
Q: How are loans booked now?
A: By book value. There was an earlier call for market-value accounting which has been watered down somewhat to this fair value proposal.
Q: What is "fair value"?
: Fair value is the current market value and it will be required as a foot note to financial statements for all financial instruments including equity, debt, loans, receivables and even options. Banks with less than $150 million in assets will have until 1995 to adhere to the new accounting disclosures.
FASB also has a proposal for troubled loans effective for calendar 1993 requiring banks to include interest components in their calculations of reserves for troubled loans. This would increase the carrying costs for troubled loans on the balance sheet and could sharply reduce reported profits.
Q: It sounds like this would hurt the banks. What is the justification for such a proposal?
A: For one thing it could encourage a faster dumping of bad loans.
Q: It seems to me if banks have to factor in carrying costs they will have less incentive to hold delinquent loans and struggling borrowers will be given less of a chance to revive---something I believe is an unfortunate consequence.
A: Philosopher kings think this is all for the good as banks will be able to put their mistakes behind them quickly rather than try and help a struggling entrepreneur weather bad times.
Q: Such a "prompt disposal" policy could intensify current real estate problems by encouraging more and faster sales of construction loans and mortgages when the market is already saturated.
A: Well the Bush administration has tried to encourage bankers to work out and resolve problem loans rather than foreclose, if it all possible.
Q: Didn't you say earlier that the banking problem in 1991 is not restricted to this country? I just wonder what kinds of problems some of the other countries are facing and how they are dealing with them.
A: Japan still has eight of the ten largest banks in the world but they are being restricted by nonperforming loans and rising costs. German and Swiss banks are more profitable. Japanese banks had non-performing loans equivalent to almost thirty and a half billion dollars ( 3.9 trillion yen) at the end of 1991.
Q: I heard the face value of those loans was worth more than five times that amount.
A: You're right. Because of lax financial-disclosure requirements, it's hard to get accurate figures. Management by bank regulators doesn't seem to be any better in Japan than in the U. S. In 1986 eleven Japanese banks had top credit ratings but by the end of 1991 none did. Many of the larger Japanese banks were being pressured to absorb failing smaller banks.
Q: That sounds like a repeat of what happened in the 1930s. There were 700 Japanese banks in 1931 and ten years later that number had dropped to 190.
A: You should know the deposit insurance system in Japan is not funded according to our American standards. Premiums paid by participating lenders could barely cover a handful of very small institutions. The banks keep small reserves because they have to pay taxes on reserves that exceed .3 percent of total loans.
Q: I know. They also pay taxes on bad loans which the government makes them keep on the books for a full year after borrowers have stopped paying interest.
A: Japanese manufacturers depended on bank loans for their rapid expansion. When their profits began to decline in the nineties, as the result of the recession in that country, Japanese banks took the hit.
Q: Not that long ago, (1989) the largest Japanese manufacturers had accumulated cash amounting to four times their annual expenditure on plant and equipment. Loans were not needed.
A: They weren't needed because the Bank of Japan adopted a loose monetary policy and cheap capital meant businesses could raise money through the stock and capital markets and by-pass the banks altogether.
Q: But weren't the banks speculating in stocks, securities, art and the already inflated real estate market?
A: That's right. Between 1985 and 1990 real estate lending tripled. Our own government pressured the Japanese Finance Ministry to lift controls on the rates paid to Japanese depositors.
Q: What do they say about misery loving company?
A: Well misery got its company in this instance. The same thing happened there as here. Depositors were paid more but it took awhile before lenders could be charged more for the use of those funds. The spread between the cost to the banks and the yield, widened.
Q: But I guess the risk was masked by the hot speculative market.
A: Then just at the very end of 1989, Uahushi Mieno, Japan's counterpart to our Alan Greenspan, raised the central bank's discount rate. It fluctuated but two years later it was still double the old 1989 rate of 2.5 percent which had provided such a joy ride for investors.
Q: I know that caused problems, but what kinds of problems?
A: For one thing, it depressed stock prices, making it harder for the banks to raise capital. In addition, many of the banks' customers and their own investments were hurt, just as banks' costs rose. Then to top it off, the Bank for International Settlements imposed stricter capital ratios.
Q: Could you backtrack and go into the Basle Accords a little bit?
