Remarks by

John D. Hawke, Jr.

Comptroller of the Currency

Before the

Bank Administration Institute Board of Directors

Washington, D.C.

September 22, 1999

I recently learned of a poll being sponsored by a leading media
conglomerate to identify the best popular song \-- not of the year, the
decade, or the century, but of the millennium. Those of you who know
about my love affair with Italy will not be surprised to learn that my
nomination is any song by Francesco Landini, the musical sensation of
14^th^ century Florence \-- although admittedly his recordings are not
easy to come by.

But the poll organizers have the right idea. Significant calendar
changes \-- and I can hardly think of a more significant one than the
Year 2000 \-- are natural watersheds: the time for sizing up the
triumphs \-- and mistakes \-- of the past. We've had plenty of both in
banking during this century, and both \-- the successes
[and]{.underline} the failures \-- have something to teach us about the
challenges we face today. What history has to offer as guidance for the
future is the subject I'd like to discuss with you this evening.

The 20^th^ century has seen three major banking crises, along with a
host of minor ones. Each had its own peculiar characteristics. The
crisis of 1907 to 1909 \-- they were then called "panics" back then \--
was the result of seasonal currency flows from the cities to the
countryside that left too little cash in vault to sustain public
confidence in the money center banks. The crisis of 1930 to 1933 stemmed
from a variety of factors: overchartering in the 1920s, lax credit
underwriting standards, and low (or nonexistent) capital requirements.
The crisis of the late 1980s and early '90s was related to, among other
things, excessive portfolio concentrations, cutthroat competition in the
financial sector, and macroeconomic instability.

Yet, while they differed in significant respects, these three crises had
some significant commonalties. In each case, bankers made business
decisions that were valid under one set of circumstances, but that
unraveled when those circumstances changed, as they inevitably did.
There was a mismatch in time horizons \-- between the bankers' planning
and vision, on the one hand, and the length of the commitments they
undertook, on the other. They weren't adequately prepared for future
contingencies. Their own optimism \-- or external pressures from
competitors or shareholders \-- overtook good business sense.

In all three crises, although the events were different, the sequence
they followed was much the same. In each case, the decisions that
determined the industry's fate were those made in the flush of
prosperity, when competition was vigorous, when even marginal borrowers
had positive cash flows, and when every deal turned a profit \-- at
least at first. Then as now, to paraphrase Thomas Paine, the good times
are the times that try the banker's character \-- times when the
pressures to ease loan underwriting standards, to cut back on internal
controls, to reduce reserves, and generally to get caught up with a fast
crowd, are hardest to resist.

And in each case, the bankers who yielded to these temptations almost
invariably came to regret it. They learned from unhappy experience what
they presumably already knew in theory: that sacrificing long-term
strategic goals for the sake of a short-term earnings boost is a
mistake. They learned that maintaining a cool head and a clear vision in
feverish times is often what separates the corporate survivors from the
victims.

Each crisis that I've mentioned has something to teach us; together,
they're even more meaningful. But we probably have the most to learn
from the most recent of these crises, if only because the circumstances
that preceded it most closely resemble those we see today. Moreover, the
participants and the principals are still with us to lend us their own
recollections and unique insights. In a recent FDIC-sponsored symposium
on the lessons of the '80s, John Medlin, the highly regarded former CEO
of Wachovia, declared that the root cause of the last wave of bank
failures was not the [kind]{.underline} of loans that bankers made \--
energy, real estate, Third World, or what have you \-- but the terms on
which they were made. In the late 1980s, he said, "the dumbest and
weakest competitors in the marketplace set the basic standard of pricing
and credit terms." It was a race to the bottom, and, in his informed
judgment, the primary responsibility for the disasters that followed
rested with those who knew better but lacked the will \-- the courage
\-- to take a stand for sanity in the financial marketplace.

That observation should have special meaning for us today. For several
years, OCC examiners have been reporting a troubling incidence of loans
with structural weaknesses. We're seeing loans based on dubious business
assumptions about the future income and cash-generating capabilities of
the borrower. We're seeing loans with equity-like features and risk
characteristics. Some of these loans are based on so-called enterprise
value, where loan amounts exceed the value of the borrower's underlying
assets. And even though many of these loans are currently performing,
we're beginning to see rising levels of missed payments, defaults and
bankruptcies among corporate borrowers.

What induces bankers to sign on to such deals is no mystery. In a sense,
some banks are the victims of their own success. Repeated years of
unprecedented earnings have raised the bar of success, and bankers feel
compelled to jump ever higher if they are to meet investor expectations.
With a limited number of good loans to be made, even in an expanding
economy, and an increasing number of lenders eager to make them, the
maintenance of market share must inevitably come at the expense of loan
quality.

I appreciate that at a time of record profits, it may be unrealistic to
expect bankers to trim back their profitability and growth targets, and
to turn their attention to the structural weaknesses of loans booked
months or years ago. Shareholders \-- especially those fixated on
short-term performance \-- may react unfavorably to the diversion of
earnings into loan loss reserves or to adding new staff to loan
administration, audit, and workout departments. In fact, such additions
run the risk of adverse reactions from the market, which can also be
personally costly for the banker whose compensation is geared to the
performance of the company's stock.

