Humpty Dumpty Had a Great Fall

Gonzo Guest Writer

January 27, 2009

View Bio

by Tripp Johnson

Humpty Dumpty sat on the Wall (Street),
Humpty Dumpty had a great fall.
W, Congress and the Senate weighed in,
But couldn’t put Humpty together again.

 In my first article of 2009, I had hoped to talk about all the wonderful and creative opportunities for GonzoBankers in the year ahead. My hopes were seriously high – and why shouldn’t they be? If the Arizona Cardinals, yes the Cardinals, can make it to the Super Bowl, then anything is possible!

Across the state of Arizona I see Cardinals banners proclaiming, “We Believe.” It is easy for Cardinals fans to adopt a “we believe” stance; with a known competitor, the Cardinals can focus their game plan on a single entity.

In parallel, when it comes to U.S. financial institutions (primarily the large ones), the majority of Americans no longer believe. At the same time, the financial institutions have no idea what to plan for in the coming year/s. With the events of the past year, rest assured GonzoBankers, you ain’t seen nothing yet when it comes to new regulations.

To set the stage let’s take a brief glimpse back to 2008.

Failures Abound
In 2008, a total of 40 bank and credit unions failed. Compare that to 2007, when only six institutions failed. I will admit that bank and/or credit union failures are bound to happen, but at the same time aren’t the regulatory bodies that govern our financial institutions supposed to prevent or circumvent some of these failures? Now I am not implying that the 40 institutions that failed in 2008 were the fault of the regulators. At the same time, it is fascinating when you take a look at which agencies “regulated” the majority of these failed institutions.

Economists and other pipe smoking philosophical theorists will debate the current crisis for years to come. Admittedly, I am no economist, but I came up with a simple Gonzo version of why Humpty fell off the wall.

A Severely Damaged Foundation
Friends, if you came across a dilapidated brick wall or a 160-year-old structure that was one strong wind away from crashing to the ground, would you be compelled to look around inside or sit on top of it? I imagine most of us would either walk by or, if it happened to be in our neighborhood, we would more than likely have it torn down.

Current Structure and How We Got Here
According to the Department of Treasury, the current regulatory framework for U.S. financial institutions is based on a structure that was developed when some guy named Abe was running the show. In fact, the foundation of this country’s regulatory framework was first laid in 1863 when Congress established the national bank charter during the Civil War. The National Bank Act of 1863 created the “Dual Banking System,” i.e. state and federally chartered institutions. Consequently, the Office of the Comptroller of the Currency (OCC) was born.

The Federal Reserve Act of 1913 created … yep, you guessed it: the Federal Reserve. This act was put into place to prevent bank runs and panic attacks in response to financial instability that often occurred in the late 19th and early 20th centuries. Makes sense … doesn’t it?

A few years later the mother of all banking acts was passed. The Banking Act of 1933 aka the Glass-Steagall Act required strict separation of commercial and investment banking and hence the creation of the Federal Deposit Insurance Corporation (FDIC).

One year later, the Federal Credit Union Act of 1934 was passed, creating the National Credit Union Administration (NCUA).

During the 1980s, the Savings and Loan crisis prompted Congress to introduce the Financial Institutions Reform, Recovery and Enforcement Act of 1989. Charged with enforcing this act was yet another new agency: the Office of Thrift Supervision (OTS).

Everything seemed to be running somewhat smoothly until 1999, when the Gramm-Leach-Bliley Act was passed, and, in my humble opinion, all hell broke loose.

So friends, in 2009 the U.S. financial industry is regulated by five federal agencies:

1. OCC
2. Federal Reserve
3. FDIC
4. OTS
5. NCUA

The aforementioned regulatory bodies step on each other’s toes more often than a pair of left footed ballroom dancers.

Thankfully for the Gonzo Nation, the U.S. Government Accountability Office issued a press release on Jan. 22, 2009, listing the federal programs it considers “high risk.” Wouldn’t you know it, folks, item number one on this high-risk list was the outdated U.S. financial regulatory system. I guess better late than never would be an appropriate statement.