A: In 1988 the Basle Accords were agreed to by the central banks of the leading industrial countries. All the world's bank regulators, Americans included, promised to compel the banks they supervise to keep capital at a prescribed percentage of assets. The idea behind the uniform standards was to prevent banks in one country from having an advantage over banks in another country. The Basle requirements meant stricter capital ratios and signaled the need for banks to raise new capital to grow or even to keep from shrinking in some cases.
Q: What exactly do you mean when you use the term "capital" here?
A: Capital is the difference between the market price of a bank's assets and market price of its liabilities.
Q: What are the uniform ratios required by the Basle agreement?
A: There is a rather complicated formula involved but the bottom line is that by the end of 1992 banks will have to have capital equal to 8 percent of their assets. It changes how banks value assets.
In the past, regulators in this country have permitted banks to value equity (assets) at the original cost rather than the current price so they don't have to write down real estate loans during depressed times. They reason that they intend to hold on to the property until the market turns and so no actual loss has been suffered until it is sold or transferred.
Q: We just got through agreeing that old practice was a good idea.
A: The new rules spell trouble not only for American banks. Midland Bank, once Britain's largest, replaced its CEO and cut its dividend in the spring of 1991 and Moody's dropped the ratings on the huge Japanese banks, leaving only one with a AAA rating.
Q: Actually these capital requirements may be less arduous for American banks than for banks in other countries.
A: Why do you say that?
Q: According to financial analyst William Ferguson, already 9,500 of thiscountry's 12,000 banks ($2 trillion in deposits) have assets of $100 million or less with capital of 8% to 9%. Anything above 4% used to be considered respectable.
A: That's true. Besides, equity accounts for about five percent of all funding sources for American banks and savings and loans; fifteen percent for consumer finance companies and seventy percent for non-financial companies. Bankers have argued for the inclusion of subordinated debt as well as equity in the regulatory definition of ÒcapitalÓ. Regulators tend to look at capital as a buffer to absorb credit losses, whereas banks view capital as an expensive source of funds.
Q: In this country, bankers figure that in order to cover reserves, deposit insurance, and other requirements, they now have to build about 1.25 percentage points into the rates they charge customers on their loans.
A: Foreign and nonbank competitors have been spared these costs.
Q: According to the New York Federal Reserve Bank, just a few years ago large U.S. corporate customers were borrowing $4 from foreign banks for every $10 they got from major U.S. banks.
A: I think you will find borrowing from the foreign banks has increased. Former Federal Reserve chairman, Paul Volcker, Douglas Barnard of the House Banking Committee and Senate Banking Committee Chairman, William Proxmire all agreed in 1987 that we needed to allow U.S. commercial banks to compete or we were going to lose our market place to the Japanese and Europeans. Ralph Ziegler, Vice President of the Union Bank of Switzerland in Tokyo was quoted as saying:
Q: Japanese banks have picked up a large market share in this country where low interest rates are more important than innovation.
A: This is especially true in the state and local government market where Japanese banks sell letters of credit which enhance the credit rating of the municipality or agency wishing to float bonds or notes. The more a bank is able to increase the issuer's credit, the less the issuer has to pay to borrow money.
Q: And Japanese banks can offer high credit ratings because the Japanese government can be counted on to bail them out.
We hear so much about American loans to Latin American countries but the Japanese got burnt in the same market ($40 billion to our $100 billion) and are therefore leery of risky or relatively unknown borrowers. Lending their credit ratings to American state and local governments is a low-risk business where the default rate is far lower than for commercial loans.
A: Tell me about it! The state of Michigan was saved from a budget crisis in 1982 when the Mitsubishi Bank agreed to guarantee $500 million worth of the stateÕs bonds.
In 1986 the Bank of Tokyo lent $5 million to a group of New York developers who were building an office complex in a run-down section of the Bronx.
The city of Boston, also in 1986, solicited competitive bids on a $100 million note. The three lowest bids were Japanese with the best U.S. bid twice as expensive as Sanwa, the winning Japanese bidder. City officials estimate SanwaÕs bid saved the Boston taxpayers somewhere between $130,000 to $400,000 in fees. And BostonÕs experience was not unique.
In December 1986 the Arkansas Development Finance Authority found its three best bids were Japanese and that the winning bid from Sumitomo Bank saved it just under $2 million in reduced interest costs and other fees over a three year period.
Q: I've heard the Japanese sacrifice profit for market share. Sometimes they earn less than one-tenth of a percentage point for supplying credit, less than half what an American bank might consider to be profitable.
A: I've heard that too. Apparently even the most westernized Japanese bankers disdain U.S. and European notions of what constitutes an acceptable profit. Some Japanese companies are able and willing to forebear profits for up to ten years in order to build up business.
