The Bank Failure Blame Game.

• Author: Elson, Charles

With the recent bank collapses, the inevitable question has once again been raised--where were the banks' boards? Were they in part responsible for these financial debacles? The answer is complicated. First, until the complete facts are finally revealed, it is hard to assign responsibility one way or another. Second, in an odd way, blame may in some part be assigned to some poorly thought-out corporate governance reforms of over two decades ago. But there are several important governance lessons that will probably emerge from the ashes of this recent financial disaster.

The failures of these institutions stemmed from a classic bank run. The financial weaknesses that were identified as the cause of the run, in retrospect, had little to do with the institutions' loan portfolios --which were the source of the 2008 financial crisis--but were on the liquidity side of the banks' holdings.

To cover deposit liabilities, these institutions had invested in U.S. Treasury bonds, generally considered the safest, most conservative investments. However, these obligations were long-term in duration. Thus, with the rapid spike in interest rates brought on by the severe inflationary pressures caused in part by the current administration's massive spending programs, the bonds fell quickly and dramatically in value. Suddenly, it was rumored that these banks could not cover their deposits, and the classic bank run occurred.

So, whose fault was this? Certainly, the current political administration has some responsibility, though, of course, they will deny it. The management of the afflicted banks who heavily invested in the long-term Treasury market bears some blame, particularly when the administration's spending proposals were clearly attacked as inflationary at the time they were made. But what about the boards themselves?

This is a much more difficult question. How much focus did the directors devote to the liquidity portion of the portfolio as opposed to the lending side? Is a U.S. Treasury obligation ever risky in the micro sense? While focus on the credit side of the bank is a natural expectation of boards, how much attention should or can be paid to macro forces affecting the Treasury market? And, most importantly, what did these boards know about the risk, when did they know it and what did they do or not do about it? The answers will eventually be revealed through the inevitable dispositions and documentary review that will occur. But it is too early...