Friday, April 16, 2004
Mr. Lawrence: Good morning and welcome to The Business of Government Hour. I'm Paul Lawrence, partner in charge of The IBM Center for The Business of Government. We created the center in 1998 to encourage discussion and research into new approaches to improving government effectiveness. You can find out more by visiting us on the web at www.businessofgoverment.org .
The Business of Government Hour features a conversation about management with a government executive who is changing the way government does business. Our conversation today is with Steve App, chief financial office of the Federal Deposit Insurance Corporation.
Good morning, Steve.
Mr. App: Good morning.
Mr. Lawrence: And joining us in our conversation, also from IBM, is Dennis Kaizer. Good morning, Dennis.
Mr. Kaizer: Good morning, Paul.
Mr. Lawrence: Well, Steve, let's start by talking about the FDIC. Could you give us a historical background of the organization and its mission?
Mr. App: We're proud that FDIC has reached its 70th anniversary serving the American public. It goes back to the United States banking crisis in the early 1930s that culminated in a panic in March of 1933. At that time President Roosevelt declared a banking holiday closing all banks in the country. There was a quick legislative response and the adoption of the Banking Act of 1933 is really what created the FDIC and we opened for business January 1, 1934, and at that time the deposit coverage was $2,500.
There are two important reasons for the adoption of deposit insurance. One was to provide protection for small savers. The other was really to add stability to the banking system. Before the introduction of deposit insurance depositors in failed banks often lost some if not all of their money. The situation contributed to bank runs and severe liquidity problems in the banking area. For example, in 1933 at the height of the crisis over 4,000 banks failed and the very next year only 9 banks failed.
Finally, we added stability to the banking system because we added examination supervision of state-chartered banks that were not members of the Federal Reserve system. They had no federal supervision and we became the primary regulator of those banks and added a lot of safety and soundness to that. All of these elements are with us today in our mission and I'm proud to say also that since the FDIC's creation, no depositor has lost a single penny of their insured deposits.
Mr. Lawrence: How's the FDIC funded?
Mr. App: We are a federal government corporation so we're independent of the appropriations process and we also don't use taxpayer dollars to fund our operation. In essence we're like a car insurance company whereby we assess the bank's insurance premiums based on both their size and their riskiness. So if they have a larger deposit base and if they have riskier practices or driving records, if you will, they would pay more premiums.
That said, over the years we have built up the fund to about $46 billion and by statute we have a ratio that's very key to how we do business. That ratio is the fund balance, that $46 billion, over the amount of deposits, over 3 trillion. If that's above 1.25 we don't charge premiums for most of the banks.
So because the fund's been very healthy for the last seven years or so over 90 percent of the banks have not paid assessments. So our funding stream over those last seven years has been about 95 percent interest earned on the portfolio, over 2 billion a year, and only about 5 percent, about 100 million, comes from the actual assessments for a few banks who are in the very risky categories.
Mr. Lawrence: You described the process of regulating financial institutions. I'm curious about the relationship between what the FDIC does and other organizations like the Office o f Comptroller of the Currency and the Federal Reserve. How do they all fit together?
Mr. App: There are four of us who are the regulators for the bank and the thrift industry and it's divided into different categories. There are about 9,000, a little over 9,000, financial institutions. We take care of the state nonmember banks. The Federal Reserve does the state member banks, OCC national banks, the OTS does the thrifts.
We work very carefully, however, and there's a council called the Federal Financial Institution Exam Council, most of our principals are on that. So a lot of policy changes and regulatory guidelines and things are issued jointly. We get comments back and we put those in place. So there's a lot of coordination amongst the four primary regulators. Also, two of those, the head of the OCC and the OTS, are actually board members on the FDIC to help make some of the decisions there.
We also interact with the nonbank regulators like the Security and Exchange Commission, other people, not on as regular a basis but for selected items. A lot of our banks are publicly traded so some of the SEC rules would apply. So we do have interaction with some of the other non-banking regulators, with people that are engaged in the financial industry.
Mr. Kaizer: Steve I'd like to shift gears a little bit. Can you tell me how many people actually work for the corporation and talk a little bit about some of the unique skill sets they have?
Mr. App: We are currently at about 5,300 people and that's significantly down from the height of the S&L crisis when FDIC and the Resolution Trust Corporation together were about 23,000 people. So we've been downsizing for over a decade.