Q: This used to be pretty standard operating procedure for any new business in this country also. However, most of our banks are not new to the market and are being forced to compete with these foreigners who are willing to lend on much more favorable terms.
A: There's truth to what you say. Some Japanese banks offer loans to U.S. businesses at between 1/8 percent and 1/4 percent below the savings rate at American Banks.
Q: A deal too good to turn down! Consequently, by the end of 1986 Japanese banks held 8.4 percent of all commercial loans in this country.
A: Actually the Japanese economy as a whole is a low-profit operation. Sumitomo Bank returns a mere thirty cents on each hundred dollars of assets whereas Citicorp returns 75 percent.
Q: Japan may be the place to borrow but not to invest!
A: We're agreed then that American banks are more profitable, measured by return on assets, than are Japanese banks. And amazingly, the ten most profitable banks in the USA are community banks with assets of $35 million or less.
A: We're agreed then that American banks are more profitable, measured by return on assets, than are Japanese banks. And amazingly, the ten most profitable banks in the USA are community banks with assets of $35 million or less.
Q: I've always wondered why the Japanese people save so much, especially as restrictive regulations are responsible for the rock-bottom interest rates the Japanese pay their own citizens on savings accounts.
A: You would hardly think this would be an inducement for the Japanese to save, but for them there is little alternative. For instance a few years ago buying a hundred shares of a $50 stock cost a Japanese investor as much as $63 in fees. Between their commercial bankÕs low government controlled rates of interest and the high fixed commissions charged by the securities firms, there is little choice.
On the other hand, you have probably heard more than you care to about the deplorable savings rate in this country and the disincentives to save built into our tax code and social policies.
Q: As far as I'm concerned, saving is for American suckers. For instance those prudent enough to have saved, rather than practice the Òenjoy-as-you-goÓ philosophy, are the ones that end up in an income bracket guaranteed to force them to pay even more taxes on their already taxed Social Security benefits.
A: You're right there. The savers are never rewarded in this country, but end up footing the bill for the non-savers, who may or may not have been profligate spenders in their youth. When will our policy-makers understand that we get what we encourage? In the future, non-savers.
Q: But in contrast to the message delivered in our social and tax policies, the government urges the purchase of savings bonds. Employees of many companies purchase savings bonds through automatic payroll deductions. This program raised $5 billion in 1985, enough to cover about 2.5 percent of new government debt. But savings bonds have to be held at least five years to avoid ending up with a return as small as four percent.
A: Still twice the best return many young people are expected to get from their Social Security contributions.
Q: If held ten years to maturity the savings bond rate is higher (varies) and they may be a viable vehicle for conservative investors.
A: Especially when you consider the tax on the interest is deferred until the bonds are redeemed. U.S. EE savings bonds had a minimum 7.5 percent guaranteed interest rate for quite some time. That was cut near the end of 1986 in order to save the government money and to reduce competition with private offerings. In the first half of 1988 a saver could receive 8 percent on a 5 year Treasury and a 30 year zero coupon Treasury (non-callable) was paying 9 percent.
Q: Ah, those were heady days! At an interest rate of nine percent, savings double every eight years.
A: Absolutely right. I think if we made sure our youngsters understood these things in school we'd have a better chance of increasing our savings rate in this country.
Q: In 1983 foreigners added $17 billion worth of U.S.Treasuries to their holdings.
A: In 1985 the Japanese increased their holdings of U.S. Treasury bonds by $19 billion, triple the previous yearÕs rise. At year-end 1985, the Japanese held $47 billion of the U.S. governmentÕs $2 trillion debt. That was up from $27 billion a year earlier. At U.S. Treasury bond auctions in the eighties, the Japanese have been known to gobble sixty percent of a new offering.
Q: The Japanese and West Germans bought the FedÕs newly created dollars in order to protect their export industries and to ensure the value of their own dollar holdings.
A: What few people realize is that until 1986, JapanÕs foreign financial investments were limited almost exclusively to the purchase of Eurobonds and U.S. Treasury issues which offered a secure return of eight or nine percent.
Q: And that was a full four percent higher than the yield on comparable Japanese bonds.
A: Right again. However, in the summer of 1986, the yield on long-term Treasuries, at about 7.1 percent, was low for the Japanese. They had been used to investing in U.S. securities only when the yield was at least 300 basis points (three percentage points) above Japanese government bonds, which were then yielding about 4.5 percent. Nevertheless that year Japanese banks purchased about a quarter of all U.S. Treasury bonds.
