#195. Main or Wall?

For the past month the stock and credit markets have been roiled by the sub-prime debacle.  Congress has been discussing a $700 billion (that’s $700,000,000,000) rescue plan for Wall Street.  Countless times I’ve heard the Washington politicians and bureaucrats talk about this as a “plan to rescue Main Street!”  Really? Main Street?  Here’s my take on the current situation, the impact I see on the Main Streets I visit and my simple suggestion for rural American banks.First let’s look at how this problem came about. Historically, Main Street banks gathered deposits and made home loans which they kept on their balance sheet, collecting a monthly interest and principle payment until the loan was paid off.  Think Jimmy Stewart as George Bailey of the Bailey Building and Loan Association from the classic movie “It’s a Wonderful Life.”  Wall Street saw the huge volume of loans, figured out a creative way to latch onto those loans, calling it “securitization” as they turned home mortgages into securities.  Think Michael Douglas as Gordon Gekko in the 1987 film “Wall Street.”  His signature line was “Greed is, for lack of a better word, good.”

Securitization didn’t factor in that someone making a loan would never have to worry about it ever being paid back, like the Jimmy Stewart banker, and was going to create a large number of abuses.  While securitization often helped to fix rates and reduce interest costs for borrowers, loans were sometimes made to people who should never have gotten loans.  Others were charged too high of interest rate by free lance mortgage brokers who knew they would never deal with that borrower again.  In 1999, the lending criteria was dramatically loosened and as a result, in hindsight, crazy loans ended up being made. This MAJOR disconnect between the lender and collector is the root cause of our problems today.

So, what happened when Wall Street securitized mortgages?  Loans were made but then shipped to Wall Street where they were “packaged” and sold around the world with companies like AIG writing “insurance policies” on these loans defaulting, called counter party agreements and credit default swaps (Warren Buffet called them “Financial Weapons of Mass Destruction’) that looked like easy money for the big insurer.  Earlier this month we taxpayers had to bail AIG out to the tune of $85 billion, when that easy money turned into actual claims that had to be paid out.

Along the way, Wall Street investment bankers, AIG bigwigs and others in the long chain of securitization took a “bite” out of the flow of money going by.  Profits were astronomical and bonuses on Wall Street were measured in the billions, not millions.  When times were good it was capitalism at its best.  Now with the whole house of cards coming down, Wall Street is looking for a handout.

My major gripe is that it shouldn’t be capitalism on the way up and socialism on the way down!On Thursday we held our annual Customer Appreciation Golf Outing with our industrial clients, community bankers from as far away as Mississippi, equity partners, economic developers and others coming into Effingham for a fun-filled day.  This year I made it a point to ask every banker that I talked to (about 8 in all) if the current Wall Street crisis was affecting their lending to small businesses on Main Street.  Only one of the eight said that they had tightened their loan underwriting “slightly”.  The rest were all “business as usual.”

I am chairman of a local bank board in my hometown, Midland States Bank, a board that I’ve sat on continuously since 1983.  I’m also a small shareholder in three other local banks in Effingham County and we deal with local bankers in our industrial development activities around the country.  I love to talk with local bankers in my many talks around the USA.

Here’s the situation at Midland and I would guess at 99% of the Main Street banks that I’ve talked to recently, which is diametrically opposite of Wall Street investment banks which aren’t really banks at all, although the media neglects to differentiate the BIG differences between investment banks and community banks, simply referring to each as ‘BANKS’.  Midland’s capital is at an all-time high with us having a 12% ratio of capital to assets compared to larger banks which typically operate at a riskier 7 to 8% capital ratio and investment banks which operate at a 2 to 3% ratio.  Our investment portfolio is solid.  We don’t own any of the toxic Fannie Mae or Freddie Mac preferred stock shares or sub-prime mortgages that are today worthless and causing so many problems at investment banks.  Our loans are being paid on time by local borrowers and our past dues are below past averages.  For our depositor’s safety, the first line of defense is not the FDIC, but rather the capital of the bank.  Midland’s strong, conservative capital base is greater than the total of uninsured and non-collateralized deposits on our books.  All in all, a typical, local conservative bank that makes loans to local businesses and helps to keep the local economy humming.  And, just like thousands of other local banks around the country that didn’t get caught up in what Wall Street was selling.

Here’s my suggestion for D.C.  Let’s help local banks bloom in rural America.  You could do that by encouraging bank startups in rural communities where the local banks have been bought up by the bigger regional and national banks, taking away that local control that I wrote about extensively in BoomtownUSA.  The big problem for small, local banks this past decade has been the extensive and growing regulations from D.C. which makes running these smaller banks much more difficult.  Those local bankers would understand their communities more, know who they are lending (and collecting) money to and invest in their local communities.  We’ve gone from over 12,000 banks in this country in 1990 down to less than half of that today, primarily because smaller banks (those under $100 million in assets) can’t keep up with all of the various regulations that come out of Washington.  We need to reverse that trend.

The current crisis on Wall Street is not a Main Street problem but a Wall Street one.  Wall Street made some bad bets, forgetting that you shouldn’t disconnect the lending function from the collecting one, and now wants us to bail them out.  Washington DC can’t solve this problem in the long term; firms on Wall Street need to fail, order restored and we as a country begin to rebuild on a stronger, more conservative capital base.  The last time that D.C. got in a hurry over some crisis was when they passed the Sarbanes-Oxley legislation after Enron’s meltdown, laws which have hurt a number of smaller, more entrepreneurial companies in their quest to raise capital.  If Washington bails out Wall Street, next up for a bailout is going to be the Big Three auto companies which failed to reinvest in innovation, have bloated overheads and legacy costs and also don’t deserve a multi-billion dollar bailout.  Then who?

What do you think?  Let us know.  We’ll publish some of your comments in next week’s Agurban.