Financial Rescue Plan: William Isaac, Former Chair, FDIC
In an exclusive interview, Isaac discusses:
Isaac is chairman of the Secura Group, a leading financial institutions consulting firm, operating as a division of LECG. The Secura Group provides financial advisory services, strategic planning, regulatory counseling, risk-management services, strategic studies, and general management consulting for financial institutions. LECG, of which Isaac is a managing director, is one of the world's leading expert services firm with professionals serving Global Fortune 500 firms from offices around the world. Isaac also serves as chairman of various Isaac family real estate development companies. He writes for the American Banker and other publications and is a frequent speaker before banking groups. He is also a founding member of the American Bankers Council.
TOM FIELD: Hi, this is Tom Field, Editorial Director with Information Security Media Group. The topic today is the Treasury's new plan to rescue the financial system, and I am speaking with William Isaac, former chairman of the FDIC and current chairman of The Secura Group. Mr. Isaac thanks so much for joining me today.
WILLIAM ISAAC: My pleasure.
FIELD: We have just seen the Treasury Secretary announce the administration's new plan, and I guess my question for you is what do we see today that is different from what the Bush administration showed us some months ago?
ISAAC: I honestly, I actually was listening to it just a little bit ago and he still is giving his talk, but I actually don't' see a lot that is different. And so, I think the short answer is that it looks like a fair amount of the same kind of thing that they have been doing, hopefully new and improved in the sense of better controls and maybe more transparency. I don't see anything that is terribly new.
FIELD: So the nation, the industry is hanging on this today. What do this plan and the announcement really mean to the banking industry? What do you expect to see of substance come from this plan?
ISAAC: Well, they are going to continue to use the TARP money, the new TARP money, which they want to call something else, I gather, because TARP has become a four letter word. FIELD: Exactly.
ISAAC: But in any event, they are going to use the second half of the TARP money to essentially do what they have been doing in the past, which is to recapitalize the banks. And I think that is a good idea; I have no complaint about that at all. And they are going to use some of that to try to forestall foreclosures, slow down the foreclosure process and prevent some people from having to be foreclosed upon. I think that is good if they can come up with something workable.
In the past these programs really haven't worked. There is about half of the people who get helped on foreclosure wind up going into default again after they have been helped, and so that is a very high rate of failure, and I'm not sure that if we can't do better than that I don't think that is the way we ought to spend the taxpayers money. So hopefully they can come up with an anti-foreclosure plan that works better than what they have done to date.
The main thing that is missing today that I really wanted to see was I wanted them to address mark to market accounting, which is a horrible system of accounting that the SEC put in place. The Securities and Exchange Commission put it in place in the early 1990s, and it requires banks to mark assets to market, even where there isn't a market, as there isn't today. They are required to mark these assets to an arbitrary market price, and it has destroyed over $600 billion dollars of bank capital, which equates to roughly $6 trillion dollars of bank lending capacity.
And they are continuing to say we are going to throw taxpayer money into bank capital without fixing the thing that is destroying all of this bank capital. They are not changing mark to market accounting, and it is just a shame that they are not doing that. I don't know why they aren't doing it.
We had mark to market accounting in the 1930s, and finally eight years into the depression in the 1930s the government, President Roosevelt and the Secretary of Treasury said, 'Why can't we get out of the Depression?' And mark to market accounting is the one of the key things they identified that was keeping us from getting out of the Depression, and they abandoned it in favor of historical cost accounting, which we used for the next 50 years or so, 50 or 60 years, until the SEC decided to go back to mark to market accounting over the objections of the Secretary of the Treasury, the Chairman of the Fed and the Chairman of the FDIC.
So why we are not addressing this problem, I don't know. To me it is a huge flaw in the plan, and I think right now the market is down, and we will see what it ends up for the day. But it is down significantly from the time that the speech started, and I think if he had said we were going to address mark to market accounting, I think the market would have shot up.
FIELD: Interesting. We don't learn history well do we?
FIELD: Now given what we have seen over the past few months, how would you say the TARP program has worked to date? And, I wonder if you reject the term that a lot of banks object to, which is the "bank bailout" term?
ISAAC: Well, I don't think it is a bank bailout. We are trying to bailout the economy, and that means we need to fix the banks, and I don't see how we get the economy turned around without a--in fact, we can't, and I know we can't get the economy turned around without a strong banking system.
