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Robert D. McTeer, Jr., President, Federal Reserve Bank of Dallas.

Statement by Robert D. McTeer, Jr., President, Federal Reserve Bank of Dallas, before the Subcommittee on Domestic Monetary Policy of the Committee on Banking, Finance and Urban Affairs, U.S. House of Representatives, May 8, 1991.

I am pleased to appear before you to discuss credit conditions in the Eleventh Federal Reserve District, which includes all of Texas, northern Louisiana, and southern New Mexico. While I am personally new to the area, having assumed my position on February 1, our staff has done considerable work on the subject, which is summarized in the annotated bibliography attached to my written remarks.(1)

As you know, the banking industry in the Eleventh District experienced much turmoil in the 1980s. Two oil price shocks and a related collapse in real estate prices triggered bank and thrift institution failures of unprecedented proportions.

Banks in the Eleventh District began the decade of the 1980s in a very strong position in terms of profits and capital and prospects for the future. Yet, during the height of the later difficulties--from 1987 to 1989--more than 400 banks failed, which accounted for more than 50 percent of all the U.S. bank failures during that period, and these banks had 44 percent of the banking assets in our region.

The number of banks located in the Eleventh District peaked at just more than 2,100 in 1986 and fell to about 1,300 by the end of 1990, a decline of almost 40 percent. Although this consolidation included the results of a new branching law in Texas, much of it reflected failures. Eight of the nine largest banking organizations in Texas either required Federal Deposit Insurance Corporation (FDIC) assistance to continue operations or were acquired by out-of-state institutions. The thrift industry underwent an even larger retrenchment, with the number of thrift institutions declining more than half. A calamity of this magnitude obviously disrupted normal lending patterns and credit arrangements.

Although the difficulties that Eleventh District banks experienced during the past decade continue to affect their performance, we are beginning to see signs of recovery. Last year, after four consecutive years of losses, they showed an aggregate profit. Year-end income statements for 1990 showed earnings of $780 million. The overall return on assets remains low, at just less than 1/2 percent, but the transition to profitability is encouraging, particularly compared with the negative returns of the preceding four years. The charts attached to my testimony generally reflect substantial improvement in the health of the banking industry in the Eleventh District in 1990.

The positive returns in 1990 helped our banks reduce their troubled assets. Their capital also improved. Capital injections from the FDIC and from private sources increased the equity capital ratios to 6.1 percent, moving them closer to the national average. And for the first time since 1984, the rate of nonperforming assets fell below the rate at banks outside our region. The troubled asset ratio at Eleventh District banks fell to 2.5 percent of total assets by year-end 1990 from its peak of 8.3 percent in the third quarter of 1988, with progress made at both large and small banks.

I wanted to avoid getting bogged down on a definition of "credit crunch," but with respect to the Eleventh District let me just say that bank credit has contracted every year since 1985, including last year. The volume of outstanding loans at our District banks fell from a peak of more than $132 billion in 1985 to just more than $83 billion at the end of 1990. The ratio of loans to assets at Eleventh District banks declined from more than 59 percent to 46 percent from the end of 1985 to the end of 1990. While that ratio is a sign of past credit restraint, it may also be interpreted as an opportunity to expand lending in the future.

Despite the contraction in credit for the past four years, an economic recovery, nevertheless, began in our region in 1987 and continued modestly through last year and into this year despite the onset of national recession. The Eleventh District economy continued to have positive employment growth until recent weeks. If the national economy begins to recover soon, we could possibly escape another recession in our part of the country, and our banking recovery could proceed.

We do not fully understand the interrelationships between banking conditions and economic activity. Statistical research at our Federal Reserve Bank of Dallas has confirmed the expected impact of the local economy on our banks, but it has failed to confirm an independent impact running the other way. The economic recovery in the face of declining local bank and thrift lending suggests alternative sources of funds to local borrowers. Since large borrowers have access to commercial paper and the securities markets and since consumers have access to nonbank sources, the likely adverse impact of the cutback in local bank and thrift lending is probably concentrated among small and medium-sized business borrowers. Indeed, that is the source of most of the anecdotal evidence of a credit crunch.

