Iowa Banking Law Blog

Preventing or Producing a Bank Liquidity Crisis: Hobgoblin of Small Minds

          As our heartland ancestors have in the past, we view the eastern financial centers with great consternation.  Their rules seem to be both special and readily malleable.  Fixed rules of law regarding failure become fluid rules of adjustment for some to fit the exigent circumstances at hand and investors both here and abroad.  For one group of (investment and indirectly the money center) banks, we observe one set of criteria for Schumpeter’s creative destruction, the great cleanser of capitalism.  For the community banks, we have another set of rules. For investment banks, there appears to be no amount of liquidity that currently cannot be provided to save the American day and their collective money center brethren.  On the other hand, the community banks are now beginning to experience financial regulators dutifully following orders from the nation’s capital.  In many cases, the regulators are rightfully, if not zealously, restricting certain bank’s conduct with various administrative orders in order to avoid even worse consequences down the road.

            As a frequent consequence of many of these detailed administrative orders, a community bank’s capital is impacted and the once well capitalized community bank is then deemed to be only adequately capitalized due to past or anticipated losses.  Suddenly, the community bank’s access to sources of liquidity becomes constricted by regulation.  The very continuation or even utilization of brokered deposits become subject to regulatory approval even though no questions were raised previously regarding those sources of funding.  Additionally, the Federal Home Loan Bank’s advances, which have become the mother’s milk of funding community banks, become more stringent.  In these cases, the community bank regulators are required to do just the opposite of the regulators of the investment banks.  In effect, the regulatory rules of the road for community banks may escalate a liquidity crisis just when the smaller community bank needs time and liquidity to resolve the issues it faces and raise capital.

            How is this different treatment fair or equitable?  Investment banks and indirectly money center banks are flooded with liquidity while smaller community banks face a liquidity crisis brought on not by the markets but by the well intentioned regulators hoping to protect the system. Ironically, the community banks with more direct regulatory oversight have their liquidity options diminished by such regulation, and the investment banks and G.S.E.s which are not subject to such regulation, receive additional liquidity from regulatory or governmental agencies. Admittedly, consistency is indeed the hobgoblin of small minds in the heartland, but without some equitable reconciliation of these disparate treatments, the uneven moral hazards of today will become political and institutional hazards destabilizing tomorrow.

-Howard Hagen

Changes to SBA Community Express Program

The Small Business Administration (SBA) is restructuring its Community Express program, effective October 1, to increase the number of eligible borrowers and funnel more lending to low-income areas.  The restructuring extends this 9 year old “pilot program with a deadline” to December 31, 2009.  The SBA Community Express loan program is designed for small businesses in disadvantaged communities to help them succeed.

            Some important changes to the Community Express program include:

• After October 1^st, anyone is eligible for the loan, while before that date only minorities, women, veterans, and those in low income areas are eligible.
• Small businesses with a principal office in a low-income HUBzone, or an area covered by the Community Reinvestment Act, will be eligible for the loans, as will any small firm seeking a loan of $25,000 or less.
• The SBA reduced the maximum interest rate lenders may charge for Community Express loans, bringing it in line with the SBA’s 7(a) program.  The new maximum rate will be prime plus 2.25% for loans with maturities of less than 7 years.  For loans with maturities of 7 years or more, the maximum rate will be prime plus 2.75%. 
• Lenders are allowed to charge an additional 2 percentage points for loans under $25,000, and an additional 1 percentage point for loans between $25,000 and $50,000.
• Lenders using the Community Express program, who are required to arrange technical assistance for borrowers, will be able to use the SBA’s online Small Business Training Network to satisfy this requirement.
• The SBA guarantees 75% – 85% of Community Express loans, and up to $250,000 can be borrowed through the Community Express Program.

Federal Reserve Bank of Chicago Economics Blog

Wade Rousse and Cindy Ivanac-Lillig at the Federal Reserve Bank of Chicago have started an economics blog entitled "Marginal Thoughts."  So far, the blog has defined and discussed various economic terms and concepts that are being bandied about these days.  Marginal Thoughts has very short, engaging posts; its informative, but not dense, you should be able to read it and understand it even before you have your morning coffee.  It hasn't been up long, here's to hoping they continue it.

I suggest you subscribe to Marginal Thoughts.  It appears that there is a post about once a week, so your inbox won't be inundated. 

Jeff Andersen

Carbon Credit / Offset Primer

Carbon credits and offsets have been in the news a lot lately and have been a speaking point for many of the presidential candidates.  In the not too distant future, your bank may encounter a customer seeking to partially finance a project through carbon offsets.  Furthermore, as markets develop, carbon credits may become a more prevalent investment.  Following is a very brief, very basic primer on carbon credits and carbon offsets.

Carbon Credits: carbon credits are tradeable permits to emit greenhouse gases. Carbon credits are generally issued as part of a government mandated cap-and-trade system.

Cap-and-Trade: a regulatory scheme under which a government sets a cap on harmful emissions. Companies that are subject to the scheme must meet the cap. If a company emits less than cap, it will receive carbon credits that can then be traded for a profit. If a company exceeds the cap, it must purchase carbon credits to meet the cap.

Carbon Offsets: carbon offsets are financial instruments representing a reduction in greenhouse gas emissions. Carbon offsets generally arise in the voluntary carbon market. Note: the terms “carbon credit” and “carbon offset” are often used interchangeably. However the terms are used, the distinction between credits/offsets in a mandatory cap-and-trade market and credits/offsets in the voluntary market should be noted.

Voluntary Carbon Offset Market: the voluntary carbon offset market generally consists of bilateral, over-the-counter transactions between a party who has instituted a project or practice that has proven to capture, sequester, or otherwise reduce greenhouse gas emissions. Organizations are emerging that verify and register voluntary carbon offsets.

