BancorpSouth CEO and Mississippi native Aubrey Patterson received his undergraduate degree from the University of Mississippi and his masters degree from Michigan State University. His education in accounting along with military service in the U.S. Air Force led to a career with Mississippi’s largest community-based bank. He became president of BancorpSouth at the age of 40; seven years later he took over as CEO. During his tenure, he served as chairman of the American Bankers’ Association, chairman of the Mississippi Economic Council, where he chaired the landmark Blueprint Mississippi Initiative on Job Creation and Public Education. During the last year, Patterson offered his expertise as a member of the Financial Services Round Table, comprised of the country’s 100 largest financial institutions. Input from that board served as formative advice in the crafting of President Barack Obama’s recently passed economic stimulus package. He has served in leadership roles for numerous, community, civic, economic development, faith-based and educational endeavors.
EDITOR’S NOTE: This is the first in a two-part interview. In this edition, BancorpSouth CEO Aubrey Patterson gives the Mississippi Business Journal his perspective regarding what happened when the housing bubble burst and the market collapsed.
Interview by Liz Blankenship
Q: How did we get into this mess in the first place?
A: That’s pretty complicated but here’s my stab at it. The top 20 financial institutions in the country control 80 percent of the assets in the U.S. Essentially, there’s a national oligopoly. That’s quite unlike what most of us experience as consumers or smaller ‘Main Street’ banks.
Q: What does that have to do with the financial crisis we are experiencing?
A: Essentially, bigger lenders lost the ability to determine who was a good risk and who wasn’t. Here’s how it happened:
Main Street banks and Wall Street banks are totally different animals. We, (Main Street) lend within our own communities, we maintain the loans made on our own books as opposed to Wall Street. During the last eight years of the housing boom, they (Wall Street) securitized more and more loans from cars, to houses, to credit cards. By securitized, I mean a batch of loans would be lumped together, put in a “debt bundle,” which is represented in varying maturities. For example, credit cards and car loans represent a shorter life span, then that credit was sliced and diced into a sort of portfolio called “tranches.” Those varying securities were sold off to investors looking for a particular “time span” or span of maturity or a particular type of credit risk. Then the money center banks gathered these loans, packaged them in securities and sold them into the secondary markets of major institutional investors.
In the process of doing that, those loans would tend to lose their identity. It’s like trying to unscramble an egg, if you try to put the pieces back together that comprise a security. As long as people were paying, everything worked fine. Things melted down when it was hard to find exactly who owned the securities.
Q: So how did the housing market situation play into this?
A: Fannie Mae and Freddie Mac had an enormous amount of government guaranteed loans. They were securitized, packaged and sold in bundles onto the investor market. They went from $1 trillion worth to $6 trillion toward the end of the housing bubble. That’s an enormous explosion of government-guaranteed debt, and as long as the collateral value was there, payments worked. With the easy availability of housing credit and the perpetuation of record low interest rates by Greenspan and the Fed, people could buy more and more house and not in a way which was necessarily good.
The goal behind the policy? Provide every American with a home, affordable homes for moderate to low-income Americans. So, we ended up with “step-up” mortgages, so called ARMS or adjustable rate mortgages with teaser rates for the first three to five years, then a re-set at higher levels with higher payments. People could afford the initial payment but when the re-set kicked in, they couldn’t afford their mortgages.
The mind-set was, “Well, housing values are going up 10 percent or more a year, so if I can’t afford it, I’ll just sell the house, make a profit and move o’”.
Then the bubble burst. The economy contracted, systems deleveraged, the worth of homes plummeted and default rates soared.
This caused the value of the investment banks portfolios to fall, there were more demands for repayment at the institutional level, securities shrank in value and markets became frozen. To complicate matters institutional investors weren’t alone. Big banks with these mortgages on their books had implied guarantees to the investors that they would stand behind these securities. With deleveraging, everything went back on the banks. Mark to market accounting required these securities be revalued at current market values, not historical cost. That loss in value had to be written down on the books of the institutions that owned them, which wiped out a big chunk of their equity, if not all as in the case of the companies which failed.
Q: This is when the investment banks became insolvent and the stock market plummeted?
A: : Yes. The investment banks that hit the rocks had leverages in the neighborhood of 30 or 40 to 1. In other words, for every dollar of assets they held on their books, they might have a capital account of 3 or 2 or 2 _ percent, which would be 40 to 1. If their assets shrank in value 30 to 40 percent and they only had 2 _ percent backed by their capital, then they were immediately insolvent. Those securities had to be revalued at market at a time when everything froze.
My mission in representing the ABA with the Securities Exchange Commission was to try and make the case that banks like ours (the Main Street banks), book their assets and have a leverage of about 10 to 1 instead of 40. We have the intent and ability to hold assets until maturity and should not be required to “mark to market,” particularly at a time when the market itself has become illiquid, there’s no willing buyers or sellers, so there’s no viable market. We’re still making our case.
The SEC through the Financial Accounting Standards Board has required everyone to continue “marking to market.” When there’s no market, values collapse and that’s what happened to previously strong companies like Merrill Lynch who went from dominant firms to not even surviving.
Q: So, we’re in the worst economic times since the Great Depression. Do you think we’re heading for another depression?
A: No. It’s bad, but we have one thing leaders during Roosevelt’s time didn’t have. We have history on our side and we have learned from the Depression. The Fed is doing the right things. They’ve lowered interest rates and they’re expanding the money supply. Now, we have to see what impact the stimulus package will have on consumer confidence.
Next week, Aubrey Patterson continues this interview with his perspective on the stimulus package and what Mississippi businesses and consumers can expect in the months to come.