In terms of the unique skills, like many of the regulators, we have some of the best talent in the industry, really, very specialized. We have commissioned bank examiners that go through a rigorous three to four-year process to get commissioned as bank examiners. Our legal team, our economic team, our financial analyst team, have very specialized skill sets, very marketable skill sets, to deal with the complexities of the industry. So we've tried to match our staffing to the changing industry.
Mr. Kaizer: Let's talk about your role a little bit. What are your responsibilities and duties as the chief financial officer?
Mr. App: Well, I have the basic package under the CFO Act and then some additional things. We have all the financial reporting, monthly, quarterly, and annual budget and financial statements. We're under commercial GAAP and again, as I explained in the revenue picture, numbers really drive our organization. So unlike some of the government agencies the financial statements are read by pretty much all the executives every month.
We also do the planning, budgeting, and performance and linking those together. In addition we have enterprise risk responsibilities for all the internal control, audit for our inspector general and GAO in some cases, and then lastly part of the basic packages and financial systems in charge of not only the core financials but the peripheral financial systems and I co-chair a corporate investment review committee, the Capital Investment Review Committee, with the CIO. So that also helps integrate the finance. But over and above that I think the CFO community always hopes that once those things were shored up we would have a seat at the table at more policy and strategic directives. So I actually also serve as one of the deputies to the chairman.
We have a great corporate team, a good C team, if you will. The chief operating officer, the chief of staff, and myself sit on a number of governing committees and that's really where a lot of the work is done. We have a national risk committee that we all participate in. We have a resolutions policy committee that we participate on and then I chair various specific committees like the investment advisory group, which is actually the group that makes the investments quarter by quarter in the portfolio where we get most of our revenues.
So we really do have a seat at the table in the CFO's office, not just on the pure finance stuff but really on some of the strategic direction of the corporation.
Mr. Kaizer: That sounds like quite a bit of responsibility. So how have any of your previous experiences prepared you for your responsibilities here?
Mr. App: Well, I have about 28 years of experience in the banking, finance, and insurance industry and it gives me a lot of different reference points. Some of those were in the government, some in nonappropriated parts of the government, some in the private sector. So I've been working the industry for quite a period of time and I've been blessed with some very good bosses who have also served as mentors to me but I've been on different sides of the equation.
I started out in the operations and payments area when I was at the Federal Reserve. I moved into the insurance realm during the height of the S&L crisis working with Lloyds of London and other insurance companies to both provide insurance to the banks and also do direct consulting to the banks and then I've been in agencies of the government that are very large like HUD and Treasury that do various things related to banking and finance from mortgage banking to some of the central cash management for the government and in general it gives you a lot of reference points to draw on so that as you are faced with new problems and decisions you don't just use one size fits all to resolve those problems. You draw on different things. You package it up correctly to provide the right solution that fits.
Mr. Lawrence: One of the unique things about both your career as well as the position you're in is the interaction between the public and private sectors. You often hear the private sector does it this way, the government does it this way. I'm curious about your comparisons of, say, just management skills in the two sectors.
Mr. App: Well, first I think it starts with the people. I think people in both cases are our number one key and there's a real war for talent to get the best people. What I found is that whether it's the private sector or the government in the best run organizations because I think there are examples in government and private sector where you don't have the best-run corporations but in the best run corporations the key is really the people, people that are competent and people that are passionate about what they do, and that makes management, of course, a lot easier.
I think it divides a little bit at that point. In the private sector the real galvanizing force is really the earnings pressure on the bottom line and it's a simple thing in a way that gets the whole organization moving in the right direction. People are always chasing price points to get the best price, best quality, and so you begin to understand that whether it's a dollar earned in revenue or a dollar of cost savings it's still a dollar to the bottom line and that just pervades everything that they do.
When you get into the government I think you have to understand that many things aren't as purely driven as that, that a lot of things have multiple goals. If you look at some of the lending programs in the government, lender of last resort-type programs, they're not just viewed as loans. They're job creation. There are other things associated with them.
So I think in the government you find that perhaps we're not as cost conscious to the bottom line because a dollar of savings doesn't quite mean the same thing. Also I think you have to get used to that. There are a lot of other variables to deal with. It takes a lot of orchestration to get results and that frustrates some people but in a way you're working on a fairly significant thing so there are some built-in checks and balances in there to make sure that it's done right.
