Thank you for bearing with me during this long period of radio silence on this blog. A wonderful family Thanksgiving weekend in Miami was marred when I took a spill while walking with my wife and shattered the bones in my right forearm and wrist... rendering me unable to write or type until recently. A thousand thanks go to a superb hand surgeon, Dr. Benjamin J. Cousins, and the excellent staff at the Mt. Sinai Hospital in Miami Beach... and of course, to my wife Tara, who is living the vow "for better or worse", and doesn't like it one bit!
Playing the Island Green
I always liked the concept of the "island green" in golf. It encapsulates, in one picture, the psychic dynamics of risk management in banking these days. A narrowly-defined field of play, with a pin (flag) in a cup, surrounded only by hazards. The objective? Put(t) a 1.68-inch golf ball into a 4.25-inch golf hole cup from a long ways away.
There is no neatly-clipped grass fairway to ease your forward progress, only the faint ovoid shape of the island putting green in the watery distance. In some of those surrounding hazards, you lose your ball (in the water), and in others, your job is made harder (rough grass, sand bunkers, and obstructions, like trees). Even a clear line to the pin requires the marshaling of absolute concentration, total situational awareness, and the precise muscle memory that comes from long periods dedicated practice and experience.
Today's risk management environment for banks stands in stark contrast to the "golden years" for the banking industry from the 1950's to the early 1980's when the old 3-6-3 rule prevailed. Pay 3% on deposits, loan those deposits out at 6%, and then get to the golf course by 3 p.m. That banking industry Elysium was besieged in 1980, when the Depository Institutions Deregulation and Monetary Control Act was enacted into law. One piece of which was the phasing-out of government-administered price controls on deposit accounts. Then, in 1982, another deregulation initiative, the Garn-St. Germain Depository Institutions Act, roughly leveled the competitive playing field between banks, savings and loans, and (by introducing money market accounts) money market mutual funds.
Given our collective experience since then, whether you judge the financial services deregulation of the early 1980's a net societal benefit (which I still do), you can surely agree that financial services deregulation significantly changed the existing landscape of the industry at the time. We can also probably agree, that we created a bright-line tipping point or pivot point for the banking industry that defined a critical epoch in the industry's evolution.
But by removing price controls and increasing marketplace competition, we introduced "wobble" and uncertainty into the inertia of the industry; forcing changes in its momentum and trajectory. Wobble which may likely have eventually reached some sort stable-state adaptation (as bankers got their new sea legs) if not for the destabilizing influences of economic events such as the Fed's inflation-fighting policy of stratospheric interest rates (and the resulting Recession of 1981-1982), the pesky Texas oil-patch crash, or the unwelcome real estate crisis in the New England states.
Instead of things getting less "wobbly" over time, things got even "wobblier", the big wake-up call coming with the declared insolvency of the Federal Savings and Loan Insurance Corporation (FSLIC) in 1987.
The legislative remedy to the industry's instability came in the form of the systemic risk reduction and accountability measures in the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) and the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA). Then came the Financial Services Modernization Act of 1999 (also known as the Gramm-Leach-Bliley Act [GLBA]). Though rolling back the provisions of the Depression-era Glass-Steagall Act for a small group of megabanks and securities houses, GLBA imposed significant new regulatory requirements on all banks (regardless of size) related to customer financial privacy, information security, and anti-pretexting. Later, after America was attacked, came the USA PATRIOT Act of 2001, strengthening Bank Secrecy Act anti-money laundering and anti-terrorist financing requirements.
All these pieces of legislation, and their implementing regulations, created new legal obligations for banks and bankers. These new, and stricter, rules of player behavior were overlayed onto an already challenging game. The game's fairways, now made narrower by these new rules, also became minefields, subjecting banks and their officers and directors to escalating levels of legal liability.
Fast forward to today. From the smoldering ruins of the financial markets meltdown and the Great Recession, the Dodd-Frank Act rolls out a foundation-shaking increase in financial services regulation. The control of industry "wobble" is now called macroprudential banking supervision and new regulatory policy goals are "financial stability and resilience". Larger capital buffers, the Volcker Rule, the too-big-to fail fixes... all remedies targeted to the problems we experienced during the Great Recession.
In addition, there is a new Sheriff in town, called the Consumer Financial Protection Bureau (CFPB), aggressively policing both old and new consumer compliance rules and establishing evolving standards of fair play.
Dodd-Frank, like the deregulatory legislation of the 1980's, may also have brought us another new, epoch-defining, bright-line regulatory tipping-point for the industry... but a flip-side version of it... with all the uncertainty and unintended consequences to financial services market structure and competition that accompanied the earlier tipping point.
This epoch may be seen by banking historians as the time when, with good intentions and reacting to our legitimate and painful experiences, the American republic began a period of over-engineering banking regulation. Even senior financial services regulators have admitted to not being sure how the interconnectedness of the 390 required Dodd-Frank Act rulemakings will play out in terms of impacts, implications, market distortions, unintended consequences, and undesired results. So much also depends on how bank examiners, while in the banks, interpret and apply the rules (and whether they are applied consistently). Those bridges, we all assume, will be crossed when we get to them.
But the danger is: Is it being over-engineered in a manner similar to what we see with ponderous Pentagon weapons systems? Having to accommodate so many desirable specifications, that the final product is prohibitively expensive and does few of its mission-critical functions well. The Pentagon's Zumwalt-class Destroyer program is instructive in this respect.
Dodd-Frank is accelerating a trend that was already slowly, but steadily, gaining traction and momentum. While chartered banks are dutifully trying to integrate these new regulations and with most being squeezed by suboptimal profitability, heirloom system platforms, and legacy thinking; the players in the shadow banking arena are attracting capital, gaining yardage, and spreading their wings (at least relatively speaking) in less restrictive airspace.
