Too Important to Fail

To the people who have worked with him, Mike Kelly is a contemporary, super-sized George Bailey, the community-oriented building and loan proprietor in the movie It’s a Wonderful Life. In real life, unfortunately, the counterpart of the movie’s money-grubbing Mr. Potter has pulled off ​“the largest bank robbery in the history of the United States” in the Chicago suburb of Oak Park, according David Pope, the village’s president.

But the real villainy – and tragedy – in this small slice of the nation’s financial crisis is a long series of inconsistent, arbitrary and short-sighted decisions by federal banking regulators. Their decisions ultimately undermined the oft-repeated pledges by the Obama administration to strengthen community banking, get money flowing into the economy, and create jobs. 

Last year the Federal Deposit Insurance Corporation closed 140 banks, mostly small to medium-sized. FDIC chair Sheila Bair expects closures to peak this year and continue at a high rate into 2011. Many of the closings will be necessary. But without more regulatory flexibility and attention to multiple policy goals, many communities could lose critical, viable local institutions and banking concentration will grow – even while the administration says it wants to break up big banks. In short, federal regulators will jeopardize President Obama’s economic goals. 

Bank robbers

White-haired Michael Kelly, a very private man, became a billionaire by putting together a string of nine privately held community banks from Illinois to Texas and California. His enterprise had $19 billion in assets under the holding company FBOP Corp.

The anchor of FBOP Corp., Park National Bank, was located in a middle-income, racially integrated suburb, but it offered banking services to many poor, predominately black Chicago neighborhoods otherwise served only by predatory payday lenders and currency exchanges. Park National refused to underwrite sub-prime mortgages, and it worked hard to prevent foreclosures – even on loans it did not originate.

But Kelly did more than run successful banks that treated their employees well, cared about neighborhood development, and operated so professionally that federal regulators often held them up as an example. Rather than pay himself dividends, he plowed all his profits into the banks, which then devoted much of their profit – 27 percent over the past two years – to philanthropic work, especially schools, parks, affordable housing, social services and community organizations.

So the question posed recently to a Congressional committee by Steven McCullough – president of a Chicago community-development group, Bethel New Life – was simple: ​“Why was a financially successful, model, community-based bank not only allowed to die, but prevented from saving itself?” 

Park National’s problems started in September 2008, when federal authorities put into conservatorship the two government-sponsored enterprises that buy mortgages from banks, Fannie Mae and Freddie Mac. Regulators had authorized banks to buy Fannie and Freddie securities to hold as capital. But that was little comfort to Kelly, since their closing created an overall loss of $885 million for FBOP and wiped out $756 million in FBOP’s capital, about half of its total holdings. 

As local politicians and community leaders rallied to his support, Kelly began looking for private investors and quickly lined up $600 million. But then TARP (the Troubled Asset Relief Program) passed in October, with a stated preference to help banks that had lost capital from Fannie and Freddie’s collapse. The big banks quickly collected billions. The Office of Comptroller of the Currency supported the application submitted by FBOP. In late October, U.S. Department of the Treasury officials said FBOP would get $545 million as part of a group of 23 smaller banks that had requested TARP money.

But two days later, Treasury told FBOP that officials had not yet written rules for aiding privately held banks. Treasury gave the other 22 banks their money but told FBOP to wait. As Kelly testified before Congress, he never received a definitive yes or no. Meanwhile, the Obama administration tightened the rules, limiting aid to banks that were already well-capitalized. 

So Kelly needed to raise private equity equal to the TARP funds he requested. But at that point, FBOP bore the stigma of failing to get TARP funds, and capital markets were extremely skittish. ​“It was the kiss of death,” Kelly says.

Park National remained profitable, and Kelly continued to negotiate with leading investment firms. By the end of summer, though, two of FBOP’s banks were critically undercapitalized. Even though Park National and a small Texas bank remained adequately capitalized on their own, the FDIC invoked an optional rule – used only six times over two decades – that made the two stronger banks liable for the losses of all the other banks in the group. The FDIC notified FBOP that it had the standard 90 days after its warning to meet capital requirements.

FBOP had $300 million in a loss-reserve fund. An outside auditor and the potential investors estimated the banks could lose $300 million to, at most, $1.2 billion on bad loans. With the loss reserves, $600 million from investors, and $500 million from TARP (for which FBOP now would qualify), the federal government could lose no more than the TARP money. Most likely, it would lose nothing.

As the October 30 deadline drew close, FBOP presented a plan for private investment but asked for a week’s extension, a common courtesy in such cases, to finalize the details. The bank knew – as did the FDIC – that the following week Obama planned to sign new legislation allowing corporations to carry losses forward for more years in the future to write off against taxes. That would have effectively given FBOP up to $200 million, making it possible to raise the capital it needed from just one investor.

FDIC and Treasury rejected pleas from the bank and members of Congress for the delay. FDIC had already reached an agreement to sell all of the FBOP banks to U.S. Bancorp – the sixth largest bank in the country – with FDIC paying out $2.5 billion as subsidy and compensation for loan losses.

Administration inaction

On the morning of Oct. 30, 2009, Treasury Secretary Tim Geithner held a press conference in Chicago and presented Park National Bank with $50 million in tax credits for expansion of its highly regarded community-development work. At 5 p.m., the FDIC seized the bank and turned it over to U.S. Bancorp. ​“A pillar of our community and an exemplary bank was lost,” says Bethel New Life’s McCullough.

FDIC officials argue that there was no clear prospect for private investment and that, in any case, they had to pursue the plan that minimized losses to the Deposit Insurance Fund.

But they could have easily waited a week to see if the refinancing with private investment, tax credits, and TARP could be finalized. That plan would have minimized federal losses. It would have also minimized disruption to the community – as the law prescribes. And if regulators had followed village president Pope’s advice and calculated the total economic impact (including philanthropy, community investments, jobs and other services), the balance sheet would have favored Park National even more.

Confirming Pope’s worries, anonymous senior Park National officials told the local newspaper, the Wednesday Journal, that U.S. Bancorp is firing up to 700 of the 840 FBOP employees in Illinois and closing branches. And beneficiaries of Kelly’s philanthropy are worried: U.S. Bancorp’s foundation contributes the equivalent of 0.7 percent of bank profits each year.

Some community supporters of Park National are considering a lawsuit against FDIC. Others are trying to negotiate a community-benefits agreement with U.S. Bancorp to preserve as many of Park National’s policies as possible.

Nationally, Obama has often spoken favorably about the important role of community banks. During his State of the Union address he proposed using $30 billion of the TARP money repaid by big banks to help community banks. Though many community banks don’t need the help and don’t do enough in their communities to deserve it, the plan could be valuable if it strengthens genuine community-development banks.

But that outcome will require regulators to have more consistency in their goals and more flexibility in their practice. ​“I don’t think the FDIC has had the same policies and purposes as Obama,” says National Community Reinvestment Coalition President John Taylor. ​“I’m not sure they maximize public benefits when they go in” to troubled banks. And George Goehl, director of the community-group federation, National Peoples Action, says that despite some good moves, ​“it certainly doesn’t feel like the administration has clearly strengthened community bank policy.”

Goldman Sachs was too big to fail, and so they got a bailout. But for many communities – and ultimately the country – it is the small, rare banks like Park National that are too important to fail.