In terms of management the continuity of leadership in the government, I think, is a challenge for people because on average at the top levels the political folks turn over about 18 to 24 months on average and that's a little bit of a challenge compared to the private sector, where you have a Bill Gates or a Herb Kelleher who've been around for many, many, many years in their organizations. So the vision is constant, the focus is constant.
At FDIC, again, because we're a corporation I think we have a little bit more focus on the private sector-type philosophy where we're very cost conscious. Our chairman has a five-year term so we get over some of those continuity of leadership issues, board of directors six-year terms, and we do have a bottom line and that affects the ratios in a lot of things.
So we're a little bit more grounded that way but we still have government responsibilities.
Mr. Lawrence: That's an interesting point about the continuity. How does the FDIC respond when a financial institution fails? We'll ask Steve App, CFO of the FDIC, to walk us through the steps when The Business of Government Hour continues.
Mr. Lawrence: Welcome back to The Business of Government Hour. I'm Paul Lawrence and this morning's conversation is with Steve App, Chief Financial Officer of the Federal Deposit Insurance Corporation. Joining us in our conversation is Dennis Kaizer.
Well, Steve, let's talk more about the FDIC programs areas. As I understand it they're insurance, supervision, and receivership management. Let's start with deposit insurance. Could you tell us how that works?
Mr. App: I'll tell you two parts about it, one, the coverage itself. It's basically $100,000 for a deposit or at an institution although there are some nuances about single ownership, joint ownership, retirement accounts, and even trust accounts and we would ask the listeners to go to our website, www.fdic.gov. In the consumer area we have a tool called EDIE, which stands for electronic deposit insurance estimator, that can help you walk through some of the nuances but basically it's $100,000 at a particular institution for a depositor. If you went to another institution you'd have another $100,000 but with that everybody, I think, goes into their banks and they see the plaque on the wall, $100,000, and they take that for granted. And while it's very unlikely that the bank will fail or be placed into receivership our guarantee of protection, if it does happen, becomes very real to people and we just want to let all the listeners know and rest assured that the staff works day and night if a bank does get placed into receivership so that you have access to your insured deposits hopefully by the very next business day.
Our goal usually is to find a local bank that can take over the insured deposits so that when the closed bank reopens as a branch of the acquiring bank there's basically no interruption in the service for the closed bank's insured depositors. If you have a loan with the closed banks you would normally continue to make those payments and oftentimes the local bank has taken over the insured deposit servicing of your loan as well.
In the case that we're unable to find a local bank to take over the insured deposits our staff works to give you your insured deposits by mail within a day or two. We pride ourselves that within 48 hours, you'll get your insured deposits back. In each case the goal is to make the process as smooth as possible so the failed bank's customers continue with their lives uninterrupted and we work hard at customer service and make every effort to provide people with the money and access to their funds, again usually within 48 hours.
Mr. Kaizer: Steve, you mentioned that financial institutions or banks don't fail often but are you able to describe a scenario where an institution did fail and what kind of assistance the FDIC actually provided?
Mr. App: Protecting the hard-earned money of Americans when a bank fails is one of the more rewarding aspects of what we do and despite the fact that there haven't been a lot of failures in the seven-year history we have never gone a year without seeing at least one bank failure. Again, in all that time no one has lost their money.
As I mentioned, in the vast majority of cases we can find a healthy bank and they can take over the assets and leave the bad ones behind for us to dispose of and that goes fairly rapidly. It's amazing when you think about how quickly you can shut down a bank and start it up again in that process. Checks continue to clear and it's business as usual for the customers.
Another thing to point out, though, is that the FDIC doesn't actually close the bank. It's the chartering authority. So it could either be the states or the OCC or the OTS would actually close the bank and then we would be named as the receiver of that bank.
An example, I think, that brings it home is a bank that failed earlier this year, Dollar Savings Bank, a small thrift in New Jersey, and here's an example of protecting the depositors. That bank also had a number of elderly customers that lived in several of the nursing centers around the bank and since no bank came forward to take over the Dollar Savings' assets we tried to get the money into the hands of the people as quickly as possible. Our closing team took it upon themselves to basically hand-deliver the checks to the elderly people in the nearby nursing homes and the other checks were mailed within a day or so. So the bank failed on a Saturday and by Monday the checks were either in the mail or being hand-delivered to these elderly citizens.
