Editor: Mike, tell us about your focus on the needs of community banks.
Horn: I continue to this day to have an intense interest in community banks. My father was a merchant. I used to go with him when he did his banking at a local community bank. He would make his night deposit after the bank was closed and then go in on Saturday morning, go to his favorite teller, and together they would count what was in the bag. When I was a little older, I worked in my dad's store and deposited my wages in a local savings and loan. When I was in the New Jersey legislature for one term, I served on the Banking Committee. I also chair the Federal Home Loan Bank of New York.
My law practice has been focused on banking and bank regulatory matters. Included among my banking clients are many community banks. As we will discuss, Dodd-Frank puts tremendous burdens on community banks. Yet, the meltdown was not caused by community banks. So, community banks are paying the price for the sins of investment, mega and mortgage banks. A very small percentage of subprime mortgages were originated by community banks.
The expense and other consequences of the regulatory burdens and litigation exposures imposed on community banks by Dodd-Frank will ultimately be borne by the small businesses they serve - the very group that has in the past been looked to to create 65 percent of new jobs.
Editor: Before exploring the negatives, you might describe some of the positive features of Dodd-Frank.
Horn: Dodd-Frank is a mixed bag for community banks; there are some good things, which unfortunately are far outweighed by the negatives. One positive is that it puts community banks on a more equal footing with mortgage banks. During the heyday before the crash, consultants would tell community banks that the mortgage banks were eating their lunch because they had all kinds of advantages. They didn't have to care whether the buyer could repay the mortgage, they had lower expenses, lower overhead and no community reinvestment obligations. In addition, a lot of the consumer protection laws that applied to community banks did not apply to mortgage banks.
The consumer protection provisions of Dodd-Frank also apply to mortgage banks. That puts mortgage banks on an almost even playing field with community banks. They still don't have community reinvestment obligations, but the fact that they now have to play by many of the same rules is very positive.
The permanent increase of deposit insurance to $250,000 is a very definite benefit for smaller banks that were at a big disadvantage because they were up against, and still are to some extent, banks that are too big to fail. It is good because it decreases the perceived difference in protection of deposits between community banks and mega banks. Another benefit is that banks with assets of less than $10 billion are exempt from the increased minimum reserve ratio for the Deposit Insurance Fund from 1.15 percent to 1.35 percent.
There are a lot of states' rights provisions in Dodd-Frank, including its treatment of preemption. Although some may disagree with me, I think that reducing federal preemption is a good thing. I am a states' rights advocate when it comes to preserving the benefits of our dual banking system. Dodd-Frank provides more balance between state-chartered community banks and federally chartered community banks.
Over the past 20 years a large number of state-chartered community banks have converted to federally chartered thrifts or banks. By giving more authority to the states, we will see some federally chartered banks and thrifts converting back to state charters.
State-chartered community banks have had to comply with applicable state law. Under preemption provisions in effect prior to Dodd-Frank, federally chartered banks did not have to comply with state laws applicable to banks, although they did have to comply with state laws relating to property, foreclosure, crime and some others. Their argument was that if we are in 50 states, we don't want to have to track changes in those laws in order to modify our forms. This is one of the reasons that a lot of state-chartered community banks converted to federal charters. It was easier and there were a lot of state laws that they didn't have to comply with.
That is all changed now with the new preemption provisions in Dodd-Frank, which overturn the Watters case that held that a state-chartered subsidiary of a federally chartered bank was not subject to state law.
Prior to the effective date of Dodd-Frank, if a national bank went to the state of Wisconsin and formed a Wisconsin business corporation to do mortgage banking, that Wisconsin chartered mortgage banking company did not have to comply with Wisconsin law as long as it complied with federal law. This approach was reflected in the Watters case. The five liberals on the court were in the majority, and the four conservatives voted in the minority. I have said on a number of occasions that I think that if that case had been decided after the crash, it would have gone the other way.
As a result of Dodd-Frank, the advantage that large national banks have over community banks has decreased due to the fact that these banks are going to have to comply with state laws except in cases of direct conflict.
Editor: Does Dodd-Frank increase compliance costs for community banks?
Horn: Community banks will be burdened by the huge cost of monitoring the myriad of regulations that may be applicable to community banks under the provisions of Dodd-Frank and, where applicable, taking steps to assure compliance. The establishment of the Bureau of Consumer Financial Protection (BCFP)will in itself result in vastly increased monitoring and compliance costs that we can't even estimate until regulations become effective. Although some special consideration must be given to banks under $10 billion, they will still have an obligation to comply with a flood of new consumer regulations.
Under Dodd-Frank, the BCFP was given a status pretty much unlike every other regulatory body in the government. It's funded by Federal Reserve's general revenues, which means Congress itself took away its own power to rein it in by virtue of annual appropriations.
The general consensus is that it is going to be harder and harder for smaller community banks to survive with those compliance costs in the offing. I expect that we will see combinations of community banks so that they can better handle the costs of compliance.
Editor: Can increased litigation costs also be anticipated?
Horn: Dodd-Frank vests state attorneys general with the authority to sue to enforce regulations of the BCFP. This will inevitably lead them to retain plaintiff's counsel to bring actions on a contingency basis against financial institutions, including community banks. Since the initials "AG" are often thought of as meaning "aspiring governors," they (whether Democrats or Republicans) look for ways to bring a lot of litigation to get their names in the paper.
The BCFP has the authority to prohibit practices that it finds to be unfair, deceptive or abusive. The terms "unfair" and "deceptive" have been in use for a long time and there is much case law with respect to their meaning. This is not true of "abusive." Its use in Dodd-Frank is a huge boon to trial lawyers because there its meaning is unclear. Some have likened it to the Supreme Court's definition of "pornography," namely that you can't define it, but you know it when you see it. Using a fuzzy term like "abusive" in a compliance context opens up a huge door for litigation against financial institutions of all sizes. This is an issue that I hope the new Congress will consider.
Editor: What role can state and federal trade associations play?
Horn: Most community banks belong to both state and federal trade associations. They both play a vital role in commenting on proposed regulations as they are promulgated and seeking changes needed by their members. They also alert members to new regulations and to steps that must be taken to comply. With a new Congress and a President who has sought compromise in the face of opposition from his party, there is even the possibility that trade associations can effectively lobby for changes in the Dodd-Frank Act itself.
Editor: Is your firm geared up to handle the needs of community banks?
Horn: Yes. We have a significant number of partners and associates who are advising clients on Dodd-Frank and its implications. We regularly alert our bank clients, both large and small, to new developments. My focus and that of those who work with me at the firm is to serve the needs of community banks.
Published January 3, 2011.
