By Steven K. Beckner

(MNI) – Kansas City Federal Reserve Bank President Thomas Hoenig
laments that little was learned from the financial crisis of the 1980s
in the run-up to the recent crisis in the foreword to a newly released
book published by his Bank.

The small but entertaining book, written by Kansas City Fed public
affairs officer Timothy Todd, is a biographical tribute to the late and
well-respected Bill Taylor, former head of banking supervision for the
Fed and former chairman of the Federal Deposit Insurance Corporation.

Hoenig, who began his own career as a bank examiner and worked
closely with Taylor, writes that the events of the 1980s and early 1990s
have “a very familiar ring.”

“If Bill were here today, he would probably share my disappointment
that we learned so little from the crisis of the ’80s,” Hoenig writes.

“Once again we are experiencing a financial crisis,” he goes on.
“Once again we are learning the lessons of too much leverage, weak
underwriting standards and too little bank director oversight.”

“After the last crisis, no ‘rules of the road’ were introduced
regarding any of these categories that history and experience tells us
are fundamental to performance and are countercyclical,” Hoenig
continues. “Rules that are clear and enforceable, work to contain excess
risk during booms, and mitigate the misery during the correction.”

The Kansas City Fed chief, who has been vocal in recent years on
the need for tougher capital requirements and an FDIC-style resolution
mechanism to unwind large financial institutions, has harsh criticism
for the nation’s regulators.

“Yet again without firm guidance, the regulatory authorities were
reluctant to insist that more conservative financial practices and
standards be adopted and implemented,” he writes.

And he deplores the fact that the concept of “too big to fail” has
still not been dealt with in a foreword presumably written before a
House-Senate Conference Committee recently finalized financial
regulatory reform legislation.

“Almost certainly, Bill would have an appropriate, cutting remark
for the fact that too big to fail is still the standard for our
ever-larger institutions, and that we appear to have learned nothing
from the failure of Continental Illinois,” Hoenig says. “Nearly 20 years
later, we still bail out the very largest institutions and close
others.”

Hoenig further writes that, as FDIC Chairman, Taylor “understood
that it is not just about closing banks in a timely manner. Yes, he knew
that if a situation was hopeless, you had to act. And he did so, many
times.”

“But he also knew that when you closed a bank, you also took a lot
of the community, its small businesses and consumers down with it,” he
continues. “When he could, he tried to work with the bank, even when it
meant taking a chance that it could cost the fund more if he was wrong.”

Todd, who previously penned an excellent brief history of the
Federal Reserve system for the Kansas City Fed, traces the life and
career of Taylor, who died of a heart attack in August 1992 after
succeeding William Seidman as chairman of the FDIC.

Included are some keen and sometimes humorous observations by
Taylor.

Describing the personality of a bank examiner, Taylor once said, “A
bank examiner is a man who always looks past middle age, is wrinkled,
cold, passive, noncommittal, with eyes like a codfish. Polite in
contact, but at the same time unresponsive, cold, calm, damnably
composed as a concrete post or a plaster Paris cast, a human
petrification — and without the charm of a friendly germ. No passion,
no sense of humor. Happily – they never reproduce and all of them
finally go to hell. (I)f you find any such people, please send them to
me.”

Taylor also served as chairman of the Oversight Board of the
Resolution Trust Corporation, which successfully liquidated the assets
of hundreds of failed thrift institutions in the early ’90s. And he is
quoted on the lessons of the thrift crisis:

“The whole thing offers many lessons, most of which have been
taught before,” Taylor said. “Fast growth, unstable funding sources,
human frailty and a lack of controls can severely damage an institution
— but the big gamble that causes the most fatalities is in the area of
asset quality. Making loans (or equity investments) that do not generate
sufficient cash flow to service the debt and cover the risks involved is
the greatest danger facing financial institutions, including banks.”

Taylor succeeded Seidman at the head of the FDIC after the first
Bush administration became convinced that the FDIC was contributing to a
“credit crunch.” But Taylor was so tough as his successor that Seidman
later joked that Bush might wish it had him back.

Todd credits Taylor with crafting a resolution mechanism for failed
banks patterned after the FDIC’s handling of the collapse of Continental
Illinois in 1984. Calling it “the hospital,” Taylor’s FDIC would take
over a struggling bank, hire a temporary manager to run it, provide
funds and act as owner.

“At some point, that thing will turn around and show a profit if
that (manager) is any good,” Taylor said at the time. “And after it runs
profitably a couple of quarters, we’ll say, ‘You’ve been in the hospital
six months, let’s take you to an investment banker or to our resolutions
division.'” Then the bank would be sold, but not at fire sale prices.

It was the germ of an idea incorporated in the financial
regulatory reform legislation now on the verge of enactment.

Taylor’s attitude, like Hoenig’s, was that no bank was “too big to
fail” but some were “too big to liquidate” without causing wider damage.

“For example, there may be banks whose role in our financial system
may make outright liquidation an inappropriate response if these banks
cease to be viable. However, this is not to say that these banks cannot
fail,” Taylor once told the Senate Banking Committee. “If they do fail,
they can be merged, sold, or recapitalized, with shareholders, managers
and directors suffering the same adverse consequences they would if the
institution had been closed and liquidated.”

Taylor, a former high school wrestler who died with so little
assets that colleagues took up a collection to help his family,
described his role as being “simply one of a group of people that tries
to keep the financial system intact with minimal government interference
and to try to get it back on track when a part of it breaks or vary a
part of it that can’t be fixed. Sort of the pit crew of finance.”

Among the other pearls of wisdom quoted by Todd, Taylor disapproved
strongly of “mark-to-market” accounting, which has been blamed for
accelerating the subprime mortgage crisis, saying, “I’d go so far as
saying it’s silly. If you are going to make illiquid loans (as banks
customarily do, e.g. to small businesses) by definition, there is no
market. So how can you mark them to market?”

Even after leaving the Fed for the FDIC, Taylor felt strongly about
the Fed’s predominant role in banking supervision:

“The key role for the central bank in all this is to see that in
the process of change the stability of the banking system is maintained.
As the lender of last resort, it is essential that the Federal Reserve
be able to assess the risk of new powers and new geography. Maintaining
a strong supervision function is essential in this regard.”

He was dubious about the need for three federal banking regulators:
“I’ve always answered this question in a very straightforward fashion
and the answer is ‘no.’ There should be one. It should be the Federal
Reserve. Many people don’t agree with that, but that’s my opinion.”

** Market News International **

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