Mr. Kaizer: That sounds like a pretty amazing feat to pull off. The second program area that was mentioned was financial supervision. What financial institutions does the FDIC actually supervise?
Mr. App: As I mentioned earlier, the FDIC is the primary regulator for all state-chartered non-member banks of the Federal Reserve System and the savings banks that are not regulated by OTS. This represents about 5300 banks out of about 9200 institutions in the country. So we actually supervise about 58 percent of all the banks and financial institutions in the country. From an asset base that's about 1.7 trillion in assets or about 19 percent of all the assets. The other banks are supervised, as I think I mentioned earlier, by OCC and OTS in close cooperation with us.
The current structure of the four different federal banking regulatory agencies is a result of evolving legislative framework and also the dual banking system of state and national banks and it's unique to the financial system of the United States. A lot of people ask how did we get here. What were the major factors that led to this structure?
Clearly, deposit insurance is one of those since we insure all of those institutions. The role of the central bank, the Federal Reserve, looking at holding companies and other things that affect monetary policy and interest rates, and then the complexity of the dual banking system with states and national charters and things that overlap, and you have the holding company regulation. So each agency while we do similar type work we have our own unique roles and responsibilities depending on how the institution was chartered and how it operates.
Many have acknowledged that the current financial institution regulatory system is not a system that you would really design from scratch. Some folks say it works in all its convoluted glory but the current system has endured and the multiple agencies do provide alternative charter choices and comprise the so-called dual banking system and, again, the differences between the regulators are minor but those that exist provide some competition and differentiation and it's produced a very healthy banking climate again for the banks in the United States, some of the healthiest in the world.
Mr. Kaizer: So in supervising these banks are there some financial indicators that the FDIC looks for to determine if an institution is safe and sound?
Mr. App: All the regulators use a uniform rating system, which is called the CAMEL rating system, and CAMEL stands for Capital, Asset Quality, Management, Earnings, Liquidity, and Rate Sensitivity to Market Conditions. Those are the bible of the CAMEL's ratings, the six factors that we mentioned.
I'll just touch on a few of the items underneath those and, again, we go into banks every 12 to 18 months depending on the risk conditions. So there's an on-site presence to look at these different factors when we go in there. We also share some of the exam functions with the state examiners and do some joint exams and alternate with those.
But in terms of capital bank capital many people feel is one of the primary things that is almost a shock absorber to the system. So if you have losses or other unforeseen events, good, solid capital is what can save the bank and helps protect depositors and in many cases we don't have to go in if you have good, strong capital.
Asset quality, of course, is another thing we look at, problem assets, assets with nonaccruing and nonperforming delinquent loans, off balance sheet commitments, things like that, securities portfolios. So the quality of the assets is important. Management, somewhat intuitive but more and more now especially with Sarbanes-Oxley and some things, integrity of the management, competence of the management, and in many cases the experience of the management all go into the rating.
When you get down from asset quality you look at do those assets actually produce the earnings. So return on assets is a benchmark 's used throughout the industry and you can just pretty much rattle off the term ROA of one point-something and know how the banking industry is doing. It's been doing very well beating some of the historical benchmarks and the ability to maintain your capital ratios, which is an important factor of capital, based on your earning stream.
Liquidity, you're looking at the trend in the stability of deposits, securitization activities, and are your sources of funding stable or volatile. How quickly could you convert some of these assets to cash?
Rate sensitivity is really interest rates, maturities of both fixed and variable rate assets and liabilities, and that's a newer addition but that's the CAMEL's uniform rating system that we use and that determines the risk level of the banks.
Mr. Kaizer: The third program area of the FDIC was receivership management. Can you tell us more about this activity and what the FDIC does as a receiver?
Mr. App: Receivership management is where we take over the assets of the bank and after we in essence provide all the insured depositors with 100 percent of their money we then look to try to recover as much as we can with the rest of the assets to take care of the uninsured depositors and some of the other creditors.
