This article first appeared in the St. Louis Beacon, April 1, 2010 -Americans who disagree with the notion that some banks are too big to fail will get no argument from Thomas W. Hough, chairman of the Illinois Bankers Association.
In a recent interview, Hough told the Beacon that if a large bank has problems, a system needs to be in place to wind down its operations without affecting other parts of the economy -- and without getting taxpayers involved.
"Maybe there's some question about how to do that, but I think everybody agrees with it,'' said Hough, who is CEO of Carrollton Bank, a privately held, employee-owned bank with $800 million in assets, headquartered in Carrollton, Ill.
Hough, who is the fifth-generation of family members to run the bank that his great-great grandfather helped found in 1877, said that granting big banks immunity from failure, in effect, gives them an advantage over smaller community banks, such as his.
"If the market knows that they have an implicit guarantee that anybody who invests money with them is going to be made whole, that's not good for a bank like me,'' he said. "I don't have that implicit guarantee from the government.''
Hough, who took over as chairman of the Illinois Banking Association last June, will hold the post for one year during what, he acknowledges, is a critical time.
"It's obviously a very important time for the banking industry and certainly its customers and the economy -- and the country, frankly,'' he said.
Hough was just in Washington for meetings about financial-reform legislation being considered by Congress that is aimed at preventing a recurrence of the financial crisis and $700 billion taxpayer bailout in 2008.
The House has already passed legislation that would create an independent consumer protection agency empowered to write and enforce banking regulations, a move that is supported by the Obama administration. A Senate version would put the agency within the Federal Reserve and give a council of regulators veto power over the agency's regulations.
Hough said he understands why many Americans are angry at banks.
"The banking industry, in general, is not well-liked and well-respected in many circles right now -- in many cases understandably so,'' he said.
Hough said that all banks tend to get lumped together, despite their differences and despite the fact that many, including his bank, didn't sell the subprime loans that spurred the financial crisis.
Commercial banks that take deposits and make loans are different from investment banks, such as Merrill Lynch, Morgan Stanley or Goldman Sachs, he said. The commercial banking sector includes both large nationwide banks and smaller community banks, such as Carrollton Bank.
"In a big picture way, banks are not the most respected group right now, but I've seen also that the way people think about local community banks is more positive -- on a more one-on-one basis,'' Hough said. "But let's face it, a lot of banks maybe haven't done the right thing by their customers over time.''
And when it comes to "doing the right thing,'' Hough is quick to quote his father Thomas S. Hough, who worked at Carrollton Bank for 70 years.
"I learned a lot from my dad, and even though he's been gone now five years, believe me if he were sitting here I would know what he would think. He wouldn't stand for an interest-only loan to somebody or a 40-year mortgage. That wouldn't be right,'' Hough said.
Hough joined his father in running the bank in 1973 after graduating from the University of Illinois. Although the bank has locations in Alton, Jerseyville, Springfield and St. Louis, it remains based in Carrollton, a town of 2,600 that is the county seat of Greene County, Illinois.
While the bank's website includes all of the modern electronic banking tools, it also contains throwbacks to the past. A $10,000 deposit will be thanked with a free apple pie, and "The Carrollton Bank Story" is told in detail.
The reason the bank is employee-owned dates back to the Great Depression. In 1933, the bank reopened after President Franklin Roosevelt's mandated 10-day holiday because Hough's great-uncle John Eldred arranged for a private loan of $40,000. The staff agreed to a 10 percent salary cut to help pay back the loan. When the loan was finally paid off in 1952, the bank thanked its employees by starting a profit-sharing plan, which continues to this day.
Here are more excerpts from the interview with Hough:
Some analysts predict that another round of foreclosures and a slumping commercial real estate market are on the horizon -- that this recession isn't over yet. Do you agree?
HOUGH: I think that's probably true. As deep as this recession is -- it's the worst economic time since the 1930s -- it will not recover quickly like you've seen in other downturns where it was not as severe.
Consumer spending is about 70 percent of the gross domestic product of our economy, and the measures I've seen consistently is that consumer activity is down about 10 to 15 percent across the board from where it was a couple of years ago, in the good times. It was really built on too much leverage -- too much debt being taken on by the consumer and it wasn't sustainable long term and was exposed in a tough economy. That doesn't come back any time soon.