Q: In effect funding our deficit.
A: However, as our interest rates began to fall and our dollar continued its precipitous slide, the Japanese suddenly began losing their appetites for our Treasury bills and started buying up prime U.S. real estate and other equities.
In the first quarter of 1987 the Japanese took advantage of the forty-five percent drop in the dollar relative to the yen (from its 1985 high) and began buying our blue chip stocks at a rapid clip. Our stock market was too good to pass up, with American stocks offering higher yields than the Japanese home markets (seven percent vs. little more than half of one percent) and much lower price-earnings ratios (16 vs. 49).
Before the October, 1987 stock market plunge, many Japanese brokers had estimated that by 1991 JapanÕs total holdings of U.S. equities would reach $100 billion or about four percent of all U.S. equities.
Q: That didn't happen.
A: Let me tell you what's happening in Japan.
Not long ago JapanÕs seven trust banks and twenty-one life insurance companies were the only entities authorized to manage tax-exempt pension funds in Japan. JapanÕs pool of retirement savings amounts to over $50 billion and is expected to skyrocket in the next decade as the aging workforce sets aside more and more for their retirement years.
The average Japanese retires at 55, earlier than in the United States and can expect to live longer. Today (1991) one in eight Japanese is 65 or older and by the year 2005 Japan will be the nation with the largest percentage of its population over age 65. With a greater need for retirement income and the poor returns that have thus far been produced by their own Japanese trust banks, there is a blossoming interest on both sides for American access to those pension funds.
Q: We are seldom told that the need has been on both sides; the need for the U.S. to borrow and Japan to lend (invest).
A: In the eighties the coffers of Japanese banks became so overladen, thanks to JapanÕs huge trade surplus, that the Japanese had no way to invest all that money domestically. In 1987 Japanese banks, insurance companies and brokerage houses were flush with more than $500 billion for investment in foreign countries.
Q: Because at the end of 1986 the Japanese Finance Ministry liberalized capital flows from Japan.
A: The Japanese Postal Insurance Fund, which is managed by the Post and Telecommunications Ministry, used to be allowed to invest a maximum of 10 percent in foreign bonds. The ministry doubled the amount allowable and also made it possible to invest in foreign corporate bonds. Formerly investments were allowed only in bonds issued by foreign governments and public organizations.
Q: I understand that Japanese commercial banks are very closely regulated. How do they decide how much interest to pay depositors or charge lenders?
A: As far as the interest rate on bank deposits goes, 60 percent is set by regulation and the other 40 percent is determined by the marketplace. certificates of deposit and foreign deposits escape rate regulation but the number and size of those deposits is strictly limited.
Q: I've heard the term "national treatment". Do you know what that means?
A: Most of the world adheres to a principle called "national treatment" which means that foreign firms must have the same rights given domestic firms. Japan doesn't abide by it. On the "level playing field" principle, the Fair Trade in Financial Services Act of 1990, backed by Senator Don Riegle and at least ten other senators, would allow U. S. regulators to limit Japanese bank expansion in this country.
Q: If the idea is to get fair treatment for American firms from the countries whose firms we treat fairly here, it's an idea whose time has come. American businessmen can forget about being successful abroad without the presence and help of American banks in foreign countries.
A: The United States dominated worldwide banking in the 1950s and 1960s but the European and Japanese banks got a real foothold in this country during the 1970s.
Q: Wasn't anything done to preserve our market share?
A: The International Banking Act of 1978 was passed in response to complaints that the operations of American banks were restricted when compared to the unchecked operations of foreign banks here. Even the proverbial "level playing field" was the goal.
Q: What did the Act contain?
A: The legislation required foreign banks to submit to our federal bank examiners, carry insurance, maintain reserves, adhere to limits on interstate banking and non-banking activities and be licensed. It grandfathered in a couple competitive advantages like letting foreign banks continue underwriting securities
Q: Even though Glass-Steagall prevents American banks from doing the same?
A: Unfortunately, yes. It also granted "national treatment" to foreign banks even though no other country gave us national treatment in return.
Q: Our lawmakers call that a level playing field?
A: In 1987 the Senate passed a bill denying the application of any foreign bank whose country does not grant American banks national treatment.
Q: I thought you said. . .
A: Hold on--- the House failed to pass the bill.
