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April 18, 2014

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Flexibility will help Nevada’s banks, economy

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The law of unintended consequences holds that the actions of people, and also governments, often have results that are unexpected and not deliberate. Sometimes the unintended consequences are positive — such as when government approval of a new drug paves the way for discovery of other therapeutic uses unanticipated by the manufacturer or government regulators.

But often the passage of new laws and regulations designed to address one problem ends up creating others. A good example is the government’s mark-to-market rule, originally intended to rein in volatile commodities futures trading markets in the wake of the Enron debacle. The rule was also applied to banks and their assets, which unlike trading markets typically change in value on a yearly, not minute-by-minute basis.

New research from the University of West Georgia’s Richards College of Business and its Center for Business and Economic Research suggests the rule could be hampering Nevada’s economic recovery rather than stabilizing the economy. The rule requires banks to write down the value of some real estate-related assets, potentially rendering them worthless on paper even if they are still performing on a cash-flow basis.

The rule has been particularly hard on smaller banks because they have more exposure to real estate loans than large banks. Ten banks have failed in Nevada since the banking crisis began, many of them community banks. In Las Vegas, several banks have been closed or sold since 2008, including local lenders such as SouthwestUSA Bank, Sun West Bank and Community Bank of Nevada.

But the findings of recent research suggest that many of the failed community banks may likely have survived the banking crisis were it not for the inflexible application of this accounting rule which forced them below the capital ratio required by regulators.

Instead, too often, small banks in Nevada were sold at a steep discount to out-of-state competitors or closed down, eliminating jobs and harming small businesses that lost access to the local bankers who had provided them with lines of credit.

The data show the extent to which these unintended consequences have had a harsh economic impact. Banks with assets of less than $10 billion saw their Small Business Administration loan volume drop $30.5 billion between 2006 and 2011.

These unintended negative consequences have a ripple effect; the job losses at small businesses and overall diminished business activity that occur when a bank’s capital is destroyed also hurt state and local tax revenue. Fewer workers means less tax revenue is collected. Research in Georgia, which was also hit hard by bank failures, found that for every banking job lost, about 1.26 jobs were lost in supporting industries during the recession. It is likely Nevada experienced a similar impact.

While it’s true that hindsight is 20/20, such clarity should also compel action. For example, former Rep. Barney Frank, co-author of the Dodd-Frank financial reform bill, now admits that rather than helping consumers, the provision in the law that capped debit card interchange fees for retailers, commonly called the Durbin Amendment, is actually harming consumers. Income from the fees allowed many banks to offer free checking accounts to their customers. Meanwhile, retailers have failed to pass along their cost savings. Like Frank, congressional leaders must be willing to admit when regulations have negative consequences that are not intended.

Although the mark-to-market rule may have been appropriate for commodities futures trading, it was inflexibly applied to community banks, where big negative fluctuations in capital valuation resulted in regulatory bank closures. As a result, Nevada’s banks continue to suffer — reducing access to capital for small businesses that drive our economy in good times and bad.

As our elected leaders work to strengthen vulnerable financial institutions while continuing to foster economic recovery, adjusting the mark-to-market rule to allow more flexibility for banks during a crisis would have a beneficial impact. Lawmakers could feel confident in this case that good intentions would produce good consequences.

Dr. Joey Smith is director of the Center for Business and Economic Research at the University of West Georgia’s Richards College of Business.

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  1. Good article. Laws, state-Federal-and-local, often accomplish just the opposite of their intended consequences. Sadly, they don't have any provisions for review, assessment, and retirement when out-of-date. They sit on the books forever, whether useful or not, oftentimes never accomplishing their intended goals and in direct contradiction to each other.

    Carmine D