Obviously, that means less demand for goods and services and therefore companies lay off people so you have the unemployment problem and it bleeds over into the commercial side and commercial real estate. Retail stores and commercial developments that have had problems have to close and it produces vacancies. And obviously in the recreational area, vacations and tourism have been scaled back quite a bit with the consumer hurting. Those things were probably built on excessive leverage. Now that we're in the deleveraging process, it's going to take a while to get it back to where it was.
A substantial number of banks that have failed during this recession were in Illinois; are we going to see more banks in trouble?
HOUGH: There are certain lagging effects. One of them is unemployment. That's one of the things that typically lags in an economic downturn. Another lagging indicator are bank failures. A lot of observers would say that 2010 may be the worst year over the last three or four years. We had 140 bank failures [nationally] last year; we're on target this year to have more than that.
Illinois had the second most bank failures of any state in the union last year. One reason is that Illinois has the most banks of any state. Illinois is a large state and was for years a unit banking state. Branching was not allowed like it was years earlier in states like California so you have a lot of more individual banks in Illinois. Second, there's been some impact in the Chicago area with some fast growth and newer banks there that have had some problems.
I think there are 700 banks on the FDIC problem list. That's about 10 percent of all the banks in the country. How many of those may not make it I don't know, but this year will probably be the worst year. You'll have some more failures in 2011 and hopefully it will start tailing off in 2011 and 2012.
How do you distinguish your bank from these troubled banks?
HOUGH: We're in a fortunate position where we don't have to maximize our profits quarter to quarter. Banks that are publicly traded, especially the larger banks, have a lot of pressure to produce profits short term. If that's the pressure you have, then right or wrong, the bank might have some motivation to do some things that aren't the best for the customers. We're not in that position. We can take the longer-term focus. We think it's right to do well by the customers because it's just right. Also, for us it's good business.
If over the long run you treat your customers fairly that's good business. You get more customers. We communicated with our customers in the last 18 months when we've had these troubled times. We've sent letters that I've produced and signed to all of our customers giving them objective answers from my perspective about what's going on.
We've had the good fortune of getting through this financial crisis in good shape at Carrollton Bank so we're able to communicate that strong financial position to our customers and explain that we've not done the subprime mortgages. We did not overreach for short-term profits. As we hit this financial downturn, we've weathered it well so far.
What happened to the old days when homeowners had to put 20 percent down on a house?
HOUGH: Especially with community banks, there are still opportunities to get a mortgage from somebody you know and trust. There are still ways to get access to that kind of credit with local banks.
My dad always would say this to me: Credit is a double-edged sword. It's a good tool if it's used properly. It's a very dangerous tool if it's not. He would also tell me, you can get people in trouble as a lender if you don't do it right. In the final analysis, doing what's best for the customer is the best thing for the bank, as well.
Sometimes short-term, overreaching issues and profit motivations get in the way, and we see what happened with that.
Did you see trouble brewing with the subprime loans?
HOUGH: I don't think we could say that we saw this coming and could predict this. I don't think there's anyone who could say that, but in the last several years we've seen more banks, new banks come into the market with new charters. And they've been competing pretty aggressively and trying to grow rapidly. We've seen more mortgage brokers pop up. A lot of them are gone now, but they popped up in the last several years to make these kinds of mortgages. We did see a lot more competition and we saw a lot of things we kind of shook our head at. How are they doing that? Why are they not requiring money down? How can they get this kind of a rate? It sounds too good to be true.
It was tough competing in an environment where other competitors were doing some really aggressive things, and they were getting the business sometimes. It was tough to hold back on that, but by and large we just did. Now, you're seeing the aftermath of all of this, unfortunately.
Does being an employee-owned bank make a difference?
HOUGH: All of my loan officers are owners in the bank, so they're invested. They invest their own money to buy stocks. So when they're loaning money, it's part of their money. They have a bona fide financial interest in making sure that their loans are good
How banks compensate their loan officers played a big part in all of this. In other scenarios at banks and with mortgage brokers, they would get a commission or fee per loan, and the loan would be sold and somebody else would fund the loan with their money someplace else,. There was no real ownership in that loan being paid back. You got a fee up front. The loan was gone. And that kind of compensation mode is not good. It does not engender the right actions on behalf of the bank and the loan officer.