But banking is not simply a shareholder venture. It's also a business
affected with a public interest. That's why banks are subject to
government supervision. And, considering how far the industry has come
in rehabilitating both its balance sheet and its reputation since the
early 1990s, it would truly be a tragedy if it were again to fall victim
to the temptations of imprudence that accompany a highly competitive
market environment. Fortunately, it's not too late to take the steps
necessary to avoid the mistakes of the past and to ensure that the
industry begins the next decade in better shape than it began the last.

In the speech I quoted earlier, John Medlin rejected the view that
regulatory failures were a significant contributor to the banking crisis
of a decade ago. Indeed, he argued that, in the end, regulatory behavior
doesn't matter much one way or the other \-- that it ranks relatively
low on the list of factors that influence the health of the banking
system.

As you might imagine, I disagree on this point \-- perhaps the only
disagreement I have ever had with John's consistently wise observations
\-- and so do many scholars of recent banking history. In fact, academic
analyses of the banking crisis of the '80s has generally concluded that
changes in regulatory practice might have made a real difference in
limiting the scope and the cost of the bank failures that occurred.
Scholars point to a variety of obstacles that prevented regulators from
moving swiftly and efficiently to identify and resolve troubled
institutions: the inadequacy of the deposit insurance funds;
difficulties in coordination among the regulatory agencies; statutory
limits on the regulators' ability to close weakened banks; and
reductions in the numbers and experience levels of examiners, brought
about by pressures to reduce agency budgets.

A number of important steps have been taken in recent years to address
the supervisory shortcomings of a decade ago. The FDIC Improvement Act,
with its focus on prompt corrective action, should significantly reduce
the prospect that institutions will be permitted to continue to operate
in a condition of insolvency, racking up greater and greater losses
before they are closed. The bank insurance fund today is fully
capitalized and fully prepared to meet virtually any contingency. The
regulatory agencies are constantly improving their supervisory
capabilities \-- hiring examiners, enhancing the quality of
examinations, and beefing up training to help examiners understand the
evolving nature of financial risk. At the OCC, for example, we employ
nearly as many examiners today as we did in 1990, when there were almost
twice as many national banks for them to examine. And we've improved the
mechanisms for interagency consultation, so that, as near as possible,
we speak with a single voice, and are able to act in concert if and when
circumstances require it. The agencies' joint response to the Y2K
challenge, our ongoing study of capital standards, and the development
of uniform examination guidance exemplify the progress we've made in
this important area.

Yet some pieces of the puzzle are still missing. Students of the last
banking crisis have made a persuasive case that with better analytical
tools, supervisors might have been better able to predict the impact of
economic changes on banks' balance sheets and prevent deterioration in
some banks' overall condition from passing the point of no return. While
no one suggests that predictive tools can change the course of the
economy or prevent all troubled banks from failing, such tools can be of
significant assistance in mitigating the extent of loss that banks might
suffer when the economy turns against them. If they can do nothing else,
they can add credibility to the cautionary notes that our examiners are
sounding. We have experienced some real difficulties in getting bankers
and bank directors to take seriously our criticisms of structurally weak
loans when those loans are currently performing well. Yet we know that
when the economy turns, these loans will experience deeper losses than
they might otherwise have.

That's why earlier this year the OCC launched Project Canary \-- an
initiative designed to use the predictive tools we have on hand more
effectively and to develop new, cutting-edge early warning systems that
will enable us to spot emerging trends in industry risk and project
future events with a higher degree of accuracy than is possible today.
The allusion is to the canary in the mineshaft that gives its life to
warn miners of deadly gasses that would otherwise go undetected. The
objective is to alert us to specific environmental changes that signal
future trouble for national banks and the national banking system, so
that we can respond in a carefully modulated way.

I emphasize "modulated" because it's important that examiners have
choices between the extremes of velvet glove forbearance, on the one
hand, and drastic enforcement actions, on the other. Incremental changes
in condition need to be accompanied by incremental supervisory
responses. Even as the work goes forward on Project Canary, I've asked
OCC staff to focus on refining and elaborating the range of supervisory
responses that we have available to apply to the diverse conditions that
exist in the national banking system. Our goal is a well-calibrated
range of supervisory options proportionate to the degree of change in a
given bank's condition.

I've often joked over the past nine months that my predecessor did me no
favors by leaving the national banking system in the best condition in
its history. Nobody's likely to remember my tenure if things stay pretty
much the same \-- even though in this climate, it will be challenge
enough merely to preserve the status quo. But if the economy should
falter, and we begin to experience serious losses in the system, I'm
likely to be viewed as the relief pitcher that put the winning run on
base. That's something I'm determined to avoid. Succeeding in that
regard will require not only the development of better supervisory tools
and better modulated responses to change, but a recognition by bankers
that the long term health of the system may require some belt tightening
during good times. The philosopher George Santayana said that "those who
cannot remember the past are condemned to repeat it." I hope that's a
mistake we can avoid.