“Market Discipline Beats Regulatory Discipline.”

“Market discipline beats regulatory discipline.”

Thus began John Allison’s description of some of the problems with government regulation of banks at the 31st Monetary Conference at the Cato Institute in November 2013. Mr. Allison was CEO of BB&T Bank from 1989 to 2008. His talk is available on iTunes and at the Cato Institute website in audio and video (Panel 3). It’s a great talk. For those who don’t have the time or technology to listen to it, here are some highlights as I have transcribed them:

In my forty year career, I don’t know a single time when the [FDIC] actually identified a significant bank failure in advance. In that context you have a one hundred percent failure rate….

Regulators regulate for the regulatory good.… They don’t manage for the public good; they manage for the regulatory good.…

Regulators are very politically driven…. So we don’t have rule of law, we rule of regulators driven by what’s happening in the current [political] environment….

One of the great myths … is that banks were [de]regulated under Bush. Three major new laws were passed under Bush: The Privacy Act, Sarbanes Oxley, and the Patriot Act. There was a massive increase in regulation during the Bush years….

Under President Obama … we have an administration that likes all regulations.… The dilemma with that is you can’t comply with every regulation because there are so many of them. The Privacy Act and the Patriot Act are in conflict with each other, which makes it tough.… This is the regulatory onslaught of all time….

In addition to regulators being too [lenient] in the good times, they’re too [strict] in the bad times. They always overreact….

In this last correction we had the … biggest failure of regulators because they spurred an unnecessary panic. We needed an economic correction, but we didn’t need a panic. A lot of the damage to the economy came from the panic, not the economic correction. And they created a panic because they basically suspended rule of law. There was no predictability, there was no policy, there was no plan.… There were no rules of the game. They let Wachovia fail and they tried to sell them to Citi Group, who everybody in the market knew was more broke than Wachovia. They saved Bear Stearns, which everybody in the market knew couldn’t possibly be a systems risk.… [So when] they saved Bear Stearns, everybody said, “Well, god, they’re going to save everybody!” Then they let Lehman fail…. When rule of law fails, when you’ve just got people making arbitrary decisions—there’s no context, there’s no rationality to the decisions—that’s when you get a panic. And that’s exactly what happened….

The Fed is basically forcing everybody to use the same mathematical model, which means we’re all collectively going to make the same mistake….

Another area that banks are having to use mathematical modeling in almost exclusively is for small business loan decisions.  Now here’s the problem: small business lending is part art and part science.… If a [small business] loan meets mathematical standards, we were going to make it anyway. The loans that matter are the ones that don’t meet the mathematical standards, but you make a judgment that that person, that idea, that plan will work, and you make that loan anyway. I did that a lot. And some of those businesses were extraordinarily successful and created … thousands of jobs. I will tell you today, if I were a small business lender, I couldn’t make those loans, because they wouldn’t have met the mathematical standards forced on us by regulators….

There’s no way regulators know what risk banks ought to take. They don’t have some special insight. Only the market discipline can [answer] that question.… And you need banks experimenting with different risk parameters…. Forcing everybody to take the same risk and the same standards radically reduces economic growth….

Free markets work. Why wouldn’t they work in the banking business?

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