Q: Terrific! So JapanÕs banks overtook their American counterparts as the worldÕs largest international lenders.
A: The Japanese have established banks in Australia and London where some 35 Japanese banks account for 20 percent of all British banking assets. The United States is now host to more than 38 Japanese banks,
Q: Including the five largest banks in California.
A: In February 1988, J. P. Morgan Co., the last of the American companies to enjoy a triple A rating, lost it. About the same time Federal Reserve Board Governor Martha Seger appeared on C-SPAN.
Martha Seger disavowed any protectionist sentiments but expressed anger because of the Òunlevel playing fieldÓ on which American banks were forced to compete. She declared that the Bank Holding Company Act, which controls how foreign banks operate in the United States, should be scrutinized. She was not shy in pointing out that in Japan U.S. banks are not treated on a par with Japanese banks whereas Japanese banks are treated even better than U.S. banks when they come to this country.
Q: Good for her!
A: You know, after the Second World War Japan had a very tightly regulated financial system. In an attempt to prevent the concentration of capital in the hands of a few institutions, the Japanese put into their banking law a word for word translation of the American Glass-Steagall Act.
Q: Our law which prohibits banks from underwriting corporate securities?
A: That's it. But the Japanese didn't mimic all American banking regulations.
Q: For instance?
A: The Japanese have lower capital requirements than do American banks. When the Federal Reserve Board required U.S. banks to set aside cash, bonds and other low-yielding capital, equivalent to 5.5 percent of their assets, Japanese banks kept about half as much in capital. That one change meant they could lend more cheaply.
Q: But we didn't always have such stringent capital reserve requirements in this country.
A: You're right. Between 1933-1947 debt to equity ratios soared in the United States but dropped under the pressure of capital regulation in the 1950s. The ratios climbed again as deposit protection expanded.
Q: Of course now the Basle Accords have made this ratio of capital to assets uniform worldwide and set at 8 percent.
A: Even earlier, in December, 1987 the Cook Committee for Bank International Settlements announced standardized capital guidelines for banks operating in 11 or 12 countries. The fear has always been that higher capital requirements may cause banks to invest in riskier assets in an attempt to maintain a given rate of return on equity. But according to bank analysts Michael Keely and Frederick Furlong
Q: I take that to mean that a bank, if allowed, can increase the wealth of stockholders by either increasing leverage or asset risk.
A: According to Keely and Furlong, as the capital of an insured bank increases, the bankÕs incentive to increase asset risk falls. Therefore banks with the lowest capital ratios have the greatest incentive to assume risky asset portfolios. More stringent capital requirements would not give banks more of a reason to invest in riskier assets, it would give them less of an incentive to do so.
Q: Yes, but insured depositors are naturally not concerned with bank risk-taking and are willing to lend to banks at a risk-free rate since their deposits are insured.
A: Exactly. And this provides banks with an incentive to increase asset risk or leverage, leaving the deposit insurance fund (taxpayers) with unconscionable liability. Specifying different levels of capital requirements for different risk assets and off-balance sheet commitments, would introduce a new dimension to decisions about loans.
Q: Isn't it true that under the new guidelines banks wonÕt be able to securitize many types of loans because they will have to supply more capital than required by their actual exposure to loss?
A: Because regulators have recently forced commercial banks to increase their ratio of equity capital to loans (debt), banks have a strong motive for trying to beef up earnings without expanding their loan portfolios. Only a few years ago hocking portions of a bank portfolio was unthinkable. But it makes a lot of sense now when banks want to get loans off their books.
Q: Actually I'm not really sure what is meant by the term "securitization".
A: ÒSecuritizationÓ is the packaging of loans for sale to investors. First mortgages now account for $300 billion-plus with securitized auto loans making up another $10 billion annually. Other consumer loans are being considered for securitization; boat loans, mobile-home loans, home-equity loans, second mortgages, credit-card loans and even non-performing loans are all examples. The trouble is the best loans are the most marketable and banks are often left with the most risky loans in their portfolios.
Q: I guess securitization has caught on because there is something in it for everybody.
A: Bank regulators were skeptical in the beginning, but in 1986 ruled that banks can eliminate the loans through a securities sale as long as the buyers are not given recourse to the bank that first made the loans.
Issuers get a financing source which allows them to take the assets off their balance sheet and thereby increase the return-on-asset and capital-to-asset ratios. Investors get a higher yield than they could get with comparable securities. Consumers, because securitization provides greater pools of money for lending, should reap the benefits of lower interest rates on consumer loans.