The banking system has been substantially weakened in significant part by very bad accounting treatment that the SEC put into place, and we have got to fix that. If we fix that, then we can get banks lending again. So I don't view it as a bank bailout; I think we all have a large stake in getting this banking system back on solid footing, and the sooner we do, the sooner we are going to come out of this economic downward spiral that we are in economically.
Anyway, that is just the way it is, and people don't like it, and they view it as a bank bailout, and I understand all of that, and politicians use that rhetoric, but the fact is that Washington played a very large role in bringing us this crisis, and we are going to have to use the government to help us out.
FIELD: Now interestingly, one of the plans that I see in the new strategy is to have a mix of sort of public and private investment. Do you see this as somewhat rising up to meet the objections of people that don't want a lot of direct government investment in banking institutions?
ISAAC: Yeah, well they are back to what they are trying to do is they are trying to remove bad assets from the banks, assets that have been marked way down and are subject to further markdowns on your mark to market accounting. Rather than change the accounting rule, what they are saying is let's just get rid of the bad assets so we don't have to mark them down. They really don't have to mark them down; they could change the accounting rules that are requiring this senseless writedown of these assets.
But what they are trying to do is they are trying to get these assets off the books of the banks, they are no longer then subject to write down under mark to market accounting rules. But the cost of getting them off the books of the banks is very high. The banks aren't going to sell them cheap, they don't want to. I mean if they wanted to sell these assets cheap, they could do it right now, and they don't even need this government program.
So the banks aren't going to sell cheap, and private investors are going to demand a very significant return. Back when we cleaned up the S&L problems in the late 1980s and early 1990s, the investors who came in to clean up that problem and take those assets off the hands of the government typically got 40% compounded annual returns on their investments.
So this is going to be a very, very expensive program to taxpayers, if it is going to work. And if it is not very expensive to taxpayers, my guess is that it won't work because neither the bank, the selling banks nor the buying private investors are going to have any incentive.
FIELD: So what do you expect we will see next to get a sense of whether this is or is not going to work?
ISAAC: Well, I mean, the initial stock market reaction is negative, and my guess is that this is going to be greeted with--I hope I am wrong, and I don't want to sound all negative here. I hope I am wrong, and I hope the world cheers and the stock market goes up 1,000 points or 2,000 points and bank stocks recover and everything is on the mend. I just don't think that is a realistic prediction. So I think we are going to see more of the same.
For example, they made a deal out of the fact that they are going to do a "stress test" on the banks that apply for the TARP capital. Well they have been doing that. They evaluated every bank that came into the program. They had the bank regulators review the bank and decide whether the bank could be viable if they got the TARP money.
And so we have we have already been doing the stress tests on every bank that has been in the program. Maybe they are going to change the nature a little bit; some of the things they do in that stress test, but that is not a new item. That has been done. So I think it is more--I am afraid it is more of the same.
FIELD: Now this new administration is coming in with sort of a mandate for change, and there is lots of talk that when a Democratic administration comes in we will see more regulatory reform. What do you see as early signs in this administration as to how it is going to approach the banking industry?
ISAAC: Well, there will be reform. Again, I don't know how much reform. I don't know how aggressive the reform will be. For example, it seems clear that people are targeting the SEC and the Commodities Future Trading Commission for merger; I think on the theory that they both do things that are similar. They oversee the integrity of markets, and one is dealing with commodities and the other dealing with securities, so why not merge them together is the refrain. And then you have got the Office of Thrift Supervision, which oversees S&L's and other Thrifts, and it is located in the Department of Treasury as is the Office of the Controller of the Currency, which regulates national banks. And so people look at those and they say, hey they are both part of the Treasury, so why don't we combine them and so that is something we might do. If we did both of those things and nothing more, I would say that we reshuffled the deck chairs a little bit, but we didn't make any sort of a meaningful reform.
The other thing they are talking about doing is creating a Market Stability Regulator and some people are saying the Federal Reserve should be that regulator, to which I would respond, 'And what is that Market Stability Regulator going to do and what makes us think that a single agency can do it?'
