Rather than wait for borrowers to repay loans, banks were adopting a technique called securitization. The banks created pools of loans and sold investors the right to collect portions of the inflowing payments. The bank got its money upfront. Equally important, under accounting rules it was allowed to report that the loans had been sold, and therefore it did not need to hold any additional capital. But in many cases, the bank still pledged to cover losses if borrowers defaulted.
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In November 2001, the Fed and its fellow regulators ruled that securitization made banks safer. In general, banks must hold $10 in capital for every $100 in loans and other assets, but banks can hold less on safer assets such as U.S. government bonds. The safe list was now expanded. The Fed and its fellow federal regulators ruled that banks could hold as little as $5 on every $100 investment in loan pools.
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The hands-off approach also was a matter of philosophy. Rather than scrutinize banks directly, the Fed decided to push them to appoint internal risk managers who imposed their own checks and balances. Regulators focused on watching the watchmen. Bernanke's predecessor, Alan Greenspan, said that banking was becoming too complicated for regulators to keep up. As he put it bluntly in 1994, self-regulation was increasingly necessary "largely because government regulators cannot do that job."
Greenspan revisited the theme in a 2000 speech, saying, "The speed of transactions and the growing complexities of these instruments have required federal and state examiners to focus supervision more on risk-management procedures than on actual portfolios."
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The Fed's power to reject the merger application was a potentially important check on the wave of mergers that created banks so large that their distress would threaten the economy. But from 1999 through last month, the Fed approved 5,670 applications to create or buy a bank and in that time denied only one. Fed officials note that 549 banks withdrew applications, in some cases under pressure from regulators.
