Guest Commentary by Laurence Cloney
Marco Community Bank closed recently due to improper capitalization. It reopened the same day under the ownership of Mutual of Omaha care of the FDIC. This closure highlights the prevalence of poor judgment and absence of fiscal responsibility locally and nationally. While all the facts are not yet in, the economic downturn seems to be only part of the story.
Lending practices have led to losses of $19.4 million in 2008/2009. Richard Storm CEO of Marco Community Bancorp, in a letter to shareholders wrote the bank was “critically undercapitalized” and that if capital was not raised soon the bank could fail. “With our prolonged loan losses over the past several years, we now find ourselves with diminished capital levels that do not meet regulatory standards” Storm wrote.
I posit that inappropriate and possibly predatory lending and FDIC insurance itself have led to bank failures and a decrease in the FDIC’s own reserves. While the FDIC is funded by bank’s premiums, the reserves are less than 2% of total backed bank assets. If banks fail, they are backed by the” full faith and credit of the US Government” otherwise known as you and me. The lack of sufficient oversight from state and federal regulators contributed to these practices multiplying.
Loans should only be granted to those with adequate income, and a history of responsible credit. In the past a 15 to 20% down payment was common. These standards precluded those least likely to be able to repay the loan. These were prudent benchmarks for success and losses due to “bad debt” were generally low.
In 1989 the Financial Institutions Reform, Recovery and Enforcement Act was passed. This act gave Freddie Mac and Fannie Mae additional responsibility to support mortgages for low- and moderate-income families. While at the time these seemed like prudent steps, it seems these two agencies have also been victimized by improper administration of loans to what I would call at best speculative risks.
The FDIC was created to instill a sense of security amongst the public after the great depression. It was needed then to “guarantee” depositors accounts, but its very existence now allows loans to be made of a speculative nature that if they payoff, yield the bank and its investors more wealth, but if they default are the FDIC’s loss and possibly all of ours.
FDIC Insurance requires banks follow certain liquidity and reserve requirements. Banks are classified by their risk-based capital ratio: Well capitalized (10% or higher) down to Critically undercapitalized (less than 2%) An undercapitalized bank receives an FDIC warning. When the bank becomes critically undercapitalized the FDIC declares the bank insolvent and can take over its management.
All banks should be required to operate in the “well capitalized” range for their own good as well as ours. The fact that this may lead to less operating banks, well so be it. Banks should be self sufficient and serve the public interest not the other way around.
While many now want less government in our lives, regulatory oversight of financial institutions is one area where we can’t “afford” less. We should enforce the laws on the books and ensure banking officials, auditors, and regulators are held accountable to the highest standards of fiduciary responsibility and face severe punishment when they belie the public’s trust.
Laurence holds a BA in Economics from S.U.N.Y Stony Brook and an M.P.A from Columbia University.