‘Time to Rebuild the House,’ Says New Chairman Mr. Isaac; Prominent Post for Critic of Bank Reform

By MATTHIAS RIEKER, THE WALL STREET JOURNAL

NEW YORK—William Isaac has been a banker, regulator and critic of the financial-services industry for 40 years, and last month he was elected chairman of Fifth Third Bancorp, where he will help its transition from crisis management to healthy growth.

Fifth Third, the 11th-largest bank in the U.S. by assets, had been fighting the fires of the financial crisis, Mr. Isaac told Dow Jones Newswires. Now, he said, “it’s time to rebuild the house.”

There have been a lot of fires in the past two years, and Mr. Isaac has been a sharp critic of the government’s efforts to put them out.

William Isaac speaks at a forum in April 2009. The former FDIC chairman has spent 40 years in banking.

It was a mistake, Mr. Isaac has said, to let the Treasury Department take charge of the rescue of banks through the Troubled Asset Relief Program rather than relying on the Federal Reserve and on the agency Mr. Isaac headed at the start of the savings-and-loan crisis, the Federal Deposit Insurance Corp.

Mr. Isaac said current efforts by Congress to fix financial regulation won’t give bank regulators the right tools. “I don’t think it’s going to be terribly onerous on the banks,” he said. Regulation won’t “end too-big-to-fail when you have five banks that control more than half the banking system.”

Mr. Isaac wants commercial banking and investment banking separated to make big banks less complex and, over time, a requirement that big banks hold more capital to end their competitive advantage over regional banks.

He also calls “insanity” the proposal of the Financial Accounting Standards Board to force banks to adjust their loan books each quarter to fair market value.

Mr. Isaac’s first stint at a bank was as chief counsel of First Kentucky National Corp., bought in 1988 by another bank. First Kentucky didn’t “make big bets on anything,” and that should be the guiding principle in banking, Mr. Isaac said.

In 1978, President Jimmy Carter appointed Mr. Isaac, then 34, to the FDIC board.

Mr. Isaac made a name for himself as a chairman of the FDIC from 1981 to 1985, when he prepared the agency for a wave of collapsing banks in the last big banking crisis.

At a time when only a handful of banks failed each year, Mr. Isaac “asked the very hard questions: ‘What happens if 25 close, if 50 close? What happens if 100 close in a year? How do we handle that?’ It changed the mind-set” about solutions for sick banks and their assets, said Mitchell L. Glassman, now the director of the FDIC’s division of resolutions and receiverships. Mr. Isaac increased staff and technology and decentralized the resolutions group to work outside Washington.

Mr. Isaac was a consultant after leaving the FDIC. He is chairman of the financial-services unit of consulting firm LECG. He is also chairman of BSE Management LLC, a private-equity group formed recently to buy failed banks.

BSE Chief Executive David Moffett recently resigned for personal reasons, said Mr. Isaac, who added that he is “not sure whether BSE is in my future.” He declined to discuss BSE’s fate further.

New Challenge

Fifth Third has been haunted by troubled real-estate construction loans and second mortgages. Chief Executive Kevin Kabat sold loans and increased reserves for troubled loans, and he simplified the bank’s business.

At Fifth Third, Mr. Isaac’s post as nonexecutive chairman—Mr. Kabat remains chief executive of the Cincinnati bank—allows him to oversee the kind of regional bank that he calls critical for the U.S. financial system.

“Banks such as Fifth Third are more important than ever,” Mr. Isaac said. “I hope we don’t have massive consolidation continuing in the industry. I think we need institutions like Fifth Third to be strong and growing and prospering in different regions in the country. I am glad we have a few banks left in Ohio.”

“Banks generally should try to get back to the basics and focus on deposits, loans, strong balance sheets. The more complex the bank, the more difficult it will be to accomplish these objectives,” he added.

While some analysts are concerned that such strict principles would lead to utility-like banks with low returns for shareholders, Mr. Isaac said banks will have to differentiate themselves through customer service. Republic Bancorp Inc. of Louisville, Ky., and U.S. Bancorp of Minneapolis are banks that stuck to plain banking and pulled through the crisis better than most, Mr. Isaac said, adding that, “if you do that, over time, you build up quite a following.”

Frank J. Barkocy, director of research at Mendon Capital Advisors Corp., which owns 75,000 shares of Fifth Third, said Mr. Isaac is “well known and respected” and the situation “suggests that Fifth Third will focus closely on disclosure and transparency with shareholders.”

In the current crisis, Mr. Isaac said, the Securities and Exchange Commission was too late to allow banks to loosen mark-to-market rules; the FDIC was too late to give temporary blanket guarantees for all deposits. Those measures would have preserved capital and given the FDIC more time and flexibility to find a solution for the sick institutions.

Now the proposed financial-services overhaul is weakening the FDIC and the Federal Reserve even more than previous curbs “in terms of their crisis-management abilities, which means if we get into another crisis, we almost certainly require more taxpayer money to get out of it,” Mr. Isaac said.

The most serious threat to regional banks is the proposal by the Financial Accounting Standards Board to force banks to adjust the value of their loan portfolio every quarter to fair market value. “If FASB is going to try to have a bank mark a loan to Ms. Smith to market, why would the bank bother making a loan to Ms. Smith? Why wouldn’t they buy a security that has a readily ascertainable market value?”

Write to Matthias Rieker at matthias.rieker@dowjones.com