Why Community Banks Feel Left Out

By Bizbox

Several months ago--before the latest round of federal government rescues--our own Michael Taylor asked, "Where's My Bailout??" Writing in the wake of the Bear Stearns, Fannie Mae, and Freddie Mac actions, Michael said, "as a small business owner, I can’t help but be a little resentful when I read about what the government is doing to make up for massive financial errors made by large businesses. I’m bothered by the asymmetrical risk borne by large company owners versus that borne by small company owners."

A good Washington Post article from yesterday demonstrated that Michael is not the only owner of a small financial services business (Michael runs Cedarcrest Capital) who is not a little miffed at the astounding mercy big banks that screwed up are finding at the hands of the federal government. Specifically, many owners of and executives at community banks--those locally-focused institutions that have under $1 billion in assets--are up in arms over the Treasury Department's new plan to take the $700 billion Congress has famously allotted it and inject it directly into struggling banks in exchange for preferred shares, including planned $25 billion investments in each of four of the country's biggest banks. Many of these small business owners, in the article's words, "don't need the money, resent the intrusion and feel it's unfair to rescue companies from their own mistakes."

A theme of the complaints is that the bailout package is upending the natural meritocracy of the free market: banks that traded risky (and lousy) mortgage-backed securities and engaged in other suspect financial transactions and loan underwriting are being rescued from their bad behavior, while, meanwhile, many community banks who spent the past few years playing it wise won't be getting that government money precisely because they played it wise. As the chairman of a McLean, Va.-based community bank put it, "We will be punished for behaving prudently by now having to face reckless competitors who all of a sudden are subsidized by the federal government."

It is worth pointing out that, as we have reported, community banks are not being entirely left out of the federal government's actions: a new tax rule--designed for precisely this purpose--is going to lessen significantly the losses that many of them incurred after their preferred shares of Fannie and Freddie plummeted in value once the two government-sponsored entities were renationalized this past summer.

Half of the $250 billion initially being invested is essentially being forced upon nine of the country largest and most prominent banks: JPMorgan Chase, Bank of America, Goldman Sachs, and the rest of that club. According to the Post, the other $125 billion will go to banks who apply for it.

Which, if the American Bankers Association and the Independent Community Bankers of America are to be believed, will not include many community banks. An ICBA spokesperson told the Post, "I'm not sure we've heard from any that want to participate. That said, if any community banks do enroll, we anticipate it will be just a small minority."

The paradox is this: if you're a bank that is desperate for capital because of a massive hangover after the binge of the past few years, then the government money is a tremendous help, particularly in the current credit-crunched economy. It really is something of a bailout. But, if you were smart and more moderate and, after the past few years, are not capital-starved, taking the government money is actually a bad deal: the deal, which gives them preferred shares that pay 5% interest for a time, and then tick up to a very high 9%, is a very good bargain for the government, and a pretty poor one for the borrower. (Of course, as taxpayers, we should all be pleased about this aspect of the program). So the result is a program that is designed to attract those whose poor decisions (although that is a more complicated question) have made them desperate as well as those who are simply large enough not really to have a choice while repelling those whose good decisions have left them with sufficient capital, which are frequently the smaller ones.

Clearly, owners of these small banks feel left out; and equally clearly, this seems to be not just a case of chips on shoulders. For the sake of the economy and fairness and its own reputation, we suggest the feds look into Sen. Chuck Schumer's proposal to loan directly to small businesses through the Small Business Administration.

Comments (1)

October 15, 2008 6:43 PM