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"Regulating" Boom and Bust


It was announced earlier this month that Piper Jaffray is buying boutique investment banker Sandler O’Neill & Partners L.P. for $485 million. The Wall Street Journal reported,

Sandler O’Neill is a leader in advising small and midsize banks on deals, having been involved in 355 bank mergers since 2010, according to Dealogic. It is an area that Piper Jaffray has wanted to enter for some time.

Piper Jaffray wants to turn into Piper Sandler Cos. because small and midsize banks are going the way of the buggy whip. In his book, Inside the FDIC: Thirty Years of Bank Failures, Bailouts, and Regulatory Battles John F. Bovenzi mentions there were 14,000 banks when he started with the deposit insurer in the 1980s. As of 31 March of this year, the number of reporting institutions was down to 5,362, according to the latest FDIC Quarterly report.

In this year’s first quarter 43 banks were absorbed by mergers and only one new charter was granted. The banking universe is becoming more concentrated. Banks are selling out and few new bank charters are being approved. At the end of 2014, there were 6,509 banks. Almost 300 banks a year are going away.

Mr. Bovenzi worked in high-level positions at the FDIC, and the last 10 years he was deputy to the chairman and chief operating officer. He worked under 10 FDIC chairmen. His point of view comes from the top, although he begins the book in Burbank, California, as he and his crew arrived to close down IndyMac in July 2008.

Bovenzi relates the comments of bank-closing veteran Rick Hoffman. “We had a job to do, but we had to be sensitive to what the bank’s employees and their customers would be experiencing.” Anyone who has worked at a bank on a Friday evening when the regulator closes it down knows FDIC employees are anything but sensitive.

One CFO told me it was the worst night of his life. Another CFO at another failed bank told me, she was told she had to come in the next day (Saturday) because they wanted to talk to her. She came in, waited all day, in a closed room by herself, and they never came.

As yellow crime-scene tape is put across the front door, bank examiners immediately begin interrogating shell-shocked employees with questions like; “Who’s fault is this?” “Was there fraud going on here?”

After IndyMac, Bovenzi points out over 400 banks would fail over the next four years. Why is it when one bank fails, despite FDIC insurance and other government interference, numerous other institutions often go bust? Murray Rothbard explained in America’s Great Depression.

Banks are “inherently bankrupt” because they issue far more warehouse receipts to cash (nowadays in the form of “deposits” redeemable in cash on demand) than they have cash available. Hence, they are always vulnerable to bank runs. These runs are not like any other business failures, because they simply consist of depositors claiming their own rightful property, which the banks do not have. “Inherent bankruptcy,” then, is an essential feature of any “fractional reserve” banking system.

Banks certainly weren’t lacking for government supervision in the 28 years Bovenzi was on the job. He writes plenty about the alphabet soup of regulators stepping on each other to regulate banks. The FDIC, the FSLIC, the OCC, the Federal Reserve, the FHLBB, the RTC, the OTS, and so on.

Despite all of this regulation banks still fail, and when they do the U.S. government unleashes “shock and awe” legal firepower. After the S & L Crisis, Bovenzi writes,

By the early 1990s, the FDIC and the RTC had more lawsuits to manage than any organizations (sic) in the world. They also had the largest legal departments to be found anywhere in the world, employing over 1,000 lawyers and additional staff.

The author reflects, “One of the greatest challenges for the staff of the FDIC and the RTC was distinguishing between malfeasance and mismanagement.”

Later he continues,

Federal bank regulators are often accused of not understanding, or inappropriately using, their power. This can be particularly true in conducting investigations. Whenever a bank fails, there is an investigation into whether there are criminal or civil claims that should be filed against the directors and officers of the bank. This is a powerful authority held by government employees. The utmost caution and care needs to be taken in utilizing that power.

My experience was any and all caution was thrown to the wind as the FDIC turned its lawyers loose on bank employees who were simply doing their jobs. Jobs which are not protected by a union, as opposed to FDIC employees, who are represented by the National Treasury Employees Union.

Bovenzi chronicles the tussle the OTS (Office of Thrift Supervision) and the FDIC had over the closing of Washington Mutual (WAMU). For a full length explanation Kirsten Grind’s The Lost Bank is excellent. Also, Sheila Bair’s book Bull by the Horns sheds some light on WAMU and Jamie Dimon’s fire-sale purchase.

In the wake of the bust the author admits, “Washington temporarily guaranteed virtually all of the debt in the financial system.” Is it any wonder aggregate debt continues to grow and the Too Big To Fail banks, often complained about by the author, have only grown and become more systemically important.

Rothbard wrote in Making Economic Sense

the entire fractional-reserve system is held together by lies and smoke and mirrors; that is, by an Establishment con. … The banking system, in short, is a house of cards. … Banking is not a legitimate industry, providing legitimate service, so long as it continues to be a system of fractional-reserve banking.

There is no reason to believe the next 30 years will be any different than the 30 years Bovenzi writes about. The regulation can never be airtight. Banks will create booms, the little banks will be allowed to fail, while the large banks are bailed out.

If you’re running a small bank, save yourself some grief, call Piper Sandler, and sell out now.


Doug French

Douglas French is President Emeritus of the Mises Institute, author of Early Speculative Bubbles & Increases in the Money Supply, and author of Walk Away: The Rise and Fall of the Home-Ownership Myth. He received his master's degree in economics from UNLV, studying under both Professor Murray Rothbard and Professor Hans-Hermann Hoppe.

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