Market discipline beats regulatory discipline.

• Author: Allison, John A.
• Position: Column

I am going to talk from a different perspective because I am the only person who actually ran a bank that's been speaking today, and from that context I can tell you with absolute certainty that market discipline beats regulatory discipline. In fact, I will argue that regulatory discipline will always fail to reduce volatility and will slow economic growth. These observations are based on my understanding of public choice theory and particularly on 40 years of concrete experience in the banking business.

One observation in my 40-year career at BB&T: I don't know a single time when federal regulators--primarily the FDIC--actually identified a significant bank failure in advance. Regulators are always the last ones to the party after everybody in the market (the other bankers) know something is going on. Thus, in that context, regulators have a 100 percent failure rate. Indeed, in my experience, whenever they get involved with a bank that is struggling, they always make it worse--because they don't know how to run a bank.

An interesting reflection from public choice theory, reinforced consistently throughout my career, is that regulators regulate for the "regulatory good." They like to talk about the "public good," and sometimes the public good and the regulatory good may align. But they don't manage for the public good; they consistently manage for the regulatory good.

Managing for the Regulatory Good

In good times, regulators basically don't regulate banks for safety and soundness. If things are going smoothly in the economy, bank examiners might see something that bothers them in a bank. But if they start raising red flags, bankers have plenty of political contacts and the examiners are going to have a career advancement problem. They can't prove their point because they are guessing what's going to happen in more difficult times. Hence, regulators basically do not regulate from a safety and soundness perspective during good times.

For example, BB&T took over a failed $25 billion bank (Colonial) with FDIC assistance. Earlier, we consciously decided not to acquire Colonial without FDIC assistance because we knew it was going to fail. How did we know? First, it was acquiring bad banks. If you make many acquisitions of bad banks, you end up with a bad bank. Second, in competing with Colonial, we observed they would take "hog shares of high-risk credits" that we wouldn't touch. Third, the CEO was a command-and-control type who could have run a $2 billion bank but couldn't possibly develop the talent to run a large bank. So BB&T would not acquire Colonial without FDIC assistance. We knew the bank was insolvent. We saw that from the outside. But the regulators missed it, despite having much more inside information.

In addition, regulators are politically driven. Those at the top of the regulatory organizations are political appointees. You don't get to be head of the FDIC without having some political contacts. You don't get to be head of the Federal Reserve without having political contacts. Hence, you have people who come from a political perspective, and regulations change a lot depending on who is at the top.

Regulators are driven by what's happening in the current political environment; there is no rule of law.

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