Friday, August 12, 2011

The Government Kills a Bank, Small Business, and Jobs

In my introductory economics classes, I teach that a well-run bank spends its time getting to know it customers and then makes loans to those who are credit worthy. I point out that the most important employees of banks are its loan officers, whose job it is to know its customers.

With creation of the mega-bank, much of this wisdom has been lost. Mega banks lend money to customers they do not know. They buy syndicated mortgage derivatives they do not understand, and they are surprised when they are left holding the bag with worthless paper. Once bitten, they fear making loans and sit on he cash reserves.

Main Street Bank of Kingwood Texas, was one of the traditional banks I teach about in my class. It got to know its local customers. It made loans primarily to small local businesses – the very ones who provide jobs for the local community. Man Street Bank was profitable, and its portfolio of bad loans was well below the national average.

Enter the federal regulators.  In July of 2010, Federal regulators ordered the bank to boost its capital and bring in a new top executive. More tellingly, it ordered the bank to shrink its lending to small businesses. It ordered that small business loans be dropped from 90 percent to 25 percent – there were too many eggs in one basket.

On Wednesday August 10, Main Street Bank surrendered its bank charter and sold its four branches. We lost a bank that was doing exactly what the economy needs – a  bank that actually makes loans to small business customers whom it knows well.

This intrusive regulation is part of the federal program to identify excessive risk and prevent bank meltdowns. As you can see, the Feds are using a one-size-fits-all approach. Regulation of this type is scheduled to get even worse with the looming Dobb-Frank Act.

Do we wonder why there is so little lending and so few jobs? Do we really need Washington bureaucrats telling small banks how to run their business? Do we really think that a Washington bureaucrat can foresee risks that private companies that are risking their own money cannot see?


  1. Being chartered by the states, and not the Federal bodies, is needed. A real regulatory competition may need getting rid off the FDIC as well, or creating its equivalent at the state level.

    I wonder if all these will give some impetus to the practice of the Tenth Amendment (i.e., The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.)

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  3. Do we wonder why there is so little lending and so few jobs?