Bankers aren’t exactly thrilled with the current proposal to reform the Community Reinvestment Act. They’ve publicly criticized much of it, from the examinations that would likely become more stringent; to online lending changes that could harm low- and moderate-income communities; to the timeline for finalizing and implementing the rule. Trade groups have even warned about filing a lawsuit if the proposal is passed in its current form.
To better understand the proposal and how it could be modified to better suit the industry, I recently sat down with Eugene Ludwig for an episode of Banking with Interest. Gene led the last successful effort to reform the CRA as comptroller of the currency under President Clinton. He explains why the current proposal should be reproposed—and dramatically simplified. He also talks bank-fintech partnerships, crypto, how to prepare for the coming recession, and more.
What follows is our conversation, edited for length and clarity.
After running Promontory Financial Group for so long, you’re back in the financial consultancy business. Tell us about your new venture.
It’s called Ludwig Advisors. We offer bank executives premier advice about regulatory, risk, compliance, operational, fintech, and internal audit matters.
We understand regulators and know Washington. Our team of former regulators, bankers, financial services lawyers and auditors has decades of experience in our field.
What’s your view of the current CRA reform proposal?
It’s well-intentioned, but long, complex, and hard to understand. It ought to be simplified materially and kept broad. This is a complex country, and different geographic areas need different forms of assistance. A one-size-fits-all approach won’t work.
Another issue is that CRA is oriented toward good economic times. But institutions face difficult circumstances all the time that aren’t their fault. Additionally, low- and moderate-income communities typically have more problems in bad times than other communities, and they emerge from those bad times more slowly. Bankers should get credit for assisting during these periods (and for anticipating them). Under the current law, they don’t.
Some industry players are so angry about the proposal, they’ve threatened to file a lawsuit.
It’s tragic. Regulators take pride in what they do—these are good people—but when you bring the OCC, Fed, and FDIC together, each agency has its own proposal. Then they start to negotiate, and before long each agency needs to accept the other agencies’ proposals if it wants the others to accept theirs. So they end up mashing three proposals together.
When I was comptroller, I simply called Larry Lindsey at the Federal Reserve and invited him to my office to write the rule. When we were done, we had a rule that was relatively brief and easy to comprehend. The current proposal seems like an attempt to give everybody what they want, but it’s too long and complex.
Do you think they need to repropose it?
Regulators are also taking a much harder look at bank-fintech partnerships. What would you tell bankers who are evaluating their fintech relationships?
I’m a big fan of technology and of banks being able to use fintechs and fintechs’ tools to better serve customers. We’re living through an entrepreneurial revolution, which is really a technology revolution. Banks can’t be kept out of that; otherwise the industry will suffer. They should be able to do what they want in this area, consistent with consumer protections and safety and soundness. But they need to do the same due diligence for fintechs that they would for any vendor.
Fintechs can benefit banks in more ways than even the most astute banker can fully appreciate. It really is a natural marriage—financial technology is only useful or valuable if its shared, and there is no individual bank, particularly a smaller institution, that has the money to invent all the technology it needs by itself. It is much more cost effective and a better bet in terms of top talent working on fintech solutions—technology that can be shared among many institutions.
Will there be a recession?
I’d be surprised if there isn’t one. Whether it’s mild or deep, who knows? Interest rates will go higher, and bank and nonbank financials are impacted dramatically by swings in rates and market volatility. On the other hand, banks are well-capitalized and well-managed, and the U.S. banking system is uncommonly strong.
Having said that, the typical mark-to-market regulatory response in down periods is too heavy-handed. High inflation and high interest rates were not caused by bankers’ imprudence, and bankers have to accept the economic circumstances just like everyone else. Regulators should be working with banks, not against them, so that banks can help their customers and communities through difficult periods.
What are some nonobvious things banks should be doing to prepare for a recession?