The robust growth in fintech and shadow banking is a dashboard warning indicator for regulatory over-engineering. Anyone who has been a parent of teenagers knows that the excessive restriction of a natural inclination breeds circumvention. It's an immutable Law of Nature.
A near-zero tolerance, over-engineered banking regulatory environment that ties the hands of the "business entities presently legally defined as banks" threatens to pretty much take away the banking game's metaphoric golf fairways altogether. So that, at every hole, bankers, when they tee-up, are playing to an island green.
I have no doubt that the banking industry will rise to this occasion, as it always has. You see, there is an additional aspect to the game of golf that provides a virtuous lesson for everyone who plays it. The game is always played forward, never backward.
Today's risk management environment for banks stands in stark contrast to the "golden years" for the banking industry from the 1950's to the early 1980's when the old 3-6-3 rule prevailed. Pay 3% on deposits, loan those deposits out at 6%, and then get to the golf course by 3 p.m. That banking industry Elysium was besieged in 1980, when the Depository Institutions Deregulation and Monetary Control Act was enacted into law. One piece of which was the phasing-out of government-administered price controls on deposit accounts. Then, in 1982, another deregulation initiative, the Garn-St. Germain Depository Institutions Act, roughly leveled the competitive playing field between banks, savings and loans, and (by introducing money market accounts) money market mutual funds.
Given our collective experience since then, whether you judge the financial services deregulation of the early 1980's a net societal benefit (which I still do), you can surely agree that financial services deregulation significantly changed the existing landscape of the industry at the time. We can also probably agree, that we created a bright-line tipping point or pivot point for the banking industry that defined a critical epoch in the industry's evolution.
But by removing price controls and increasing marketplace competition, we introduced "wobble" and uncertainty into the inertia of the industry; forcing changes in its momentum and trajectory. Wobble which may likely have eventually reached some sort stable-state adaptation (as bankers got their new sea legs) if not for the destabilizing influences of economic events such as the Fed's inflation-fighting policy of stratospheric interest rates (and the resulting Recession of 1981-1982), the pesky Texas oil-patch crash, or the unwelcome real estate crisis in the New England states.
Instead of things getting less "wobbly" over time, things got even "wobblier", the big wake-up call coming with the declared insolvency of the Federal Savings and Loan Insurance Corporation (FSLIC) in 1987.
The legislative remedy to the industry's instability came in the form of the systemic risk reduction and accountability measures in the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) and the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA). Then came the Financial Services Modernization Act of 1999 (also known as the Gramm-Leach-Bliley Act [GLBA]). Though rolling back the provisions of the Depression-era Glass-Steagall Act for a small group of megabanks and securities houses, GLBA imposed significant new regulatory requirements on all banks (regardless of size) related to customer financial privacy, information security, and anti-pretexting. Later, after America was attacked, came the USA PATRIOT Act of 2001, strengthening Bank Secrecy Act anti-money laundering and anti-terrorist financing requirements.
All these pieces of legislation, and their implementing regulations, created new legal obligations for banks and bankers. These new, and stricter, rules of player behavior were overlayed onto an already challenging game. The game's fairways, now made narrower by these new rules, also became minefields, subjecting banks and their officers and directors to escalating levels of legal liability.
Fast forward to today. From the smoldering ruins of the financial markets meltdown and the Great Recession, the Dodd-Frank Act rolls out a foundation-shaking increase in financial services regulation. The control of industry "wobble" is now called macroprudential banking supervision and new regulatory policy goals are "financial stability and resilience". Larger capital buffers, the Volcker Rule, the too-big-to fail fixes... all remedies targeted to the problems we experienced during the Great Recession.
In addition, there is a new Sheriff in town, called the Consumer Financial Protection Bureau (CFPB), aggressively policing both old and new consumer compliance rules and establishing evolving standards of fair play.
Dodd-Frank, like the deregulatory legislation of the 1980's, may also have brought us another new, epoch-defining, bright-line regulatory tipping-point for the industry... but a flip-side version of it... with all the uncertainty and unintended consequences to financial services market structure and competition that accompanied the earlier tipping point.
This epoch may be seen by banking historians as the time when, with good intentions and reacting to our legitimate and painful experiences, the American republic began a period of over-engineering banking regulation. Even senior financial services regulators have admitted to not being sure how the interconnectedness of the 390 required Dodd-Frank Act rulemakings will play out in terms of impacts, implications, market distortions, unintended consequences, and undesired results. So much also depends on how bank examiners, while in the banks, interpret and apply the rules (and whether they are applied consistently). Those bridges, we all assume, will be crossed when we get to them.
But the danger is: Is it being over-engineered in a manner similar to what we see with ponderous Pentagon weapons systems? Having to accommodate so many desirable specifications, that the final product is prohibitively expensive and does few of its mission-critical functions well. The Pentagon's Zumwalt-class Destroyer program is instructive in this respect.
Dodd-Frank is accelerating a trend that was already slowly, but steadily, gaining traction and momentum. While chartered banks are dutifully trying to integrate these new regulations and with most being squeezed by suboptimal profitability, heirloom system platforms, and legacy thinking; the players in the shadow banking arena are attracting capital, gaining yardage, and spreading their wings (at least relatively speaking) in less restrictive airspace.
The robust growth in fintech and shadow banking is a dashboard warning indicator for regulatory over-engineering. Anyone who has been a parent of teenagers knows that the excessive restriction of a natural inclination breeds circumvention. It's an immutable Law of Nature.
I have no doubt that the banking industry will rise to this occasion, as it always has. You see, there is an additional aspect to the game of golf that provides a virtuous lesson for everyone who plays it. The game is always played forward, never backward.
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