The Impact of Monetary and Regulatory Policy on Main Street Banking.

• Author: Allison, John A.

I spent my career in business. In fact, I was at one time the longest-serving CEO of a major financial institution in the United States. BB&T, the bank I ran from 1989 to 2008, is a Main Street, community bank, and so I tend to think from that perspective. However, my experience since stepping down from BB&T has made it clear to me that a lot of influential people just do not see the world in the same way.

Between 2012 and 2015, I was president and CEO of the Cato Institute, and so I encountered a lot of policymakers. Right now, I'm teaching at Wake Forest University and so work alongside a lot of academics. Of course, I also have many friends and colleagues on Wall Street. And the thinking that characterizes each of those places is very different from the kind of blinking that takes place on Main Street. Certainly, there are some commonalities, but in the end it's a very different world view.

Accordingly, my goal in this article is to explain the impact of Federal Reserve policy on Main Street and--by extension-fundamental economic activity. In what follows, I am going to deal separately with monetary and regulatory policy. Sometimes those policies work together, but often they actually pull in different directions. I will go on to draw a distinction between the policy responses to the financial crises of the 1980s and 1990s, on the one hand, and the approach taken to the more recent crisis on the other. Finally, I will offer my droughts on the state of banking today, and its prospects under the new U.S. administration.

What Caused the Crisis?

I want to begin with some context, by looking at the last economic cycle. The commonly held belief is that deregulation, coupled with greed on Wall Street, caused the 2008 financial crisis. To put it bluntly, however, diis account of the crisis is simply not true. On the contrary, based on my own experience, I believe very strongly that the recent financial crisis had its roots in government housing policy, which aimed to provide affordable homes now and gave no thought to the longer-term consequences. The Community Reinvestment Act, which put banks under enormous pressure to expand subprime lending, deserves particular blame, as do the activities of those giant government-sponsored enterprises Freddie Mac and Fannie Mae, which by the time they failed had amassed liabilities of $5 trillion, including $2 trillion of subprime mortgages. (1)

These misguided policies were amplified and made much worse, in my view, by the actions of the Federal Reserve. As CEO of BB&T, I saw this up close. It began in the early 2000s, when Alan Greenspan--at that time the Fed chair--responded to a much-needed market correction (the bursting of the dot-com bubble) by engineering a radical reduction in real interest rates. That turned out to be an incredibly destructive move.

You see, at that point we already had a housing bubble in the United States. At BB&T, we gauged the market by looking at the debt service on people's home mortgages versus their incomes. On that basis, we thought house prices were at least 10 percent too high and were gearing up for a housing correction. But the opposite happened when the Greenspan Fed crashed interest rates. It was like pouring gasoline on a fire: all of a sudden, house prices were 30 to 35 percent too high, and there was enormous overinvestment in the housing sector as a whole.

What followed was very interesting. Greenspan claimed that there was a global savings glut and that as a result, interest rates would stay low indefinitely. At BB&T, we didn't pay too much attention to that. But then it went on for several years. At that point, we had to pay attention--for banks, prolonged low interest rates mean you have no spread in your business and therefore struggle to turn a profit. That's why many hanks at that time started to lengthen the duration of their bond portfolios--they needed to find higher yields somewhere. BB&T was one of the last banks to join that party (Allison 2012: 27-28). But then--wouldn't you know it?--Greenspan suddenly started raising rates. He raised them very...