It was just over six years ago that the Federal Deposit Insurance Corp. stepped in to prevent the collapse of Continental Illinois. Today, the man who heads the bank says one of the biggest favors the insurance fund could do for American finance is to go ahead and let banks fail.
Thomas C. Theobald, chairman since 1987 of the now-renamed Continental Bank, argues that deposit insurance should, if anything, be cut back and that regulators need to turn their backs on even the largest banks in the country after depositors are insured of recovering their first $100,000 in a bank failure. (Any reduction in insurance coverage probably would have little impact on Continental, which has become a business-only bank that does not seek retail deposits.)
In an interview with Tribune banking reporter Mike Dorning and deputy financial editor Owen Youngman, the 53-year-old former vice chairman of Citibank also tilted at the FDIC for refusing offers for its remaining 26 percent stake in Continental. Theobald defended his decision to remold the bank to serve only commercial customers, and asserted that the bank`s low earnings mask long-term strengths.
An edited transcript of the interview follows.
Q-Isn`t it true that, in something of the same way that the savings and loans lost their uniqueness and their customers (in the years leading up to the S&L crisis), commercial banks have been experiencing the same thing with other means of financing?
A-In all the perimeters there have been inroads, whether you`re talking about credit cards, looking at the Sears Discover card, or whether you`re talking about what used to be short-term commercial loans, when you look at commercial paper, or when you look at private bank loans to companies, (loans) that got substituted by the junk bond. It`s absolutely true that there`s a range of competition that didn`t exist 25 or 30 years ago. On the other hand, it has not been overwhelming competition, and it`s not competition that has proved to be economically superior and consistent. Junk bonds-you couldn`t sell one with a gold coin attached today. Commercial paper-unless you have the highest rating, there`s no longer a market for that.
Now, this can swing back and forth. So there`s certainly this new competition, and that`s part of the reason why I`m the first to assert there`s an excess of commercial banks for the new environment. But it is not that it has become an economically obsolete industry in which you can identify who`s going to replace it. If you`re a corporate finance officer today, you wouldn`t dream of saying, ”Oh, I don`t need a bank.”
There is more competition, and what the competition is now forcing banks to do is to differentiate themselves one from the other. You`re not going to be able to add them all up and talk about them in a meaningful way after they`ve differentiated themselves. It needs to be talked about in terms of its substantive characteristics, as opposed to a four-letter word called a bank that everybody knows what it is: That`s where you go in and make your savings deposit.
A-But when the government gets around to tightening regulation or reconfiguring regulation, they`re likely to do it in the aggregate.
A-You`re correct. That`s part of what concerns me. They don`t regulate the computer industry in the sense of having a policy that says everybody must make 13 size machines and they must use Unix and blah, blah. They let the market (determine).
I think enlightened public policy would be to have rules that say, if you`re going to call it a bank, you have to have some kind of supervision, you have to have some sort of capital requirements, and something on this deposit insurance, which really has to be dealt with.
But it shouldn`t say you must have this number of branches, they must be open these hours and they must sell these products-which is implied in the way this all developed. Obviously there is a rationale that says, ”Well, if you`re going to insure the deposits, you ought to say how you operate.” If you buy boiler insurance, Hartford Steam Boiler Co. is going to come around and say, ”We want to inspect your boiler and tell you you can`t operate it above so many pounds, you`ve got to have a qualified engineer,” and all that. We face that, which is one of the reasons I think deposit insurance has to be trimmed back.
Q-What do you propose to do with deposit insurance? You said it should be cut back.
A-If you go back to what it`s all about, you were supposed to protect the individual that was not sufficiently financially sophisticated to make astute investment decisions every time they used a bank. It started at $2,500, which even if you adjust for inflation and so on, is not $100,000 by any means today. It`s closer to $50,000.
All this business of adding accounts and everything: Egads, what kind of people are keeping $500,000 or a million dollars in one bank? If that`s the only thing you can think of doing with your money, try two banks. The average insured account is $8,000. So we`re talking not about protecting individuals but about protecting banks when we say keep it at $100,000, or raise it to $500,000, or the system, or whatever else. It ought to be at least strictly enforced at $100,000, and frankly, if I were emperor, it would be $50,000.
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The other side is we ought to say there is no longer any implied government ”too big to fail” doctrine. There are certainly some substantial banks that have gone down, which, if they had not insured deposits over $100,000, the world would have worked out.
It`s interesting to take the old Continental Illinois as an example. The record is pretty much complete now on the whole disaster from 1984 through today. According to FDIC, their total loss on the exercise was about $1 billion. At the time Continental Illinois got into trouble, it had assets of about $40 billion. So if you had stopped paying everybody at $100,000 and said ”beyond that you share in the recovery,” the people beyond that would have gotten 98 cents on their dollar. Is that a national disaster? The fluctuations on the New York Stock Exchange could reduce your dollar by more than 2 cents in a day.
Q-Do you think the deposit insurance system encourages financial institutions to take unnecessary risks?
A-I don`t see it that way at all. Look, I`m working here because I own a substantial part of the company. The dumbest thing in the world is to say,
”It doesn`t matter if I lose my equity, the depositors will be insured.”
I mean, if personal motivation has anything to do with it, you care a whole lot about losing your own wealth, and I think there`s a message there. It`s that you really ought to have a capital standard that says you ought to have an equity buffer in there with somebody responsible, with something to lose.
Q-Maybe, if I`m reading this correctly, you`re saying that insurance is an inhibition to competition in the long run.
