Federal Regulators are currently accepting public comments for modernizing outdated broker and listing service rules for insured depository institutions (i.e. banks). (The proposed changes first appeared in the Federal Register on February 6th and comments will be accepted through May 7th.)
While the rules look like they will open some doors, we can’t be sure exactly how until a final rule is issued. What’s too many, and even the definition of a brokered deposit are, at this point, a matter of debate. So, over the next several weeks, we will be examining some of the aspects of that debate.
Let’s start with a quick overview of how we got here in the first place. It actually begins over a half a century ago, in 1950s and ’60s when large volumes of fixed-rate mortgages were issued by Savings and Loans across the nation. That sounds like a good thing, and it was, for a long time. But when the 1980s rolled around, high unemployment and even higher interest rates came along, too.
The prime lending rate rose to 21.5% and inflation hit 14%. If anyone was interested in buying, S&Ls could make new loans at higher interest rates but not too many people were buying at that time. And there was a cap on the amount of interest those S&Ls could pay on deposits. For the first time in U.S. history, home-owners were finding themselves upside down on their mortgages.
For those of us who remember the ’80s, the music was good, but not much else. We had American hostages in Iran, and at home: farmers were struggling in the Midwest; oil companies struggling in the Southwest; and real estate was crashing on both coasts. Congress felt the need to get involved.
In an effort to help S&Ls with the interest rate mismatch and make them better situated to help their customers, restrictions on the amount of interest they were allowed to pay on deposits were removed. This deregulation was coupled with a rise in deposit insurance coverage from $40 to $100k. The Jumbo CD was born.
It wasn’t long before Mr. Paul Bauer noticed that the interest rates offered on the $100k deposits did not seem to depend on the health of the S&L that was offering them, but on its location. Even though these Jumbo CDs were fully insured, Bauer saw the value of evaluating the financial picture of the S&L before becoming a depositor. So he did.
Jumbo Rate News wasn’t the only Deposit Listing Service to start-up around this same time, but Bauer’s was the only one that had a self-imposed restriction that it would not publish the rates of S&Ls (or banks) that did not meet his strict financial criteria.
Listing services (Bauer’s and others) never actively get involved in the placement of insured deposits. Because of that, these deposits have not historically been considered to be brokered. About a quarter of all U.S. banks have some amount of non-brokered listing service deposits on their books today.
While other listing services may have contributed to the S&L crisis of the 1980s, it wasn’t really their fault. Many S&Ls set dangerously high interest rates, attracting large sums of deposits that they would basically gamble with. And then there were deposit brokers, many of whom placed deposits wherever they would get the most commission, rather than what was best for their clients.
For years this continued. Then, on July 6, 1982, Penn Square Bank of Oklahoma City, OK failed. Penn Square had used brokers to bring in deposits it then used to make speculative gas and oil exploration loans. Between 1977 and its failure, Penn Square grew from a $30 million asset bank to a $436 million bank. However, many of those assets were totally worthless.
Penn Square was just the beginning. By 1989, hundreds of banks and S&Ls had failed. Congress got involved again and passed the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA). FIRREA Restricted “Troubled” institutions from: a) accepting brokered deposits without a waiver; or b) offering rates that were “significantly higher” (typically 75 basis points) than those of similar institutions within the same market area.
On page 7 we list 50 banks with highest $ volume of brokered deposits: the first 25 are the Big Banks while the second half are community banks with the most. Then, in the next couple of weeks, we will continue the saga of the brokered CD—not just historically, but where they stand today.