The High Cost of Government Intervention

Here's a link to an interesting article by Rajshree Agarwal, a business professor at the University of Illinois. According to Ms. Agarwal, "Massive bailouts and other moves by the U.S. government to stem a near-epic economic meltdown could set the U.S. economy back by more than a half-century..."

This story presents another aspect of the "too big to fail" argument that doesn't receive a lot of press.

Interested? Click here to access the article.

The High Cost of Solving "Crisis" Situations

It seems like we've gone from a crisis - we have to act immediately or everything will come crashing down around us - to a calmer perspective on the economy. As has happened in the past, we are adjusting to the current situation and are likely to do quite well over time.

Our government has moved on to solving another "crisis" - the high cost of health care.

We are just now beginning to read and hear concerns about the possibilities of high inflation and costs of financing a huge federal deficit. Strangely, these concerns were ignored when we were dealing with the last crisis. I'm certainly not an economist, but it seems odd that the solution for an economic downtown resulting at least in part from too much individual debt is for the government to take on huge amounts of debt.

Let's deal more deliberately and rationally with the next crisis. Health care for everyone is a wonderful idea. However, if we can't afford it, we shouldn't mortgage our futures to provide health care for everyone. Seems like it would make more sense to figure out what we could afford to pay and then see what we could buy with those dollars.

Leadership in Difficult Times

Uncertainty, fear and worry are usually associated with difficult economic times. These attributes are constantly reflected in media reports. One possible consequence is that affected individuals look for someone or something to place where they can place confidence and trust.

Consequently, individuals with a positive vision of the future who can inspire trust have a unique opportunity to provide leadership. A morally and ethically responsible leader of this caliber can have a positive effect on those around him or her.

According to research by Cass Bettinger, extraordinary leaders:

1. Know themselves; are emotionally intelligent, fully aware of their strengths and developmental opportunities, and are on a quest for continual self-improvement.
2. Foster adaptive, values-driven, high performance corporate cultures.
3. Build high-performance teams.
4. Are visionary; conceptualize, communicate, and reinforce a compelling vision of the organization's ideal future.
5. Are proactive agents of appropriate strategic change.
6. Master the financial and non-financial drivers of their businesses.
7. Focus, inspire, and build self-esteem.
8. Mentor, coach, and develop others.
9. Execute brilliantly.
10. Never stop learning.

Another essential quality of leaders is an ability to build effective teams. Leadership isn't about shouting orders so much as it is about building teams who understand the mission and are committed to working together to accomplish the stated goals and objectives.

Transparency

Although it sounds like a good idea to let the public know the condition of the large banks, I wonder about the potential negative short-term and long-term effects.

Does the U.S. government really know the parameters for a stress test? Are the parameters of the stress test "worse case," "expected" or something else? Shouldn't stress testing involve a number of scenarios? Will analysts and media experts believe the results? Will the results be reported fairly? Will there be a run on banks that fail the test? If so, how will the government handle the situation?

If our deposits are secure, why do we need to know the results of stress testing? When will the regulatory agencies start to release the CAMELS ratings? How will the public handle that disclosure? Will every bank need to be a "1"?

What do you think?

Community Bank Directors Conference

Topics & speakers were:

• Director Priorities for 2009 - Cass Bettinger, Cass Bettinger & Associates
  
• Financial Trends in Community Banks - Bob Walters, The Bank Advisory Group
  
• Audit Committee Challenges & Issues - Dan Trigg, McGladrey & Pullen, LLP
  
• Regulatory Perspectives from a Former Regulator - Sam Golden, Alvarez & Marsal
• Economic Perspectives - Brian Wesbury, First Trust Advisors
• Capital Issues - David Baris & Charles Thayer, American Association of Bank Directors
• Balance Sheet Strategies for Difficult Times - George Darling, Darling Consulting
• Strategic Planning & Acquisitions in Troubled Times - Peter Weinstock, Hunton & Williams, LLP
• Lessons From Regulatory Exams - Matt Schriner, RSM McGladrey, Inc.
• Credit Issues - Merrill Reynolds, Reynolds Williams Group

General comments from participants are listed below.

"Best line up of speakers and relevant content of director conferences to date. Best two days of relevant material that I have experienced. Annual director conference is the best possible director education in the industry. Please continue."

"This is my first year as an outside director of a community bank. I felt that I received great value from the presentations. The educational opportunity presents an opportunity for me to challenge the bank's mgmt to adapt to the external "dynamic" changes they are experiencing today. Great job!"

"All great speakers."

"Great presentation. Excellent"

"Very good conference"

"All presentations were excellent. I would hope there will be another conference next year. After attending these meetings, I always feel more comfortable in a board meeting session - more especially, I hope, in these uncertain economic times. As an outside director, I can never have too much information."