Right now, when this crisis was developing, we had the SEC, the FDIC, the Federal Reserve and the Department of Treasury, who I think we could argue all four of those were responsible for a significant part of this. Their mission was to maintain stability in the financial markets. So if four agencies couldn't see this coming, couldn't prevent it, couldn't nip it in the bud, what makes us think that one of those four is going to be able to do that? That it is that wise and all knowing and has the political will to do what four agencies couldn't see or couldn't do? So I am dubious about that reform, and I think it would be better to have those four agencies meet on a regular basis, say three or four times a year, to discuss what is going on systemically throughout the financial system and try to agree on a plan of action for addressing any emerging issues. But I think we need more points of view in the room and not fewer.
FIELD: Well, that's a good point. What do you see for signs in the economy so far this year? ISAAC: Well, I think it's a mixed bag. I mean obviously some sectors are not doing well, and we are getting a lot of layoffs and real estate hasn't stabilized yet, foreclosures still go on, but yet out in the tech field we see some positive things.
So I mean it is a mixed bag, but clearly the economy is weak and getting weaker and we need some help. We need some good policies.
FIELD: Is the Depression our best frame of reference for what we are seeing right now?
ISAAC: Well I don't think we have gotten that bad yet. We've got to get beyond 1981 to 1983, and we haven't even met that standard yet for bad.
In the 1980's we suffered 3,000 bank failures, including a lot of big banks. We lost nine out of the 10 largest banks in Texas. We haven't seen anything like that this time, and I don't believe that we will unless things get a lot worse. So that is the major thing.
I think unemployment, that's the last number I saw and it was something like 7.6% and we were up somewhere in the vicinity of 10.5% to 11% in that 1981-1983 period. We had a prime rate that got up to 21.5% in 1980, which caused all sorts of damage. I think that the people who say this is the worst period since the Great Depression are too young to remember what really was going on in the 1980s.
Another serious problem we had was in 1973-1974, which looked an awful lot like this one in terms of the real estate debacle. We had a collapse in real estate in 1973-1974 that threatened many of our largest banks and it came about in a lot of way similar to what we have today, which was where banks originated a lot of loans and sold them off into securitizations. In 1973-1974 the banks originated a lot of loans and then sold them off through real estate investment trusts that they created and took public. So there are a lot of similarities between 1973 and 1974 and today.
We have got a ways to go before we get as bad as either one of those grids. The thing that really bothers me most about his period though is that it is so unnecessary. We did need an adjustment. Housing had gotten way overheated. We needed to come back down to earth, but we really didn't handle it well from a government point of view and created a lot more instability and disruption in the markets than we needed to.
We let institutions fail that should not have been allowed to fail and we imposed losses on creditors of failed institutions like WaMu and IndyMac that were destabilizing to the financial markets when they did fail. And we scared the public, and we are continuing to scare the public. The public officials keep on making speeches about how this is the worst disaster they have ever seen. They did it last fall in October when they wanted the first bailout bill. They scared the death out of the public and I think shut down a lot of spending, and we just really are not handling this well.
This latest plan of the Treasury, I don't know why we needed to announce two or three weeks ago that we were going to have another plan and saw that daily in the media. So people anticipate it, and they talk about it, and they get expectations built up, and it is really hard to imagine how you would meet the expectations.
I mean, why wouldn't the Treasury have sat around and come up with some ideas and just started dropping them in place instead of having all of this fanfare? We really are focusing way too much attention, and we are still scaring people way too much.
Back in the 1980s when we had far more serious banking problems, I don't recall Ronald Reagan going on the airwaves probably any more than once or twice. And it was really low key. In one of his State of the Union addresses he mentioned the banking problems and didn't dwell on it. He just said we were on top of it or whatever, and it was not something that the President focused a lot of attention on; I mean he was well aware of the problem, but he didn't hype it in the public, and neither did the Secretary of the Treasury. It was left to the Federal Reserve and the FDIC and the bank regulators to stay active and clean up the mess and try to stay as low profile as possible while doing it.
FIELD: And you did.
ISAAC: And we did and we got it done. By the way, I would note that form 1983 on the rest of the 199's while we were still having thousands of bank failures, the economy enjoyed unprecedented economic growth.
FIELD: You're right. Bill, you offer great insight and more important, historic perspective. I appreciate your time and your insight today.
ISAAC: My pleasure.
FIELD: We've been talking with William Isaac. For Information Security Media Group, I'm Tom Field. Thank you very much.