|2009 Annual Report|
Banking Issues in the Southeast
It really stands to reason that a region like the Southeast—that for some decades has enjoyed in-migration—would have had a very active residential real estate building program. And too many of the banks in the Southeast sort of failed the diversification test and got themselves highly concentrated [in] real estate development, particularly the land acquisition and development lending that precedes the sale of the homes to consumers.
The pace of development could not last forever and didn't last forever. And when the economics began to reverse, many of these banks got into significant trouble. And they were essentially fighting fires of defaults and properties that were put back to them—[properties] the bankers call "real-estate owned." And they were put in a position of really having to try to liquidate properties in a very illiquid market.
Bankers, regulators, households or consumers, business people—we'd all experienced a long period of prosperity and growth, and everyone got a bit complacent.
Bank Failures in Georgia
Georgia in many respects—particularly North Georgia and the environs of Atlanta—was the epicenter of bank failures in the country. [There were] more bank failures here by number of banks than any other single state in the country. Now, I should point out that that's measuring numbers of banks, not total assets of all banks, and that tells you that many of these failures were relatively small and, to some extent, relatively young banks.
Why did that happen? It happened because of excessive exposure to residential real estate development in various forms, because Atlanta was such a growth city for virtually two decades and was the beneficiary of annual growth of population that requires, of course, building to house all those people.
There were a lot of lessons learned, but I'll emphasize two. First, for the Federal Reserve System overall, we learned the importance of macroprudential supervision, looking at the largest institutions—those that represent risk for the whole system—and learning to look at those institutions as a group, a horizontal cut at the growth of concentrations of risk or of business practices that are unsound, really looking at them as an industry or as a whole group of banks as opposed to single institutions.
The second major lesson learned related to the importance of being forward looking, doing more exercises in what could come about in a given bank, in a given portfolio—putting for example, methods such as stress testing in practice opposite an individual institution, and looking at groups of institutions and stress testing their exposure as well. So those were the two major lessons at least I think are most important.
We here at the Federal Reserve Bank of Atlanta have taken a close look at our supervision and regulation department and have identified a number of ways we can improve. One example is that we have improved our risk evaluation capability by forming a specific department that specializes in analysis of certain kinds of risks.
We have also redistributed some of our people to put the numbers of people opposite the most intense needs. So we are trying to improve the way we go about the whole function of supervision and regulation.
Returning to a Healthy Banking System
Certainly an improving economy will help banks regain their health. But over and above that, the banks can do a lot for themselves, particularly in the area of increasing their capital levels, improving their risk management, rebalancing their portfolios to get greater diversification across their portfolios, the management of cost levels within the banks to insure that they have all costs under control. These are all elements of bringing a banking institution back to health.
2010 I view as a transitional year. There certainly will be a numbers of banks that are still dealing with nonperforming assets and dealing with problems that they have to work out. But this will also be a year of opportunity for a number of the healthier banks to begin to grow their business again and improve their position with their clients.
Fed Involvement in Bank Supervision
My key argument is that the role of monetary authority, lender of last resort, and bank supervision and regulation—those roles are linked. I would argue they are almost indivisible. The lender of last resort role requires a central bank to carry it out. And in order to responsibly make the decisions required of which banks deserve emergency liquidity funding, I feel that we need intimate knowledge, both quantitative and qualitative knowledge, of the banks that are asking for temporary liquidity assistance while they are certainly in a condition of clear solvency. We only lend to solvent institutions. So I see those three roles as very tightly linked.