The reduction in bank credit no doubt resulted from the massive loss of bank capital, and new sources of capital were scarce. It is also true that the major changes in our financial structure disrupted traditional relationships between borrowers and lenders and between correspondent and respondent banks--to the detriment of both business borrowers and the surviving banks. Rescuing banks brought needed capital to the devastated industry and stabilized the situation. Nevertheless, as the restructured banks shed problem loans and changed lending focus and strategies, even high-quality borrowers were forced to make new credit arrangements. Long-lasting relationships were severed and had to be replaced, often with new bankers unfamiliar with the borrowers' business or credit history. These disruptions occurred within an environment of closer scrutiny of new loans, rising loan standards, and declining appraisal and collateral values. And there seems to be a genuine perception of heightened uncertainty that has made bankers more cautious about putting their funds at risk.

Surviving banks had to contend with their own problems while their correspondent relationships were being disrupted. Furthermore, they had to compete with new players that had the advantage of government assistance and with existing troubled players that were paying a "Texas premium" trying to grow out of their problems. Banks that had remained relatively conservative during the boom years found their own survival threatened first by competition from their less conservative brothers and then by the subsidized rescuers of those competitors. It is no wonder that all involved have felt great frustration. That frustration was only compounded by the knowledge that these problems were considered to be merely "Texas problems" or "Southwest problems" until they began to be experienced elsewhere in the nation. Then they became national problems.

I know that you are familiar with the history that I have tried to summarize here and with the frustrations felt in my part of the country. I recall it here only because I consider it part of the responsibility of my new job to do so.

In concluding, let me say that bank credit by local institutions has been constrained and continues to be constrained in our area. However, the conditions that led to this credit "crunch," if you will, have been improving and an increasing number of our banks are poised to resume more normal lending activity. Surprisingly, our local economy has been able to recover despite the local credit situation, although no doubt the recovery would have been more vigorous without that constraint. If the national recovery comes soon and financial conditions remain favorable, the climate is right for the continued healing of our banking system and the continued recovery of our local economy.

Monetary policy has provided a positive environment for both. Short-term interest rates are at very low levels. The money supply is growing in the middle of its target range. The banking system is liquid. More money in the economy is no substitute for more capital in the banking system.

Fundamental banking reform is needed to prevent another disaster and to foster a healthier, more viable banking system for the future. However, care must be taken to avoid a worsening of the current banking situation in moving toward long-term reforms. For example, one concern I have is that deposit insurance might be cut back too severely before the "too-big-fail" problem is solved. Such a development could result in unfortunate unintended consequences for the many community banks and their borrowers in the Eleventh District and in the nation.

In the long run, the best thing the Federal Reserve can do for banking, as well as for the economy generally, is to provide a stable monetary environment.

Even the Texas banking crisis, though usually thought of as an aberration having its roots in an OPEC-related collapse in oil prices, can be traced to the inflationary seventies. It was in that period that the fiction was created and nurtured that betting on inflation generally, and higher oil prices in particular, was a sure bet. We have been reminded, once again, that markets eventually adjust and that exploding oil prices or real estate prices will sow the seeds of their own correction. In a stable monetary and price environment, extreme relative price changes will be more evident, not being masked by an inflationary price level, and lenders and investors will have a better basis for rational decisionmaking.

(1)The attachments to this statement are available on request to Publications Services, Board of Governors of the Federal Reserve System, Washington, D.C. 20551.
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Title Annotation:Statements to the Congress
Publication:Federal Reserve Bulletin
Article Type:transcript
Date:Jul 1, 1991
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Next Article:John P. LaWare, Member, Board of Governors of the Federal Reserve System.

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