Too Small to Fail

With the big guns in the financial services industry in turmoil, it’s a good time to ask hard questions about the nature of our finance system. Does bigger always mean better? Or does small-scale "relationship" banking, in which individual savers and borrowers are members of the same community, help to make a better banking sector? Community banks and credit unions were regarded until recently as vestigial players in a new world of global consumer finance. But today they aren’t merely doing well; they also seem to have a lot to offer.

In this event, New America and the Washington Monthly explored ways to encourage the health and number of small-scale financial institutions as a means of thwarting the tendency toward excessive consolidation in financial services and restoring a mutuality of interest between borrowers and lenders. By encouraging thrift, responsibility, and a sense of community, small-scale financial institutions could play a leading role in digging out from the current recession and avoiding the next one.

Phil Longman began the discussion with a look at why community banks are relatively successful compared to their larger, national (and sometimes multinational) counterparts. Longman argued that in many cases, community banks are “too antiquated to fail,” in that they haven’t had access to global markets and they haven’t had the ability to experiment with risky and complicated products such as subprime mortgages. These smaller, regional banks provide “informational capital,” much like in the movie It’s a Wonderful Life, where banks (like George Bailey’s) know the borrowers, the borrowers know each other, and the institutions are much more likely to behave responsibly.

Ellen Seidman followed with a brief talk on the policy levers that can be pulled in order to incentivize the growth of these responsible, small-scale institutions. Seidman said that we need to provide for patient capital and deposits, longer-term mortgage rates, and creating more connectivity between borrowers and institutions such that we maintain the all-important mutuality of interest. Seidman and Longman propose a new Community Banking Trust Fund, perhaps modeled on or within the current Communicty Development Financial Institution Fund, which would make equity investments in small-scale depository institutions that need patient capital to serve their communities effectively. For credit unions and mutually owned banks that do not issue stock, the fund would provide net worth certificates, which would count as equity, but pay a set interest rate. In addition, the fund would make technical assistance grants to cover critical investments in areas such as information technology and disaster recovery. The fund would encourage these institutions to offer financial services that are limited in many communities, such as lending to local businesses and homeowners, safe and convenient mechanisms for savings, and transactional, cash management, and investment services. The initial cost of such a fund could be as much as $30 billion, which would come from the Treasury's TARP money. Seidman argued that while that looks like a lot, as many as 15,000 institutions could be covered, which makes $30 billion look small in comparison to the $25 billion each of three large banks received.

Josh Rosner (Managing Director of Graham Fisher & Co.) continued by discussing that one of the main drivers of the current financial/mortgage mess was the consolidation of the industry--that is, the financial industry increasingly relied on automated underwriting, automated valuation models and other impersonal tools that made many community banks and other local institutions unable to compete. Rosner also added that the notion of a company or bank being “too big to fail” is a relatively new and counterintuitive one. He said that perhaps instead of propping up these behemoths that have engaged in unhealthy behavior, we should let them die and “feed the carcass” to these more responsible institutions that have seen some success while acting responsibly.

After the excellent analyses on the virtues of community banking in the context of our current financial mess, Jan Miller, a community banker gave a description of his institution – Wainwright Bank – where he serves as President/CEO. Wainwright serves the Boston area and currently holds around $1 billion in assets. While the bank offers many of the same services and products as other banks, they concentrate on social justice and green banking as well. They were voted as the company with the highest level of community involvement per employee in the Boston area, and are 4^th in the country in residential loan growth (according the American Banker). Miller stressed that loans that serve the community can be extremely profitable, that customer loyalty is incredibly valuable, and community involvement can allow banks such as Wainwright to have political clout in the community.

Doug McGray, a New America Fellow, followed with a snapshot of the check-cashing and payday lending industry, which has seen an enormous boom in recent years. McGray stressed that there are many flaws with check-cashers and payday lenders (not the least of which that they impede people from saving), though he explained that there are reasons that they are staples in many communities. McGray argued that there success can be attributed in large part to the sense that they are “of the community,” that many banks seem like alien entities, that many of the fees that banks charge drive people into the arms of check cashers who are members of the community and have sold themselves well.

A spirited discussion followed that touched on the nature of community banks – whether or not a “community” must involve a specific region or whether banks can market themselves to more general demographics – as well as the advantages and disadvantages of community retail banking relative to national chains that are on nearly every corner. All panelists agreed that we must incentivize more responsible lending behavior, and Rosner in particular stated that, for example, we should not put so much emphasis on increasing the homeownership rate through complicated and unattractive loans while wages remain mostly stagnant.

A new paper in New America's "Big Ideas" Series and a feature article in the Nov. 19th Washington Monthly both explore this question in detail. Copies will be available at this event.

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Participants

Featured Speakers
Phil Longman
Schwartz Senior Fellow and Research Director, Next Social Contract Initiative
New America Foundation

Ellen Seidman
Director, Financial Services Policy, Asset Building Program, New America Foundation

Respondents
Douglas McGray
Fellow, New America Foundation

Joshua Rosner
Managing Director, Graham Fisher & Co

Jan A. Miller
President & CEO, Wainwright Bank & Trust Company