     The United States has not instituted a cap-and-trade system. The U.S. has not ratified the Kyoto Protocol and has not developed a domestic system. The Kyoto Protocol caps the emissions of ratifying, non-developing countries. Countries exceeding the cap can purchase credits from countries who emitted less than the cap, or can purchase credits from projects that capture, sequester, or otherwise reduce greenhouse gas emissions, similar to the voluntary carbon offset market. Regional initiatives to cap major emitters are emerging in the U.S., but a unified system has yet to be established. There are currently bills before Congress seeking to establish a cap-and-trade system.

     Lacking a cap-and-trade system, the voluntary market has developed in the U.S. In the voluntary market companies, governments, and individual buy carbon offsets to mitigate their own greenhouse gas emissions arising from energy use, waste, transportation, and other sources. A the rationale for the purchase, purchasers cite care for the environment, customer goodwill, positive press, gaining valuable early experience in an emerging market, and the inevitable institution of higher emissions regulations, be it a cap-and-trade system or a straight emissions tax. Offsets can be generated from projects such as wind energy, the capture or sequestration of agricultural gas, renewable energy, and forestry. Generally, to obtain voluntary offsets for a project, strict protocol of the body verifying and registering the project must be followed. One key requirement in the voluntary market is additionality. Although there are different definitions of additionality, the gist is that the project must reduce emissions over and above “business as usual” and would not have gone forward without carbon offset funding. Although difficult to grasp and prove, this concept is intended to ensure that purchasers are buying a true reduction in emissions and are not merely padding the pockets of a project, and emission reduction, that would have occurred anyway.

OTS Authorizes Establishment of Foreign Subsidiary; Employment Articles

I neglected to post a link to the January / February Community Bank Brief.  Click here for a pdf of the newsletter, which contains an article on the OTS's approval of a federal savings bank's application to establish an operating subsidiary in China, among others. 

Also, here is a link to the labor and employment law newsletter, Hire Perspectives.  It contains articles on email policies, pre-employment testing, and FMLA absences for substance abuse treatment. 

Subpoena Scam

If you get an email purporting to be a Subpoena in a Civil Case in California Federal Court do not open the attachment and do not click on any links in the email.  There is a virus going around that is masked as a subpoena.  We were forwarded such an email from an Iowa financial institution client today and want to make sure no banks fall victim.  Out of state subpoenas are generally not enforceable unless they go through an Iowa court first and they would probably not be sent via email.  Nonetheless, we have encountered out of state subpoenas that appear to be bogus and were merely faxed to a client, but turned out to be linked to a real case.  If you have any questions as to whether a subpoena or email is for real, contact your legal counsel.  Let them open it. 

The case number on the bogus subpoena we encountered was 28-913-FRG.  The purported issuing officer and address was:  O'Mevely & Meyers LLP; 400 South Hope Street, Los Angeles, CA 90071. 

Subprime Lineage

          The reports of a recent depositor run at the Countrywide Bank in California may reveal an emerging shortcoming in comfort with the industry's FDIC insurance.  See article in Atlantic Journal-Constitution.  This new phenomena of undifferentiated fear may be the result of the increasingly complex and intertwined system of financial products confronting and confusing investors.  An insightful analysis of this growing customer anxiety and the potential inability or unwillingness of bank customers to differentiate the "insured" financial product from the uninsured financial instrument can be found in the Op-Ed column by Paul Krugman of the New York Times available here (subscription required). 

          Whether more regulation, or simply more common sense, is needed to deal with the recent credit events, Barney Frank, Chair of the U.S. House Financial Service Committee believes in and is urging more federal intervention.  See Financial Times article.  Mr. Frank calls for regulation of mortgage brokers, guidelines for securitization of mortgages, and a total reevaluation of the regulation of financial markets. 

Wal-Mart to Enter Prepaid Card Market

       The Financial Times has reported that Wal-Mart will partner with GE Money Bank to launch a prepaid card product aimed at the 80 million U.S. residents without a bank account.  Link to Reuters article.  Prepaid cards are a growing industry, generating a market worth $76 billion last year, according to the Financial Times.  Wal-Mart's "quasi-bank account" cards would have a $3,000 limit and would be covered by federal deposit insurance through GE Money Bank.  This news comes just weeks after Wal-Mart announced its entrance into the financial services market by offering a discount brokerage service.  Link to previous Iowa Banking Law Blog article.  After withdrawing its bid to create an industrial loan corporation in March, Wal-Mart seems intent on offering a broad range of financial services through other avenues.

       Will prepaid and other payment methods linked with cellphones be the future of banking?  Will new banking technology have the same effect on the banking industry that the internet had on newspapers?  Will the new Nonbanks be Viral Banks?  These are the questions that immediately come to mind.

Wal-Mart Enters Investment Services Market--House to Vote on Bill Barring Retailers from Operating Own Bank

After withdrawing its bid to start an industrial bank in March, Wal-Mart announced that it will offer discount brokerage services.  Wal-Mart will team with ShareBuilder Corp., a Bellevue, Washington-based discount brokerage in what is sure to be the first of many Wal-Mart ventures into the financial services market.  Link to Wall Street Journal article. (subscription required for full article).  On the Wal-Mart website it is described as "Wal-Mart Easy Investing by ShareBuilder."   

In other Wal-Mart news, the House is scheduled to vote today on a bill barring retailers such as Wal-Mart from opening their own banks.  The bill would "block non-financial companies from setting up or owning so-called 'industrial loan corporations,' which can issue credit cards, make loans and, in some cases, take deposits."  http://www.businessweek.com/ap/financialnews/D8P8N38G1.htm.  A similar bill passed the House last year, but ultimately stalled in the Senate.

For more information contact Howard O. Hagen or Jeffrey J. Andersen.