Let's Snooker The TARP Babies

Snook, Texas, a town of less than 600 souls, is best known for being the home of Sodalak's Country Inn, the originator of country fried bacon. It may seem an odd place to launch a return to financial health, but that's exactly what Dean Bass has in mind.

Bass, a veteran banking entrepreneur from Houston, in November bought the tiny First Bank of Snook as part of his plan to build a new financial powerhouse amid the worst economic downturn in a generation. The old bank, which also had a branch 15 miles away in College Station, home to Texas A&M, provided Bass with his charter, as well as access to a strong market on the far periphery of his home town.

Since buying into Snook's bank, now renamed the Spirit of Texas Bank, Bass opened a new branch in the Woodlands, northwest of Houston. Over the past six months, the new bank's assets have doubled to over $70 million, and by the end of the year he expects to break $100 million. Longer-term plans include expanding as well into Austin, Fort Worth and other major Texas markets.

Bass' basic strategy: Take advantage of the stumbling TARP-funded banking giants and steal what he calls their "disenfranchised customers." This approach has implications well beyond the Lone Star State. Like other successful community bankers across the country, Bass believes that the mega-banks have been hopelessly tarred by TARP taxpayer funds. They have been revealed to be, if too big to fail, also too incompetent and poorly run to trust.

"This is one of the worst banking markets I have ever seen--but the best for people like me," said Bass, who sold his last venture, Houston-based Royal Oaks Bank, for $38.6 million in 2007. "When else would you see A+ customers fleeing places like Bank of America, Chase and Citi? People can't even understand their balance sheets and stress tests. Their customers are ready to move on."

Over the next few years, the emergence of banks like Spirit of Texas could prove the silver lining in the largely bungled Bush-Obama bail out of the big financial companies. Ironically, the attempt to shore up the mega-dinosaurs has revealed these mega-banks to be creatures of little brain and even less principle. They now seem more akin, as economist Simon Johnson has pointed out, to Third World crony capitalists than paragons of free enterprise.

In comparison, independent, non-TARP banks like the Spirit of Texas appear like paragons of traditional capitalist virtue and homespun values. For the time being, their rise will be most notable in "the zone of sanity," the vast range of territory between south Texas to the Great Plains, which largely resisted the housing and stock asset bubbles of the past decade.

In this region, most homes are well above water and many businesses--in everything from agriculture and energy to manufacturing and high-end business services--remain on solid footing. Of course, notes Randy Newman, president and CEO of Grand Forks, N.D.-based Alerus Financial, many local companies have been slowed by the recession. However, for the most part, places like the Dakotas and Texas enjoy relatively low unemployment and foreclosure rates, making them relatively good places for cultivating new customers.

Politics and a sense of propriety also may play a role for resurging community banks. In places like the Great Plains, people prefer old-fashioned shots of banking fundamentals to the exotic financial cocktails concocted by the "genius" financiers on the coast. Politicization of banking is even less popular than elsewhere.

"For the government to come out and stimulate the economy seems OK, but you think, jeepers, this TARP business makes little sense," says Newman, whose bank enjoys assets of roughly $750 million. "TARP," he adds, "is simply prolonging or delaying what has to happen. The walking dead will have to die sometime."

Uncertainty about the big banks, Newman believes, is leading customers, particularly smaller firms, to rediscover the merits of old-fashioned relationship banking. At banks like his, each loan is scrutinized not only by formula but also by things such as character, markets and a firm's record of accomplishment.

"The big banks will tweak their standards system-wide. There are no individuals in their book," says Newman." The big banks are geared to mass markets and big customers. But if you are looking at the $1 to $5 million loan a small business wants, the big bank does not look at you as an individual."

This up close and personal approach may seem laughably archaic to the once-celebrated "genius" quant jocks and bonus baby M.B.A.s on Wall Street--and perhaps also the brainy financial types running the Obama economic team. Yet if a sustainable private sector economic recovery is to take hold, the key may well lie with smaller bankers who can help small firms survive the recession

Of course, the administration's favoritism of the big boys also creates some real problems to community banks. Some fear the mega-banks will use TARP funds to acquire better-run, local institutions. Newman calls this prospect a "travesty." Given their awful real balance sheets, Newman believes, banks like Citicorp and Bank of America "really shouldn't be in a position to grow, much less expand."

So here's a better course. Let these giants shrink or even fail. Let their insured depositors seek out new banking relations; with the stronger, well-run community banks. It's widely believed that some 500 to 1,000 smaller banks may fail in the next year or so, so why not some big boys, too?

Many economists, both right and left, including Nobel Prize winner Joseph Stiglitz, have urged this course. It would pave the way for well-run banks to expand at the expense of the incompetent and venal. Competition, after all, is supposed to be the basis of capitalism.

Right now, the zone of sanity probably offers the best chance for this capitalist revolution. However, the shift to smaller banks may prove even more important in reviving the epicenters of lunacy, such as my adopted home state of California. Here, little banks like the privately held Montecito Bank and Trust are quietly expanding as customers leave the TARP babies for an institution a little more personal and grounded in sound banking principles. "Better boring than broke," jokes Janet Garufis, Montecito's president and CEO.

It also helps to be local, she notes, even in a mega-state like California. Much of the damage to the TARP banks came when they bought into sliced and diced mortgages in locations they didn't know. It turns out that local knowledge counts--not only in real estate, but in deciding about the right business to back.

"The differences between a big-box bank and community are the difference of night and day," suggests Garufis, who spent 35 years with Security Pacific, a onetime L.A. area powerhouse. "People like to see the whites of the eyes of the people they are doing business with. We know the community. We are part of it, and we understand what is going on here."

Of course, being local, smart and disciplined may not be enough for all these upstart banks. The failures of the mega-banks have increased the costs of things like FDIC insurance for even well-run institutions--in Montecito's case, from $400,000 to $1.2 million over the past year. Equally challenging, TARP funds are helping the big boys offer slightly higher rates for mass-market products like CDs.

Rather than focus on saving their Wall Street friends, the administration needs to allow an upsurge in smarter, smaller and better-run banks. Let us give these grassroots capitalists a chance and see what they can do.

The road to a financial and economic recovery does not run through Wall Street and K Street, which, after all, are the primary originators of our distress. It lies in places that look more like Snook--even if country fried bacon is not to your taste.

This article originally appeared at Forbes.

Joel Kotkin is executive editor of NewGeography.com and is a presidential fellow in urban futures at Chapman University. He is author of The City: A Global History and is finishing a book on the American future.