Quelle Surprise! Fed Defends Incompetent Bank Management Against Investors

Reader Hecht pointed out a new piece by Steven Davidoff at the New York Times’ Dealbook, illustrating the lengths to which the Fed will go to defend incumbent bank managements.

The story recounts the sorry conduct of the bank regulator with regard to two small banks, one the $1.1 billion in assets savings & loan First Financial Northwest, the second Cardinal Bankshares, which has a mere $250 million in assets. Both are under supervision of the Fed, neither bank is doing well (First Financial is under “special supervision” as a result of having lost over $90 million in recent years), yet in both cases, true to an apparent long-standing practice, the Fed is siding with the management that is responsible for the banks being in bad shape over activist investors who look to be urging sound measures.

Davidoff recounts the First Financial case in more detail. There, Stilwell Group, which bought 7.9% of the stock, got Fed approval to have its general counsel appointed as a board member. He then made radical suggestions at a first board meeting:

“terminate the director emeritus program,” which Mr. Schneider claimed paid directors as much as $150,000 a year even after their death for doing “nothing.” He also proposed to “remove the directors’ photographs from the executive suite walls” since the photos rewarded poor past performance and the bank was “not a country club or an English manor.”

Finally, as a symbol of First Financial’s newfound austerity, Mr. Schneider [the Stilwell nominee] wanted to “serve only hard candy at the upcoming annual meeting.” He also protested the board’s policy of free iPads for directors.

$150,000 for current, much the less ex, directors of a bank that small is a ridiculous amount of money. Schneider resigned when the board refused to act on his recommendations (note the Times says that Schneider wanted his demands implemented immediately; Schneider counters that the board was unwilling to act. Given the obvious feather-bedding, I suspect Schneider could tell he would be stonewalled).

Stilwell renominated Schneider and sought to have a second director appointed. The Fed intervened, invoking regulations that define 25% ownership of a bank voting shares as “control” and hence subject to Fed approval. But this is ridiculous. Stilwell doesn’t come close to having 25% of the shares, and even if it had won both board seats, it would have only 22% of director votes.

In the case of Cardinal, the activist investor, Schaller Equity Partners, got itself in the Fed’s crosshairs by proposing to place five of six directors (this when it owns 9.8% of the stock). The Fed said if it did that, it would regulate Schaller as a bank holding company, which would make its life miserable. The Fed is pushing hard to neutralize Schaller’s efforts:

Schaller has subsequently dropped the number of its nominees to three to placate the Fed. Even so, the regulator has taken more steps to ensure that Schaller does not have control over these nominees, claiming that even this number of directors could still make Schaller a bank holding company. The directors are now executing passivity agreements that will limit their ability to coordinate activity with Schaller.

This stance, of favoring bad bank managers over reform-minded investors, speaks volumes about the Fed’s priorities. These aren’t complex, difficult to operate banks where management has special know-how. If the dissidents wanted to throw the entire management team out, it would not be hard to replace.

The fact that the Fed so reflexively defends banks against any outside influence, even positive ones, is proof of how the Fed is badly in need of reform. One idea that has been set forth by the Alternative Banking Group of Occupy Wall Street is ending the private ownership of the Fed by banks and barring members of management and boards that the Fed regulates from serving as Fed directors. There are plenty of recently retired financial firm executives who know tradecraft, and the Fed through its supervisory powers can get lots of information about what is happening in markets, rather than relying on the spin of people like Jamie Dimon). The Fed is already a popular target for Congressmen on the right and left ends of the spectrum. If it does not relent from its profoundly pro-bank posture, it may find more changes foisted upon it.