Just to give you a general sense of that, on average we return over 80 cents on the dollar, which is pretty remarkable also for the banks, for the sale of the assets and liquidation. We return these proceeds as we go through the process. We have streamlined the process quite a bit. In the old days some of the receivership activity could take as long as nine years. We challenge ourselves now to wrap it up as fast as possible, on average three years or less. So it's been a remarkable achievement and I think the big thing is that since I've been at the FDIC I've been impressed with the innovations that they've used to accomplish these goals.
Fifteen years ago largely paper-based, very labor-intensive, to move these assets. We've leveraged technology. We have a proud history of innovation. A lot of that was forced by the S&L crisis.
Just to give you some examples, during the late eighties and early nineties nearly 2,950 banks and thrifts and 950 billion in assets failed. Combined we had about an inventory of over 170 billion of assets to sell. Through that process we developed innovative techniques such as asset securitization, innovative sales structures, that really became a model for how the rest of the world could handle these things, and some of those innovations are with us today.
We do a lot of things over the Internet now. We market a lot of these things over the Internet. We have buyers and other people that are waiting. When these things become available they can look at them. So while there are fewer banks than there were during the S&L crisis we think we're much more efficient at it and as we go through that we have a very competitive process now to market the assets sooner and get a better dollar return on investments.
Mr. Lawrence: That's interesting. You really cleared up a lot of the unknowns. The President's management agenda drives much of what's taking place in management of our government. How's the FDIC dealing with the issues called out in the PMA? We'll ask Steve App of the FDIC to give us his perspective when The Business of Government Hour continues.
Mr. Lawrence: Welcome back to The Business of Government Hour. I'm Paul Lawrence and this morning's conversation is with Steve App, Chief Financial Officer of the Federal Deposit Insurance Corporation and joining us in our conversation is Dennis Kaizer.
Well, Steve, in the previous segment you talked about the FDIC's three program areas. In this segment we'd like to talk about how the FDIC works towards the goals set forth in the President's management agenda. Let's start with HR. Could you describe the human resources challenges that you face as the CFO?
Mr. App: Yes, I think like most government agencies we've looked at the National Commission on Public Service, the Volcker Commission, we've heard Dave Walker, General Accounting Office, talk about some of the looming threats in the HR area, and we pretty much agree with that. Our world is getting more complex and changing with technology. We need to have more rapidly changing skill sets. It's not a static environment any more. Our work force is also aging so some of that expertise will be walking out the door in the next five to ten years. We feel that somewhere between 35 to 40 percent of our folks, some of our most experienced, may actually exit in the next 5 to 10 years. So there's the need to, I think, take a hard look at the civil service system that was really designed for a stable world and to see where some of those outdated things could be changed.
Unlike some organizations in the government we do have some flexibilities that get us a little closer to dealing with some of those dynamic needs but not completely. We have experimented and have a pretty good program for pay for performance, if you will. We've gone to pay banding for the executives and managers. We've put pay at risk so there's no automatic cost of living increase. Everything is tied to how well we perform and get results. We've got some new classifications to separate the executives from managers and we've actually cascaded that down to the rank and file.
We're also investing a lot in training. We have created a corporate university similar to GE, Crotonsville (?), and that's been launched recently and the notion is to really provide a lot of the specialized training that we're seeing a need for in the banking area.
We're also looking at what some of the other agencies have been granted recently, GAO, NASA, Department of Defense, Homeland Security, some of the flexibilities. They've gotten greater ability to hire, flexibility in hiring, restructuring your work force, taking care of poor job performance, and even acquiring temporary folks so we're considering a legislative package on that that mirrors some of the other things that folks have been granted basically to try to stay ahead of this curve so that we can get some of these flexibilities in place before a lot of our expertise walks out the door and that over time we can add folks much quicker as needed in specialty areas, be it securitization, derivatives, things like that, that they merge fairly quickly.
Mr. Kaizer: Steve, if we move to strategic planning how do you as a CFO facilitate the process of integrating the planning and budgeting processes?
Mr. App: We have a process that's almost completely integrated at this point. We've streamlined that process to about 90 days so we start in mid to late July and there's a very immediate connection with our process. So unlike appropriated agencies we begin to develop our strategic plans and corporate goals in the July-August time frame and we craft that into a budget and we take it to the board in December of that year and it's immediately effective in January.
