Regulatory Reform: 'I Worry that We Won't Get it Done' - William Isaac, Former FDIC Chair

It's been a year since the financial services industry was first rocked by the global recession. The 'crisis of confidence' resulted in scores of bank failures, major mergers and acquisitions, and a very public cry for regulatory reform.

A year later ... is the banking industry better off?

William Isaac, former FDIC Chair (1981-85), believes the recession is over, but he also is concerned about the future of regulatory reform, as people's attention turns to the healthcare debate. "I worry that we won't get it done at all," Isaac says.

In an exclusive interview, Isaac discusses:

How the banking industry has changed over the past year;
Lessons learned from the recession;
Regulatory reform - will it happen, or has momentum been lost?

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. I am talking today with William Isaac, Former Chair of the FDIC, and we are talking about the financial services industry a year after its meltdown. Bill, thanks so much for joining me.

WILLIAM ISAAC: Nice to be with you.

FIELD: Bill I am going to ask you a question that your boss asked a number of years ago, which is: Are we better off today than we were a year ago?

ISAAC: [laughter] Yes, of course we are better off today than a year ago, but that is damning with faint praise because a year ago we were in pretty miserable shape. But we are definitely on the uptick now, and we are in better shape than we were then.

FIELD: Where do you see us being better off? I mean, there are some obvious ways; we don't have the industry bleeding as badly as it was. But what do you see as sort of positive improvements over the Fall of 2008?

ISAAC: Well, you named the biggest one. The financial industry at that point was frozen, and banks were afraid to deal with each other and weren't dealing with each other. The financial system basically wasn't functioning very well. We have gotten that fixed; that is stabilized. I don't mean that it is ready to go out and run a marathon, but it is certainly well out of the recovery room and maybe even out of the hospital at this point. So that is much better.

I think the economy is on the mend. I think even Chairman Bernanke, who was bold enough to say yesterday that he thinks the recession is probably over -- I think those were his words or something to that effect, and I would agree with him. I believe the recession is over. It doesn't mean we can't fall back into one, but for right now the recession--I think we are moving out of recession and into recovery.

The main way in which we are not better off today is on the unemployment numbers because those are lagging indicators, and unemployment will probably continue to rise for a while and also the bank failure numbers. The problem banks and bank failure numbers are also lagging indicators, and so those numbers will continue to go up for a while. Usually they lag for 18 months to two years, so we will continue to see bank failures and additions to the problem banks list over the next year and a half to two years.

I am not at all concerned that we will experience anything in the banking area that we can't handle, and it is certainly not going to be anywhere near as bad as it was in the 1980's and early 1990's.

FIELD: Bill, how is the banking sector specifically different now than it was 12 months ago?

ISAAC: Well, banks are lending to each other and banks are--they have been writing off their problem assets, their problem loans and making I think a fair amount of headway to strengthening their balance sheets and starting to improve their earnings. They are not out of the woods. They are still having their problems. But I don't have any doubt that the banking industry is no longer in intensive care. I mean, it is on the mend now.

FIELD: What would you say the industry has learned from the troubles of the past year, 18-months, or are we sort of setting ourselves up to repeat history down the road?

ISAAC: I don't think it is the industry that really needs to learn a lot of lessons here, and whatever lessons the industry learns it will probably forget some day. I have been around long enough to be through a number of these cycles.

At the front-end of my career in the 1972-74 recession and real estate crisis, which was very severe and had the potential to bring down a lot of large banks -- it didn't but it could have. And I think that the government handled that situation very well and gave the banks some time to work through those problems, but that was a very, very dangerous period.

The 1980's were a horrendously bad period. We had a very severe recession in 1981-82, which so far was worse in almost every respect than anything we have experienced so far this time around. And if this recession really is over, I think that history will show that the 1981-82 recession was much worse in most respects.

During the 1980's we had 3,000 bank and thrift failures -- from 1980 through the end of 1991 -- and at the end of that period, after all of those 3,000 banks and thrifts had failed, we still had 1,500 on the problem bank list. Today we have fewer than 100 failures so far, we might have another 100 to 200, I am not sure; I don't think it would be much worse than that. And I think as of the last count maybe 400 problem banks. So these numbers this time around are not nearly as bad as we have been through before.

I think we are coming through this fine. What we did have this time that we didn't have last time was a severe crisis of confidence, and I think that is largely because the government really mishandled the crisis last year. I think the government needs to learn a lot of lessons more than the industry does.

FIELD: Now six months ago, eight months, after President Obama came in, there was a lot of buzz about regulatory reform. You don't hear so much about that now. What do you think the future is of banking regulatory reform?

ISAAC: We need some regulatory reform, but the Obama Administration has put forward a very disappointing proposal and I think that is one reason why we have lost the momentum. They really didn't take it seriously and put forward -- in my opinion they didn't put forward a serious proposal. They have things in that bill that have nothing to do with this crisis such as they want to create a new consumer protection agency. That is somebody's political agenda, and that is not a reaction to this crisis. And it is hard to take their bill seriously when that is the centerpiece of it.

