by Calculated Risk on 11/08/2006 04:07:00 PM

"We're too sophisticated to get into trouble."
Bank Manager, early '80s, just before getting into trouble.

Kansas City Fed President Thomas Hoenig offered some cautionary words last week: This Time It's Different (Or Is It?).

Those of you with several years of business experience in this part of the country may recognize that many of the things we are hearing today about the economy have counterparts in the past: Asset values are appreciating, farmland values are strong ... In short, for many in this area of the country, times are good.

At the start of the 1980s, we were told ... farmland was a solid investment ... housing and stock markets would continue to climb.
...
Of course, if you were involved in business or banking 20 years ago, you will recall that several of the financial decisions made on those speculative forecasts created their own sets of problems ...

Today, I am told that while there may be some similarities with current banking conditions and those of a quarter a century ago, things are different this time. You may be hearing the same thing from investors and bankers, and, in fact you be saying to yourself: This time, it's different.

Or is it?

Hoenig's speech is copy protected, so please read his speech. This excerpt sounds familiar:

When our examiners would ask about a loan with questionable characteristics during this period [early '80s], they too often heard bankers say, "If I don't make the loan, the banker down the street will." In many cases, unfortunately, this turned out to be a race to the bottom.

Needless to say, Hoenig offers several cautionary tales about human nature, hubris and banking. He concludes:

My purpose in reviewing these stories with you today is not that I think a return to a 1980s-style crisis is imminent. Certainly, banking conditions today are good: strong earnings, good asset quality, no bank failures in more than two years. However, those who, in the early 1980s, predicted an endless rise in energy markets and real estate values were as confident in their outlook as we are today. And, certainly, the same rules and lessons continue to apply in banking and finance.

Although the world has changed during the last quarter of a century, at least one thing has not - human nature. As I mentioned earlier, greed, pride, arrogance and other human frailties are often at the root of bad banking decisions, and those qualities remain with us today. They still motivate behavior as they have in the past, and, in many cases, these frailties keep us from acting on the lessons we have learned from previous generations. In addition, no matter how sophisticated we think current analytical tools, management information systems and financial instruments are, the most critical element in banking is still individual experience and judgment. In the end, bank employees, and, I would stress to this audience, bank directors, are still making the important decisions. The quality of those decisions will always depend on human characteristics and our ability to learn from the past.

One banking scholar said, "There is really nothing new in banking and finance, each generation just thinks there is." So, are we in a different situation than 20 years ago? I would suggest that one way we can ensure a different outcome is if you, in your capacity as bank directors, are willing to be skeptical, willing to ask the difficult questions and unwilling to accept the answer "This time, it's different."