What we do is we convene the entire senior management team, the chief operating officer, and myself, with all of the division directors and we go over the goals for the prior year and then we see how we want to modify those goals and the real theme to keep in mind here is that these plans and goals really drive our budget. There's a very direct connection between what we want to accomplish and how we budget.
We look at workload projections. That's a part of it along with the goals. And we reaffirm last year's goals or we modify those goals and then that gets funneled down into a budget. We try to stay with the concept of vital few so we don't have 100 corporate goals. We have about 15 to 20, 16, I think, for this year and then as we go through that process and we vet it with the chairman and other members of the board it culminates in a budget approval process, again in December, but there's a very immediate connection and I want to underscore that because, having come from the appropriated world, a lot of times the folks working on a budget aren't there when that budget actually gets enacted. It's a two-year hence process so I think you get the sense that the leadership of the corporation from the chairman on down really have an immediate connection where we set things as the plans drive the budget and that immediately becomes effective.
Mr. Kaizer: So as part of that process how are you linking resource allocations to your performance?
Mr. App: We don't exactly link resource allocation to performance at this point. Instead, what we do, the chief operating officer and myself, we have a very structured quarterly performance review process where we go down all of those vital few 16 goals and we look at those areas in a very affirmative way to see who is performing, who is on target, who is not on target. We make adjustments. If the target was incorrect or if some additional emphasis needs to be put on a place we do that but we don't necessarily readjust the allocations like you would have.
Another important thing to mention is that as you look at the President's management agenda of integrating performance and budget I think the other connection has to be not just that the plans drive the budget but that how you accomplish the results drives compensation. So as we go through that quarterly performance review at the end of the year we do an annual review and then that pay for performance is really how the executives are compensated. Again, all increases for executives are at risk.
So we deliberate with the chairman on what kind of year we had against these objectives and then that drives how we do it and, again, we've cascaded that to some effect down to the rank and file.
A big part of what we're trying to improve because this is a work in progress is as we upgrade our financial systems we're putting in a robust state of the art cost accounting activity system so we're going to look at maybe 50 to 60 different cost buckets that are really very meaningful to how we manage the corporation and those things in many cases can be cross-walked into some of these goals as well so you have both performance and cost information on a particular goal or activity. I think that will enhance it and may lead us down the road maybe to be able to allocate some of these resources throughout the year into different buckets.
Mr. Kaizer: Earlier you mentioned that you were the co-chair of the Capital Investment Review Committee. What are the responsibilities of that committee and how does it improve the efficiency and effectiveness of the corporation?
Mr. App: The Capital Investment Review Committee or the CIRC as we call it is just a wonderful tool and I think the rest of the government agencies are envious that we have this. There's been a lot of talk in the regular government how the lack of a capital budget creates lots of perverted outcomes, especially in the systems area, and we've crafted this in a way to try to mitigate some of those risks. So in essence what we're trying to do is make sure that every investment dollar is used intelligently.
So the process really has become a very standardized way to look at our big ticket items, the 80-20 rule, those 20 projects or 20 percent of the projects that result in about 80 percent of the IT dollars, and to superimpose a standardized process on it, standardized in terms of which projects we select, standardized in terms of how we monitor those projects over the life cycle, and standardized in terms of how we look at the business case. Did we actually achieve what we said we were going to do, which a lot of systems never get to that point, after the fact?
The way the process works is as an idea for a project comes along it goes through two filters before it gets to us. We have a very rigorous financial analysis group that looked at the return on investment, the cost factors, is it a least-cost option or a big return on investment option, and standardizes that in a certain way.
The other filter is the Enterprise Architecture Group to make sure it fits in with the whole data architecture. If it passes muster with those two groups it comes to the CIRC. I co-chair it with the CIO but all seven division directors sit on that so you can see the integration of these projects. If we approve it it goes to the board. If the board approves it it gets full life cycle funding, not annual funding, full life cycle funding.
The tradeoff is that we have to report to the board every quarter on how that project is doing, three categories: budget, project plan and milestones, and is it still achieving the business case. What's happening is we're getting a much more integrated look at this portfolio where the portfolio intersects and also I'm very proud of the fact that everybody's being very honest about sharing the lessons learned on some of these projects.
Everything hasn't been all roses. Some of the projects have had little hiccups. We've made some adjustments, we've re-baselined some things, but we're learning and doing a much better job of improving the management of these projects. So I think over time it'll actually get to the result stage where it will hit the return on investment for most of these projects.