A-It has been. We`ve ended up with this very rigid set of bank rules. If you see yourself as the protector of an insured deposit, you`re going to be extraordinarily careful. And in this case, I`ve got history on my side. There`s a whole body of evidence that American banks have gone from dominating the world to being relatively uncompetitive and relatively unsubstantial in the world because we`ve had such a conservative policy.
Foreign banks, by most measures, are about a quarter of the business here, which is the same proportion as in autos. What an uproar we`re in over the trade in autos. ”Geez, what are we going to do about all these Japanese and European manufacturers of autos? They have up to around 30 percent of the market.” They have 30 percent of the loan market in the United States. But because it`s not hard goods-you can`t count them at the port of entry and all that-it doesn`t attract the same attention.
Q-Ultimately what concerns you is that the government may make it less attractive to leave the banking industry.
A-You put your finger on it. We need to have it a free market where the returns are determined by your success rather than forced in by the government.
Q-The FDIC still holds a stake in Continental, and certainly the management has tried to arrange a buyout a couple of times to no avail. Why haven`t they sold yet, and what do think it will take to arrange a sale?
A-If you look at the reality of it, the FDIC is a group of people under intense political scrutiny, who get no bonuses or brownie points for making money but who could be pilloried if there`s a basis for criticizing them. So the inherent prejudice is to say ”no” to everything. And they have, I`m sure to their chagrin today, turned down $22, $15, $8.
Now (the stock price) is $9, so they can say that $9 is better than $8 that they turned down. But it`s a really awful situation. I`ve certainly known individuals who say that, if the market for a stock was $15 and they didn`t sell it and now it`s $10, they say I can`t sell it now because it really was worth $15. I think that`s the sort of thinking we`re experiencing.
They can`t go to Congress and say, ”Hey, this (insurance) account will be down from $11 (billion) to $7 (billion) or something,” and not sell the assets they`ve got. In the real estate problem, there`s always the issue of what`s it worth. With the stock of public companies, there`s the New York Stock Exchange, so they can`t question that they don`t have the market value. They have to say, ”We think it will go up in value in the future.”
And when you`re reaching out to the Congress to tax the banks to raise an emergency fund, it`s pretty hard to say, ”Hey, I`m going to keep speculating on this common stock.”
Q-Clearly you want someone else to have those shares besides the FDIC. Why is this so important?
A-Because the other federal regulators, particularly the Federal Reserve, think it`s grossly inappropriate, and are very discouraging on initiatives on our part-any initiative that would require their approval-as long as the FDIC owns the stock. These guys get this bureaucratic war back and forth as to whether it`s appropriate for the FDIC to own shares, and the Fed has turned down several things on the basis that, as long as those shares are owned by the FDIC, it`s inappropriate for the Fed to act on applications.
Q-At Continental, you have decided to take the approach of focusing on business lending. I`m wondering how successful that`s been. You certainly hear a lot in the aggregate about problems with commercial lending and commercial real estate. And your earnings have been poor for some time now. In light of that, how successful do you think this strategy has been?
A-If you take the national economic statistics, about two-thirds of the gross national product is in the consumption sector and one third is industrial, commercial, trade and what have you. There is not a specific public statistic that says how much banking service that is sold to each sector, but we`re making a leap of faith, which I think is credible, that the demand for services is roughly proportional to the GNP pie. So a third of demand for financial services originates in the corporate/commercial sector.
On the other hand, there`s 12,000 banks. Ninety-six percent of those I`m sure, if not higher, are (geared toward) consumers. So, yes, the consumer sector is bigger, but there`s more competition.
I would rather, as a first principle, be in a business where competition is leaving rather than where competition is arriving. Secondly, we have a strong franchise in business, and the franchise is increasing in value as the competition quits. I can assure you that the customers we serve think it`s just wonderful we`re concentrating on their business.
In the period we`re in, where there`s all kinds of stresses on a system that is reforming itself, it`s pretty hard to read one quarter or one series of quarters` statements and read a whole lot into them. For example, in the last three years, we have reduced our employment by over 40 percent. Well, we have substantial severance arrangements and everything else. You don`t reduce your employment 40 percent without incurring big costs. You incur the costs in lumpy periods.
Eighty percent of the people we compete with are headquartered in New York and incur the major part of their expenses in New York. And let me tell you, Chicago is a cheaper place to operate. Think of things like rent, taxes, the basic cost of your infrastructure, the basic cost of getting things done. This place is a bargain.
We`re going to end the year, for example, with an increase in corporate finance fees. Nobody headquartered in New York is going to do anything like that. Because actually, the market did go down. What counts is what the marketplace says, and the static in our cost structure has impacted our earnings so that they`re not as good as we aspire for them to be.
Q-In light of the recent poor earnings you`ve had, is your dividend safe? A-I can`t talk about that in particular, because it`s way too sensitive in the market timing sense. But the fundamental issue to be looked at is the concept of dividend: You`re returning some portion of earnings to the shareholder. So one question is, are we profitable? The second one that is certainly relevant is, do you have the capital base to sustain the business you`re in?
Our total equity-to-assets is higher than Morgan (Guaranty). We`re not the least concerned about the adequacy of our capital. The real test, then, becomes: Are you earning a sufficient amount that warrants a dividend? In the third quarter, which we obviously can talk about since it`s past, we earned about twice the dividend. So it doesn`t seem unreasonable, but I`m not forecasting the future, because it gets you in trouble.
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