Caught in the money pit

The federal government struggles to yank banks
out of the hole it dug and then let them fall into.

As autumn’s chill fell, financial institutions that seemed strong and nimble creaked and buckled. The U.S. Department of the Treasury and the Federal Reserve System tried to ease the pain with hundreds of billions of bailout dollars, but action came too late for Charlotte-based Wachovia Corp. The nation’s fourth-largest bank holding company, choked by subprime mortgages and struggling to borrow what it needed, was married off shotgun-style by regulators to San Francisco-based Wells Fargo & Co. in December. Other Tar Heel banks suffered, too, and the agony will continue for some, says John Allison. He retired in December after 19 years as CEO of Winston-Salem-based BB&T Corp. but remains chairman of what is now the second-largest bank based in North Carolina.

BNC: What surprised you about the financial crisis?

Allison: The magnitude and the diversity of the problems — and how poorly it was handled by the Treasury and the Fed. They handled it on a case-by-case basis with no systematic approach, and that magnified the problems.

Did any other state’s financial industry suffer as much?

Ohio’s, probably. But because the financial industry is such a big player here and Wachovia has been such a large force in the economy, the impact has been significant. Real-estate markets have been much more severely impacted in Florida than in the Carolinas. And to some degree, the problems in the real-estate markets are reflected in the capital markets and the financial industry. So from an overall economic perspective, North Carolina has not been one of the hardest-hit states.

You’ve blamed most of the mortgage mess on Freddie Mac and Fannie Mae, both chartered by Congress, yet other companies made most of the subprime loans.

Government policy created this situation more than any action of any individual financial institution. First, the Federal Reserve mismanaged the interest rates. It drove rates too low, which caused people to make investments they wouldn’t otherwise have made. Then it raised rates very rapidly and put huge stress on bank margins. Second, the very existence of the FDIC encourages what I call a moral hazard. If you look at the companies that have had problems — Washington Mutual, Countrywide or Golden West — they all raised deposits using the FDIC insurance, paying above-market interest rates to get those CDs to fund high-risk assets. Without FDIC insurance, that could have never taken place because people would have looked at the quality of the companies instead of relying on government insurance.

Wouldn’t people have less confidence in banks without FDIC insurance?

They might, which means banks would have had to raise more capital. Once you get in this mess, you can say the insurance was necessary. But if it hadn’t existed, banks would have been better capitalized than they are today.

What about Freddie and Fannie?

When they failed, they had $5 trillion in liabilities and hundreds of millions of dollars of subprime mortgages. In 1999, the Clinton administration basically forced Freddie and Fannie to increase significantly the percentage of their lending activity in the affordable-housing market. They basically created the markets for subprime lending. Independent brokers would make the loans and sell them to companies like Washington Mutual, who then would package them and send them to Freddie Mac and Fannie Mae so that Freddie and Fannie could meet their goals. They were, by far, the biggest force in creating the subprime market. That doesn’t mean individual institutions didn’t do crazy things. They did. But the big player was government policy.

Was survival about luck and timing? Or did Wachovia pay a price for being reckless?

Timing is always an issue in business. But Wachovia, from a management perspective, is really First Union. And First Union, over the years, had been an institution that took on a lot of risk. Obviously, that risk was magnified by the Golden West acquisition. That was a bad investment, but Wachovia already had a very high-risk investment portfolio.

BB&T is part of a bailout you criticized.

We didn’t think the bailout was necessary. In fact, the creation of it was part of the problem. When the president of the United States, figuratively speaking, goes into a crowded theater and yells, “Fire,” people get scared, right? So the whole process made the problem much worse. We participated for two reasons. One, we didn’t have a choice. The FDIC and the Fed, our primary regulators, said they expected us, as large and visible as we were, to participate. Two, the bailout represented a subsidy to our competitors. To not take advantage of it would be a disadvantage to our shareholders.

Why didn’t BB&T snap up banks dirt-cheap at the height of the crisis?

When we looked at the company we were interested in acquiring, we were concerned about its underlying credit risk. We felt it would be difficult to do due diligence on real-estate portfolios in that market and that our primary obligation was to protect our shareholders. We’ll certainly do some acquisitions, but we’ve been very careful to be sure that we make acquisitions that make sense for our shareholders and don’t increase the risk. Also, we don’t think this is a limited-time opportunity. A lot of community banks are going to have a real challenge with their fundamental operating model. A lot of what community banks were doing isn’t going to work now. A lot of them were doing a lot of high-risk real- estate loans, paying high rates for CDs. They might get through this credit crisis, but that doesn’t mean they have a bright future, so we think time is on our side.

What’s your forecast?

I expect 2009 to be a challenging year for the economy and banking, not just in North Carolina. My guess is you’ll see the economy recovering in 2010 — and with it, the banking industry.