"Good conference with timely info always organized well"

"This conference is a very thought provoking conference that deal with real issues and practical advice. Keep it going."

"My first time with this group. Would repeat for sure."

"My first meeting - very informative and I learned a lot"

"My first time - great event. Do again next year."

"Great program!! See you next year."

"Please continue. We have been to others, but this is by far the best with the most meat."

"I think this conference is always a great learning time, especially in this new banking climate. Very important to outside directors."

"I appreciate the quality of the conference program and the quality of the speakers. A little fast paced for outside directors."

"This is my second conference. It's a great working seminar. It definitely makes me a better outside director. I would like to see all of our directors at the seminar in the future."

"This was my first time in attendance. I feel the information and speakers were very relevant to my bank and what is happening in the industry."

"Excellent conference - but as an outside director I would suggest that much of the material and the "speed" at which it is presented is difficult to fully understand and appreciate."

"A little too much history and background. A number of speakers went over the same material. Have an overview session and then have each speaker address his area of expertise and not traverse ground already covered."

"Use of many abbreviations/acronyms made it difficult at times"

Managing & Accounting for Risk

Management has a lot of roles. One very important role is to lead the organization in a way that produces acceptable returns within acceptable risk limits.

Credit risk has always been of primary importance in the long-term success of financial institutions. An overwhelming percentage of community bank failures have resulted from loan losses.

There are many ways to mitigate credit risk. Theoretically, a bank could severely limit its loan portfolio. (Community Reinvestment Act & related regulations make this approach virtually impossible.) Risk can be mitigated by lending only to certain types of enterprises that are deemed to be less likely to fail. (Even unlikely candidates for failure may find themselves in difficult financial situations.) Risk could be accounted for by providing allowances for losses that may ultimately occur. (This approach was used until the accounting rules were changed to allow reserves only for known losses.)

Bottom line: There are few, if any, guarantees in the lending business.

Long ago, in a quieter and more civil time, community banks were managed to assure consistent earnings streams. Management knew "good times" don't last forever and some sector or sectors of the economy would become stressed. Allowances were provided for losses that were not "known" but were expected to occur. Securities were purchased to provide a return and liquidity and were managed prudently. If liquidity was needed, securities that best met the bank's liquidity and earnings goals were sold. Decisions were based on current conditions.

Although accountants say they only report results, accounting rules dictate how the results are reported and force management to make decisions that would not have been made under different circumstances.

Accounting rules require a security to be classified as either held-for-sale or held-to-maturity at the time it is purchased as if the purchaser knew in advance what interest rates, bond markets, and securities issuers would do in the future. Securities classified as held-to-maturity can't be sold prior to maturity except under unusual circumstances without severe accounting consequences.

What's wrong with the notion of allowing community banks to operate in a way that provides for expected potential losses and allows investing decisions to be made on the basis of current conditions?

Mark-to-market Accounting

Is mark-to-market accounting the cause of all our financial problems? If we answer this question "yes" the implication is that mark-to-market accounting caused bad judgment, greed, and numerous other social problems.

Are current mark-to-market accounting standards appropriate? Mark-to-market accounting was heavily promoted by accounting theoreticians and analysts who wanted to show the "real" value of a business. The flaws, of course, are numerous. In fact, the real value of a business is based on its ability to produce earnings over time (a concept that is ignored by mark-to-market accounting). Mark-to-market accounting as currently practiced:

• Shows liquidation value of some assets as of a specific point in time.
• Ignores the possibility of the market recovery of an "other than temporarily impaired" asset.
• Does not allow for the possibility the value of an asset held to maturity may be more than the current market value.
• Arguably does not reflect true value of an asset sold in an illiquid market.
• Attempts to place a market value on assets that are not actively traded and for which there is no active market.
• Results in changes in equity without resulting changes in assets owned (and sometimes without changes in cash flows).

In addition, unless there is daily real time reporting of financial results, the marked-to-market financial statements are not likely to reflect market values by the time they become available to the public.

Auditors are caught in the middle. Accounting and auditing rules force them to be the arbiters of "fair market value." Auditors aren't valuation experts. Presumably an auditor has extremely good judgment that allows him or her to examine the available information and make a decision as to the value of an asset or liability. A value that is later proven to be too high can result in disastrous results for the auditor and the audit firm, so there is a built-in bias toward valuing assets at the low end of any range.

Let's acknowledge the flaws in mark-to-market accounting and move quickly to either make the adjustments necessary to make it work or to move mark-to-market accounting back to the financial statement footnotes.