Mr. Lawrence: A lot of our conversation has been about efficiency and effectiveness. I'm curious. Is the FDIC looking at competitive sourcing as a way to accomplish those goals?
Mr. App: Since we're independent we don't really follow the FAIR Act and so we're not looking for certain targets or goals but in general we look for best value and we're always trying to find that in our competitive areas. So in our commercial space, in the noninherently governmental, probably the biggest area we look at is in the IT functions. So we're taking an aggressive look at all of us trying to get better competition on those contracts. We also look at some specialized areas where we need maybe special legal counsel on certain areas or for asset sales, things where the marketplace does that on a regular basis more efficiently. So we're always looking at those values and we've done a lot of it. We're just not quite subject to all the other government agencies' goals on that.
Mr. Lawrence: That's interesting. As we look to the future what are the top threats to the Nation's financial systems? We'll ask Steve App, CFO of the FDIC, for his thoughts when The Business of Government Hour continues.
Mr. Lawrence: Welcome back to The Business of Government Hour. I'm Paul Lawrence and this morning's conversation is with Steve App, Chief Financial Officer of the Federal Deposit Insurance Corporation, and joining us in our conversation is Dennis Kaizer. Well, Steve, you've talked a little bit about the banking and thrift crisis in the 1980s and early 1990s. Could you tell us a little bit more about that and what provisions were put into place to avoid such a crisis in the future?
Mr. App: The rise in the number of bank failures in the eighties really had no single cause or even a short list of causes. It was a confluence of various forces, almost a perfect storm of events, economic, financial, legislative, and regulatory changes at the time that, pieced together, produced a decade worth of banking crisis.
In general first there were some broad national forces at work and I think these established the preconditions for the increased number of bank failures. Secondly you had a series of severe regional and sectoral recessions that hit banks in a number of markets that led to a majority of the failures. I think people remember the Dallas-New England-California regions. And, third, some of the banks in these markets assumed excessive risks and were insufficiently restrained by supervisory authorities and that also resulted in disproportionate numbers.
Just to give you some specifics, I think it's interesting: Between 1980 and 1994 over 1600 banks failed or received assistance from FDIC. During the same period over 1300 S&Ls failed. The failures more than bankrupted the old S&L fund, the old savings and loan fund, and those failures cost the American public directly over $125 billion and more billions in indirect costs.
Congress responded with a number of pieces of legislation and I think these pieces of legislation restored confidence, strengthened deposit insurance, and also streamlined the process for the resolution of failed institutions and the disposal of assets. To further strengthen the hand in 1991 Congress passed the Federal Deposit Insurance Corporation Improvement Act of 1991 or FDICIA, as we call it, and this did a number of things that I think will help prevent any crises in the future.
It expanded our borrowing authority from the Department of Treasury so if we needed more money than is in the fund we could go to Treasury and get that. It mandated risk-based deposit insurance assessment system. It restricted the use of brokered deposits, required on-site bank examinations, and, importantly to us, least-cost method for resolution of banks and prompt corrective action to deal with banks.
Mr. Kaizer: Steve, those are some of the threats that challenged us in the past. What do you see as the top threats that will challenge the future of the Nation's financial system?
Mr. App: Well, "threat "is a strong word. We prefer the term "risk" and certainly there are risks out there. I think one of the risk we look at naturally arises out of the ongoing consolidation of the banking industry. Consolidation means that the risk deposit insurance faces is increasingly concentrated in the large banks.
I think you've heard about the proposed mergers recently of J.P. Morgan and Bank of America. Along with Citibank those three banks alone would represent about a third of the total banking assets, about a trillion dollars each, so $3 trillion on a $9 trillion base.
When you add in the top 25 banks you're about half of the industry assets, top 100 about two-thirds of the industry assets. So unlike most of the banks that failed in the last crisis these banks are highly diversified and they're well positioned to absorb those losses; however, the challenge is to manage such large complex organizations, for them to keep the handle on it.
So our task, I think, is to be forward looking in how we assess risks, how the risks are managed and contained, and there's a lot of unforeseeable things, shocks, 9/11, wars, policy mistakes. This is why we're putting so much emphasis on our National Risk Committee and our Resolutions Policy Committee to monitor that. So that's the concentration side of it.