First, determine which borrowers to work with. Community bankers have a lot of authority. People listen to them. If they tell a borrower to dial things back and ensure they have enough cash to pay their loans on time, the borrower will listen in most cases. Bankers know better than anyone how to manage through these periods.
Second, avoid any undue conflict with regulators. When regulators ask questions, banks should think hard about their answers. They should be honest, of course, but thoughtful. Regulators too often aren’t clear in written communications, and that lack of clarity can lead bankers to interpret things in an overly rosy manner. But when regulators write things, they don’t intend to be rosy. Any time there’s ambiguity, banks should clarify what the regulator wants.
Third, clean up any outstanding MRAs and MRIAs. Letting them drag on won’t make them go away, and as the pile gets bigger, it becomes harder to deal with—especially during down cycles, when bankers have more to do. It could also make the regulators come out with public orders and cease-and-desist and all the things that make life more difficult.
Crypto markets are in turmoil. Democrats say the instability supports why U.S. regulators have been skeptical of the relationship between banking and crypto. Republicans say that if regulators were less skeptical and offered guidance on relationships between banks and crypto firms, the crypto markets would have more oversight and be safer. What’s your take?
Crypto isn’t going away. The two big questions are: 1) how big is it going to be? and 2) what are the functionalities that will genuinely be beneficial to end-use consumers and financial institutions? Crypto may be faster for certain types of transfers, but maybe traditional money-transfer mechanisms used by the Fed and others can adapt to compete.
Regulators should begin crafting rules for crypto firms, but keeping banks out of crypto altogether is a bad idea. Banks should be able to experiment with it. Otherwise nonbank players will end up dominating the market. We ought to watch the space closely and be flexible, and we need sensible standards that apply to banks and nonbanks alike.
What should banks be doing as calls for a CDBC get louder? Is it possible to have a CBDC that doesn’t lead to disintermediation?
A CBDC would be a very bad. What banks should do—and I think the trade associations are already moving in this direction—is to come up with standards that have no give. They should be clear that they don’t want the Federal Reserve or another federal entity to become a bank. It’ll never work, it’ll be inefficient, it’ll create unfair competition, it’ll be terrible for the country. It’s also unnecessary because banks are already performing the intermediation function just fine.
In terms of a more stable and reliable cryptocurrency, this is something banks ought to issue. In 1863, the federal government decided to allow banks to issue the federal currency, so why not allow banks to create their own crypto today, subject to certain rules and regulations?
Over the years, you’ve talked a lot about right-sizing regulations. But many small banks contend that rules created for bigger players are drifting down to them.
It’s true, and if you look at the bank rulebook, it’s enormous! Many of the rules are out of date and so complex a normal person can’t understand them. Yet they’re still applied. Federal regulatory agencies should be spending as much time trying to simplify the rules as they do adding new ones. They should draft rules that anybody can read and understand and eliminate redundant rules that make life unnecessarily difficult, particularly for community and regional banks.
Why did you form the Ludwig Institute for Shared Economic Prosperity?
Policymakers today rely on economic statistics developed in the 1930s which, believe it or not, were based on concepts from the 1870s. And the headline statistics—unemployment, CPI, GDP, wage growth, and so on—are dramatically misleading.
For example, the federal government considers you “employed” if you’ve worked ten minutes in the last two weeks! If you filter the BLS unemployment rate for simply two things: 1) People who want a full-time job but can’t get one and 2) People who can’t earn above a poverty wage, functional unemployment is really about 23%. And it is nearly 27% for black Americans. Same kind of definitional weaknesses with the CPI. If you limit your focus to the goods and services low- and moderate-income people can actually afford, a much, much smaller basket of necessities than the CPI’s 80,000 goods, they’ve inflated 50% more than the CPI over the last twenty years! Meanwhile, real wages haven’t grown for middle-income Americans sufficiently so median-income American wages have actually declined in the last two decades. Policymakers don’t understand this because they’ve been given the wrong set of numbers, which prevents them from making good decisions. That’s the fundamental issue we’re trying to address.