They say we ought to get rid of the thrift charter -- why would we want to get rid of the thrift charter in the middle of a housing depression? We need these thrifts, and we need people to be focused on home lending, and they are proposing to get rid of the thrift charter while we are in a housing depression, and that makes no sense.

They propose to get rid of the Industrial Loan Company Charter, those industrial loan companies that are owned by major corporations and industrial loan companies those charters are usually located in Utah, there are some other states as well, but why? What problems are there in the Industrial Loan Company Charter that we need to solve? As far as I know, none of them has failed. At least not any of them that are significant have failed, although there might have been a small one here or there. But these things haven't failed and they are not in trouble, they are not part of the problem so why are we doing that.

And then on the other side, they are dealing with a bunch of political issues that somebody has an agenda on that had nothing to do with creating this crisis, and then on the other side they ignore the things that really need to be addressed.

Let's take the biggest one, Fannie and Freddie -- where are we going to go with Fannie and Freddie? Because they had a major role in this housing crisis that we are experiencing this time around. So what is the future of Fannie and Freddie? And that is not addressed in their bill. How about the Federal Home Loan Bank System, which is also very important to our housing markets. What is the future of the Federal Home Loan Bank System? You don't see a word in the bill about that.

And then when it comes to strengthening the watchdogs so that we don't have these kinds of problems in the future, one of the most important reforms we could make is to create a systemic risk council that would be reviewing the entire financial system and looking over the shoulders of all of the regulators and trying to publicize developing risks that need to be attended to. They proposed a systemic risk council, but they gutted it. It is at Department of the Treasury, and the Secretary of the Treasury is the Chairman of it, the Treasury provides the staffing for it. Treasury is one of the main agencies that this systemic risk council should be overseeing because the Treasury creates a lot of systemic risk, and yet they make it a bureau of the Treasury? It makes no sense at all. We need an independent systemic risk council with its own staffing, headed by a presidentially-appointed Chairman who is completely independent and has the right to blow the whistle on the Treasury or the Fed or anybody else that is causing problems.

So I could go on, but I don't want to go on too long with a single answer. But this bill is disappointing, and I think we need some serious reform. We need to strengthen the FDIC's watchdog role in some important ways, and we need to have a strong systemic risk council and the Administration's bill is not viewing those issues at all.

FIELD: So looking ahead, Bill, what do you foresee in the industry over the next 12 months? Will we see some serious attempts at reform or is this going to get put on the backburner while we do things like healthcare and cyber security?

ISAAC: Well, that is another--you raise a good point there, frankly. It is another thing that puzzles me. To me, the number one problem we have in the country when President Obama took office was the financial system and the economy, and he has made his number one priority the healthcare system. That is not the order I would have taken things in.

The healthcare system is a serious problem, and it is a serious issue, and it needs to be addressed. But I think our first obligation was to make sure that we had the economy fixed, the banking system fixed ,and by making healthcare the number one priority it has crowded out these other issues. Senator Dodd for example, who is Chairman of the Senate Banking Committee, is also deeply immersed in the healthcare system crisis and how to resolve that, and he has said that that's got his priority right now, and he will deal with the banking system and the financial system reform at a later stage. I am not saying that he is totally ignoring the banking side, but clearly he can't be all things to all people, and he has got to have his priorities, and his priority right now is healthcare. So I think it was an odd choice. I think the healthcare debate could have easily been had next year just as well as this year, and instead it has pushed the financial reform aside I think.

FIELD: Bill, what is the risk if we don't address financial reform now?

ISAAC: Well, I am not too troubled about it except I hope that we--the main problem in waiting too long is that you loose all momentum. You know, when the stock market is back up to 12,000 or 13,000, all is well and the recession is over and unemployment is coming down, and it is hard to get people all jammed up to have to look at a financial reform package that doesn't have any--that most people don't understand it, and they don't care about it, and it is really hard to get it done in normal times.

So I think that I worry that we won't get it done at all, and it is too late to go back. I mean, healthcare has already taken front and center stage, but I am afraid that we won't do serious financial reform and hopefully we can--if we don't do it again, we will be back. If we don't do it, we will probably be back in the soup again one day. Not anytime soon -- it is not tomorrow, it's not a year or two years or three years -- it is several years out, I am sure, because it will take us time to forget the lessons we learned and for banks to start getting more aggressive in all of this.

So it will take time for the system to get in trouble again, but I think if we could take some measure to strengthen the watchdogs on our system, the controls, I believe we could hopefully get ourselves into a place where we don't have serious crisis like this and that we nip them in the bud much sooner.

FIELD: Bill, as always I appreciate your time and your insight today.

ISAAC: My pleasure. Good talking with you.

FIELD: We have been talking with Bill Isaac, Former Chair of the FDIC. For Information Security Media Group, I'm Tom Field. Thank you very much.




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