The other area that we're looking at is really the personal balance sheet that has us concerned a little bit. When you look at the household sector, which has been the engine for banking growth in the 2001 recession and beyond, personal bankruptcies are occurring at a near record pace and household indebtedness is rising. It's at a historical high now of 112 percent of disposable income.
Part of this is the lowest mortgage rates in a generation and it's prompted households to take out over $1.4 trillion in new mortgage debt. There has also been a democratization of credit so consumers have unprecedented access to credit these days; however, the amount of disposable income homeowners must use to keep their debts current has been rising in this low-interest rate environment. We are concerned about the long-term sustainability of the growth in the consumer spending. If there's a steep decrease in consumer spending that could be of a concern.
Lastly, commercial real estate, high concentrations there are a concern although banks have learned a lot from the crisis. They diversify the risks. They do better underwriting. They farm out some of the credits to pension and other investors, but our experience from the eighties and nineties lingers so we still always look at commercial real estate as well.
Mr. Kaizer: Other than these financial risks do you think there are any other challenges on the horizon for the FDIC?
Mr. App: Yes, we do. The overall industry is very dynamic and I think we have to always be forward looking in these risks, new products, new procedures, new risks of that nature. We're going to have to continue to look for these potholes out there on the horizon as it goes forward. We are again, because of the concentration, concerned about almost a two-tier banking system where you have so much concentration over on the one side in the top 100 banks, and then smaller banks on the other side, different capital standards, just different things like that. We're taking a look at that.
Mr. Lawrence: So what is your vision for the FDIC over, say, the next five to ten years?
Mr. App: I think, number one, we need to maintain our posture as a very risk-focused organization. Risk is what we look at all the time. We have to always be assessing where the risks are. We have to be anticipating where they are. We have to be educating banks and we put out a lot of information to banks in states and other levels about where we see these trends going. So we have to be ever vigilant on that.
As an organization we need to maintain our focus on being a low-cost provider. Chairman Powell is very focused on us having a high-performing organization. So we're trying to keep our cost as low as possible. We're pushing real-time information as a way to help us analyze that and we're also pushing performance culture. Those three ingredients are going to be the hallmark of how we conduct ourselves as we maintain this risk focus.
Mr. Lawrence: Your career has been dedicated to public service and so we're curious. What advice would you give to somebody who's interested in serving the public?
Mr. App: I would say give it serious consideration. I think when I answered the human resources question what I was saying is that government work for us is changing. I think some of the young folks out there look at the government as if I go in I have to be there forever. I think more and more we'd like to have the flexibility for people to enter the government for certain segments of their career then maybe go out.
I found that personally rewarding because you had these different points of reference. I look at the world through the lens of civic, government, and business and all three of them have to work together and I think ideally you could spend some time in all three areas.
The government's the largest corporation on the planet. There's a lot of different activities in there. I would suggest that at some point in time you try to find an area that you're really passionate about, that you really can make a difference in, and the government does give you some advantages. The size and scale and complexity of some of these things like FDIC insurance can affect millions of people all over the country and that's very rewarding.
So I would say look for an area that you're passionate about. Gravitate toward bosses that are passionate about what they want to do. Look at them as mentors who you can network with through your whole career and, as frustrating as it might be on certain days, try to just appreciate all the things you're learning from dealing with all the variables in government, Congress, different oversight groups, different constituencies.
You will learn a lot about carefully choreographing many variables to get results in the government and, again, if you straddle these different sectors of civic, government, and the private sector I think you'll have a lot more reference points to draw on no matter where you go in your career.
Mr. Lawrence: That'll have to be our last question, Steve. Dennis and I want to thank you for joining us this morning.
Mr. App: I would just like to mention again our website, www.fdic.gov. A lot of information out there, particularly our Money Smart program, which has been very well received, on financial literacy. It covers many aspects of that and we're very proud of that and so I would steer you to that website.
Mr. Lawrence: This has been The Business of Government Hour featuring a conversation with Steve App, Chief Financial Officer of the Federal Deposit Insurance Corporation. Be sure and visit us on the web at businessofgovernment.org. There you can learn more about our programs and research. You can also get a transcript of today's fascinating conversation. Again, that's businessofgovernment.org .
This is Paul Lawrence. Thank you for listening.