Continue Reading Below
One Wells Fargo Center in Charlotte, N.C.
Four years ago, one-time FDIC chairman William Isaac sat down with former Wells Fargo chairman and CEO Richard Kovacevich for a wide-ranging conversation about banking and the financial crisis. It's one of the best interviews about banking that I've come across in the last three years.
It would be an understatement to say that these two men know a thing or two about the subjects at hand. Isaac led the FDIC during the tumultuous 1980s, when thousands of banks fell prey to an unprecedentedly severe interest-rate environment. And thanks to Kovacevich's leadership, Wells Fargo was positioned to exploit the crisis of 2008-2009 by, among other things, doubling in size thanks to the bank's 2008 acquisition of Wachovia.
While the interview covered a lot of ground -- here's a link to the full transcript if you're interested -- I've pulled out the nine most important points made by Kovacevich in response to Isaac's questions.
1. The riskiest part of banking is lending
Continue Reading Below
I quickly learned that the riskiest part of the banking business is lending. If a bank's growth is focused on making more loans and its loan risks become concentrated, whether geographically, by borrower or by industry, [then] the bank's total risk becomes excessive, even if the bank underwrites those loans well.
2. The importance of spreading risk
Even if you underwrite well, when real estate goes to hell or the economy slows significantly, you're going to get hammered. So you must underwrite well. But then to mitigate the macro factors you can't control, you have to spread the risk. Risk management in banking should be more like it is in an insurance company. You spread and diversify the risk.
3. Size alone doesn't matter
If a bank becomes big because it has grown to be more diversified in products, geography and risk, that is a good thing. If it is big because it is even more concentrated, that is a bad thing.
4. The biggest mistake of the financial crisis
The biggest mistake [of the financial crisis] was not, as most people think, failing to bail out Lehman. The mistake was bailing out Bear Stearns and then [a few months] later not bailing out Lehman. The market just said, "We have no idea what's going on. We don't know what's happening next. We are getting out of the market."
5. Ineffective regulation is worse than no regulation at all
Ineffective regulation is worse than no regulation at all because it gives investors a sense of confidence that a competent organization is monitoring the company so that they don't have to be vigilant themselves.
6. On TARP
I think TARP was one of the greatest economic mistakes ever made in the history of the United States. It was unnecessary. It solidified "too big to fail," forever. It absolutely led to further panic. It also led to the demonizing and vilifying of the banking industry by the Obama administration and Congress. It has even caused our citizens to question our entire free enterprise system, the greatest economic system for creating the most wealth for the most people in the history of the world.
7. Only about 20 financial institutions caused the financial crisis
Only about 20 financial institutions perpetrated [the financial crisis]. ... About half were investment banks and the other half were savings and loans. Only one, Citigroup, was a commercial bank but was operating more like an investment bank. These 20 failed in every respect, from business practices to ethics. Greed and malfeasance were their modus operandi. There was no excuse for their behavior and they should be punished thoroughly, perhaps even criminally. Yet 6,000 commercial banks are being punished with Dodd-Frank penalties in the same way as the guilty parties. Why punish the vast majority of banks that behaved appropriately?
8. Why banks fail
Banks fail due to concentrated risk. Risk has little to do with the size of the bank. ... In fact, more small banks fail than big banks because they are generally more concentrated geographically, by product and by industry.
9. The fine line between risk and reward
There have always been bank failures and there always will be. The trick is to allow sufficient risk-taking to promote economic growth, but not so much that it leads to widespread bank failures and financial panic.
The article 9 Critical Insights About Banking From Former Wells Fargo CEO Richard Kovacevich originally appeared on Fool.com.
John Maxfield has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of Citigroup Inc and Wells Fargo and has the following options: short April 2015 $57 calls on Wells Fargo and short April 2015 $52 puts on Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
Copyright 1995 - 2015 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.