Proposed new structure
But wait, Gonzos, a proposed new banking regulatory structure document was published in March of last year. The Gonzo summary of The Department of the Treasury Blueprint for a Modernized Financial Regulatory Structure proposes the following:

• Create a new federal commission called the Mortgage Origination Commission (MOC)
• Get rid of thrift charters and convert them all to national bank charters
• Create three distinct regulators:
  • Market stability regulator. This group would address overall conditions of financial market stability that could impact the real economy. Whew … for a moment I thought they would only look at Alice in Wonderland’s economy. The Uber god of this division would be the Federal Reserve.
  • Prudential financial regulator. Addressed by this unit would be issues of limited market discipline caused by government guarantees. This unit would see the OCC, OTS and NCUA combined into one entity. We think this might be called the OCCTSCUA for short.
  • Business conduct regulator. This special group would be linked to consumer protection regulation and address standards for business practices. In charge of this consumer centric unit would be the combination of the Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC). The SEC seems like quite an advocate for the little guy. Just look how it kept Bernie Madoff under control.

The U.S. Treasury calls this new model an objectives-based regulatory structure. I guess today we have a subjective based structure? Nevertheless, on page 142 of the Treasury’s report they do admit that this type of structure does pose a key problem in ensuring that effective lines of communication exist among the various objectives-focused regulators. Effective communication among regulators is critical for coordinating examinations and other activities impacting the operations of financial institutions.

Basically, my Gonzo brethren, our own government just suggested that its proposed “objectives-based” framework may not work. Seriously, isn’t the lack of communication and collaboration among our existing regulators part of our current problems?

In today’s real world the regulators have us running around like ADHD 10 year olds on Red Bull. The focus of everyone in the Gonzo Nation for the past several years has been compliance, privacy, security, risk, etc. The good guys are getting screwed down tighter than ever while the big and bad guys take undue risks that tear our economy apart.

Sadly, I don’t think we will see relief any time in the near or distant future. And heaven help us if this country actually does revamp its regulatory framework because it could end up shooting the innocent while doing nothing to stop the unholy alliance of Wall Street, big banks and Washington.

That said, you can bet your ass more regulatory change is coming. The scary question is when. Yet have no fear, Gonzos, I have put together a small watch list for 2009.  

2009 Top Regulatory Issues

• Future of Regulatory Agencies: keep your eyes and ears open on this one – it could confuse us more than we already are.
• ID Red Flags: the cases of identity theft and fraud continue to increase, so if you have not implemented your plan you best do so pronto.
• GLBA Requirements: according to Bank Info Security, online transactions in the U.S. are nearing $130 billion; therefore, the need to properly implement top security regulations will remain a priority.
• Remote Deposit Compliance: the FFIEC just released its guidance regarding remote deposit. My suggestion: read it and make sure you are in compliance or you can probably kiss all those new ATM remote deposit capture machines goodbye.
• BSA/AML: according to Sai Huda, chairman and CEO of Compliance Coach, many financial institutions have taken their eye off the BSA/AML risk as they cut costs and focus on credit. My advice: put some eyeballs back on this. Huda goes on to say that many institutions will not be permitted to acquire others or merge because of deficient BSA/AML programs. Umm … there are a lot of opportunities out there, Gonzos, so if you have allowed your BSA/AML programs to falter, I recommend shoring them up quickly.
• Vendor Management: 2009 will see a continued focus on ensuring that third-party providers meet standards of information security and data protection. If you have yet to implement an effective and efficient vendor management program, 2009 would be the year to do it.

 Compliance isn’t cheap, our budgets have been sliced to the bone, and most of the people possessing the necessary skill sets within I.T. to actually implement the majority of these regulations are being reviewed for “budgetary” purposes right now. So I say to you, Gonzo Nation, the next time Humpty Dumpty falls off the wall … we scramble up those eggs, fry up some bacon, add some grits and enjoy a healthy breakfast.

See you in the trenches.
-tj 

Regulators rocking your boat?

We can help calm the waters.

Cornerstone Advisors can assist in your preparation for an IT exam, or respond to findings related to your policies and procedures from a prior exam.

Visit Cornerstone’s site to learn about our Risk Management Services.