Q: At the beginning of March 1987, Bank of America announced a $400 million public offering of securities backed by credit-card loans. In this instance investors will receive the cash flows from repayments but must absorb any losses if the default rate on credit-card loans runs unexpectedly high. Account holders should not detect any difference because the bank will continue to service the credit-card accounts the same as always.
A: The sale of these loans give banks additional room under regulatory capital-to-loan guidelines to make new loans.
Q: This may sound stupid, but I'm serious. Why do we need banks? We can get cash through automated teller machines set up by companies like Sears, AT&T and American Express. To put our money into savings and checking accounts for safety and convenience we can use mutual funds.
We don't even need banks for loans. Auto companies finance car loans, mortgage bankers finance homes and entities like GE Capital and insurance companies lend to businesses. Big borrowers can often borrow more cheaply in the public debt markets than the bankers can.
A: In his 1991 book, The Future of Banking, University of California (Berkeley) professor of economics, James Pierce agrees that there is nothing especially unique about banking anymore. At the end of 1990 banks held only 16 percent of the $3 trillion in residential mortgages and less than 50 percent of all auto loans.
Prudential Securities has an insured income account which includes checking privileges covered by the FDIC $100,000 guarantee. The business community can raise short term cash by selling commercial paper or for long-term money they can issue bonds. As you said, small and medium sized companies can turn to General Electric, General Motors and Ford who all offer business loans to consumers.
Q: You realize that because investments were restricted at home, Japanese investors were induced to make large scale overseas investments. Now it is up to policymakers in this country to loosen the restrictions they have placed on American financial institutions and to allow them to compete on that mythical level playing field.
A: I agree. In an unregulated market place borrowers and lenders are free to make their own decisions and innocent taxpayers are not made to pay for the mistakes of professionals.
Q: We've been dwelling largely on Japan. What about Europe?
A: A lot of exciting things are going on there. In 1990, months before full reunification, state property in East Germany. . .
Q: Then you must mean all property in East Germany.
A: Anyway government property was turned over to an agency called Treuhandanstalt (Trustee Institute) known as THA. In April, 1991, under the dynamic leadership of Birgit Breuel, once the finance minister in Lower Saxony, THA began to sell the property. In less than six months it had sold 3,788 businesses.
Q: That must have produced a lot of revenue.
A: Only $8 billion but you can imagine the run-down condition of the communist managed properties and it is a wonder that there were any bidders. On the bright side, the purchasers promised to invest $50 billion to restore the properties.
Q: Which I would imagine would create a goodly number of jobs.
A: 7,200 new jobs.
Q: I don't suppose I'm alone in my suspicions but to tell you the truth the thought of that many properties being sold at such low prices makes me think of government favoritism.
A: You're right, you're not alone in your suspicions. And the fact that many German citizens were claiming the government failed to get high enough prices and that buyers might not fulfil their investment commitments and so forth, only increased my admiration for the woman who was brave enough to go ahead and do what had to be done despite suspicions and criticism.
Q: One can hardly help but compare Germany's THA with our RTC (Resolution Trust Corp.).
A: Now you've got it! East Germany, of all places, is actually privatizing while our own congressmen and women ho and hem in an attempt to curry favor with their constituents.
Q: I can understand how many of the cumbersome restrictions imposed on the RTC were attempts to appease both the banking and real estate industries. Is that what you are getting at?
A: There's more to it than that. In formulating the rules by which the RTC, as landlord of confiscated property, was to offer it for sale, an effort was made to cater to many special interest groups. Before soliciting buyers in the regular marketplace, first right of refusal sometimes has to be tendered to representatives for low income-earners in need of affordable housing, minority groups, homeless advocates and even government agencies who might make use of habitable buildings.
If you know anything about me you know how I hate the many trite comparisons of the United States with other countries. This case is an exception. The THA is selling off miserable assets at a business-like clip, partly because it has its management staff on a strict budget of $22 billion a year.
In this country we fund everything according to need or desires. If the job takes more than the money authorized, the RTC, or any and every other agency, simply asks for more money. No discipline, no budget, no limits.
Q: And the worst thing about the way we have been doing business in the United States over the past couple decades is that our leaders don't bother to ask their constituents for the extra funds, they just put it on the tab to be paid by future generations.
A: I'm mad as "all get out" and I for one am not going to take it any more. I put a lot of time and effort into raising five members of this "future generation" and that's why I'm determined to do my darndest to turn things around in this country.