We never paid by loan volume. Our people are salaried, and they're owners. They make a loan; they live with the loan, with the customer they know.
Do your loans stay at your bank?
HOUGH: We do it both ways; most of the loans we make do stay at the bank. The loans that we sell are the long-term fixed-rate home mortgages that we cannot fund with short-term deposits. But we sell all of them to Fannie Mae, the government.
Fannie Mae's standards were relaxed in the last few years. Now they've tightened again like they should have been all along. I remember several years, ago a couple of my loan officers came to me and said, 'Fannie Mae has more programs now, and zero-money down, and 40-year loans -- can't we offer those like other banks are doing?' I said we've got basic products that we use. I don't think it's right -- and I'm not saying this to make myself look good or that I was a soothsayer -- but I remember saying that a 40-year loan doesn't help anybody. A no-down payment loan doesn't help anybody. We're just not doing that. We're sticking with our basic products; the down payments, the 15- or 30-year fixed-rate loans. That's what we're going to do.
We all agreed with the philosophy of why we shouldn't, but in the heat of the moment we're in a competitive business and you want to do business. It's tough. But that's part of that owner-operated thing where I've got 55 or so shareholders; about 42 of them are people who work in the bank everyday.
The banking business as we would remind ourselves in the last few years is a long-term business, by nature. It's not a flip-it business where you make a fee and the next quarter earnings are higher. Or, where a bank will come in that's new and hope in five years they can grow real fast and sell out to somebody and make a big profit.
We've been around for 133 years, so we're pretty long term.
While a certain amount of greed was involved, isn't it also true that some homeowners simply didn't understand how subprime loans work?
HOUGH: There's always a discussion of where the culpability is. Is it the fault of the consumer or the fault of the lender? Probably some of both. There's talk in Congress about banking reform legislation. One of the areas would be consumer protection where consumers would be shown a vanilla 15- or 30-year fixed rate mortgage that we all understand and then anything else would be compared to that vanilla example. That may be a way of showing people that here is conventional and here is what is not conventional.
As you acknowledge, people are angry at banks right now and calling for reform. What are your thoughts on reform?
HOUGH: There have always been some regulations put in place by the Federal Reserve about how bankers are compensated. There has been some action on that already, which is good.
The sticking point for some bankers is the consumer protection agency that the Obama administration wants that is separate from the bank regulators. We have a lot of consumer protection right now that banks work with, but it's regulated by the FDIC and the Fed and so forth. There's talk of having that separate from the regulators so it's truly a consumer agency.
Bankers agree with consumer protection, but it's how you do it. I would like to see it where perhaps you have an independent agency come up with the rules and regulations, but I think the bank regulators need to OK them. Because there could be a conflict from time to time about what's best for the consumer, but it might impact the safety and soundness of how the bank is run.
I'd like to see ideas for simplification, clarity and consumer protection come from a separate agency, but they would have to be approved as workable by my regulators, the FDIC in this case. That would be applicable to all people who lend money, not just banks. So across the board the same type of regulations -- whether you went to a commercial bank, a savings and loan, a mortgage broker or a big bank, you'd have the same disclosures in front of you -- and ones that you could understand.
Another part of all this is better consumer education. Consumers are not in the financial business, and this is not what they focus on everyday and a home mortgage is usually a person's biggest financial transaction. So perhaps a consumer protection agency could help with the financial education. I think individual banks -- my bank -- could do a better job of trying to educate our customers. There are certain things that are out there -- whether it's payday loans or the use of high-rate credit cards -- that can get people in trouble pretty fast.
Do your St. Louis customers ever ask where Carrollton is?
HOUGH: When I first started doing business in St. Louis I thought that maybe I need to change the bank's name. And I remember having dinner one night with some friends in St. Louis and I said, 'Do you think I should change the name?' They said, 'We don't know where Carrollton is anyway. We don't know what it is. We don't care what you call it; it's better than First This or First That, which all banks are named it seems. So a lot of people don't know where Carrollton is, but I'm glad I didn't change the name because of the history of the bank and the Carrollton roots. It's worked out fine.
