Banks to bail out the regulator?

posted at 10:55 am on September 22, 2009 by Ed Morrissey

If Americans have had enough of government bailouts of banks, maybe they’ll like the latest twist on the financial collapse — but they shouldn’t.  The New York Times reports that banks may have to bail out the FDIC instead of the other way around, thanks to a cash shortage in the deposit guarantor’s insurance fund.  That would certainly put the FDIC in an awkward position to enforce its own regulations:

Tired of the government bailing out banks? Get ready for this: officials may soon ask banks to bail out the government.

Senior regulators say they are seriously considering a plan to have the nation’s healthy banks lend billions of dollars to rescue the insurance fund that protects bank depositors. That would enable the fund, which is rapidly running out of money because of a wave of bank failures, to continue to rescue the sickest banks.

The plan, strongly supported by bankers and their lobbyists, would be a major reversal of fortune.

A hallmark of the financial crisis has been the decision by successive administrations over the last year to lend hundreds of billions of taxpayer dollars to large and small banks.

“It’s a nice irony,” said Karen Shaw Petrou, managing partner of Federal Financial Analytics, a consulting company. “Like so much of this crisis, this is an issue that involves the least worst options.”

That is open to debate.  The driving principle of this decision comes from a mutual antagonism between FDIC chair Shiela Bair and Treasury Secretary Tim Geithner.  The Treasury Department has already set up a $100 billion credit line for the FDIC to use if the agency finds itself in need, and Bair doesn’t need to get Geithner’s permission to access it.

However, for some reason, Bair would rather borrow the money from banks she has to regulate at the same time.  While the law allows for that, it sets up at least the appearance of a conflict of interest.  It also puts the government in the position of issuing bonds to float its own insurance agency that should run on dues and fees, bonds which will have to be paid back at some point, with interest.  It seems as though this decision will get made on the basis of personal animosity rather than rational thought, as this quote indicates:

“Sheila Bair would take bamboo shoots under her nails before going to Tim Geithner and the Treasury for help,” said Camden R. Fine, president of the Independent Community Bankers. “She’d do just about anything before going there.”

And of course, the biggest part of the story is the fact that the FDIC has to get a bailout in the first place.  Like the FHA, it appears that the front line of the two administrations over the past year has been underresourced and the problems underestimated.  Having the regulated bail out the regulators appears likely to make those problems worse in the long run.


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TKSnider on September 22, 2009 at 1:47
PM

Nice to “see you”.

singer on September 22, 2009 at 1:57 PM

It is interesting what Ms. Bair had to say about the need to bolster the FDIC (from WSJ):

The financial crisis has clobbered the FDIC’s deposit insurance fund, forcing the agency to impose a special assessment on the industry to rebuild the fund. Ninety-two banks have failed so far this year. The deposit insurance fund fell by $2.6 billion to $10.4 billion during the second quarter, after 24 banks went bust.

In a speech at Georgetown University’s McDonough School of Business, Ms. Bair strongly cautioned the Financial Accounting Standards Board, or FASB, against expanding market-to-market accounting rules to bank deposits and loans.

Currently, banks are required to write down certain securities to market values when they become impaired. FASB is proposing to extend that to other bank assets, such as loans and deposits.

Ms. Bair said the move would create more volatility for bank balance sheets, exacerbating the financial crisis, with no measurable improvement in transparency.

“Marking banking assets to market prices doesn’t make sense,” she said.

Ms. Bair argued that policy makers, after the extraordinary government interventions of the past year, need to work now to dispel assumptions that certain “too big to fail” companies will be bailed out. She said larger, riskier firms should face higher capital charges. She also repeated arguments for creating a process to wind down teetering nonbank financial firms similar to the FDIC’s system for resolving banks.

“The process is harsh. It is painful. But it works,” she said, by sending “a strong message that investors and creditors face losses when banks fail.”

She is arguing against rating and judging loans and assets against the risks that can come with them. I would argue that firms with dubious ability to back the assets put into banks serve as a nasty surprise package if the firm goes under: the ‘reliable’ money in the bank moves quickly out of the system and a bank can over extend itself if it DOESN’T put a risk on those putting assets into them. Loans and deposits should have a risk analysis done on them to help better understand the solvency and backing of each institution. While it would put some instability into the current market, it would see banking institutions tighten up on the level of risk they are willing to accept for such things.

Right until they run smack-dab against federal regulations telling them to TAKE risks for certain sectors for loans and deposits. We saw that with No Income No Job or Asset (NINJA) loans in the home mortgage arena which were pushed by regulators on institutions. Yet those are not good risks to take and should be judged as such on the books… and tie those risks right back to the regulations, the regulators and the laws that put them in place.

Which wouldn’t be too nice for the FDIC having to see exactly what sort of risks the federal government is forcing institutions to take… perhaps if we had fewer regulations telling these institutions who to lend to, and let them judge based on how risky such things were, we would have a better system. But that depends on independent experts to judge these things, not federal regulators with guidelines pre-set to tell them who is risky and who isn’t based on the political whims of Congress.

ajacksonian on September 22, 2009 at 2:00 PM

Zam88 on September 22, 2009 at 1:28 PM

Thanks for the heads up. I recommend taking his advice soon.

And by soon I mean NOW.

Chaz706 on September 22, 2009 at 2:07 PM

I am not very knowledgeable about these types of financial issues. I can only go with my “gut” reaction. That is, I would rather the money to keep the FDIC afloat come from the private sector then come from the Treasury. The Treasury is so steeped in debt right now, it almost seems laughable that they are willing to shell out more money, or setup credit lines. If the Administration gets its hooks into the smaller banks being insured by the FDIC, then say good bye to private banking.

drocity on September 22, 2009 at 2:08 PM

ajacksonian on September 22, 2009 at 2:00 PM

As someone who works in this field, I can certainly understand the argument. I am completely against MTMing the loan and deposit portfolios and here is why.

1) How do you do it? Each and every loan would need its own CPR rating to be effective and calculating that on a loan by loan basis would cost more than it is worth.

2) It makes balance sheets way too volatile, people forget that accounting is supposed to be about facts, not educated guesses. I have no issue with there being finanical notes (which already exist btw) discussing the economic indications of the portfolio, but to make that appear to be fact by booking it to the balance sheet is not good business to me.

3) What would it solve? You would simply replace facts with guesses and thus add one more level of manageral questioning to the process.

This very concept has been brought up time and time again and thankfully has been shot down, both in good financial times and bad, simply because it is a bad idea.

Also know, most people outside the banking industry don’t know (but probably should) banks do internally (and are reviewed on this) risk grades for their loan portfolio. I believe this information is even released in certain financial documents and just about everythign you want to know about a bank is released on the FFIEC website where you can get information on any bank including their portfolio repricing schedules, their past due loans, their charge offs, etc. Just have to go find it.

TKSnider on September 22, 2009 at 2:35 PM

singer on September 22, 2009 at 1:57 PM

Not really sure what you meant by that :)

TKSnider on September 22, 2009 at 2:36 PM

Not really sure what you meant by that :)

TKSnider on September 22, 2009 at 2:36 PM

BO?

singer on September 22, 2009 at 2:39 PM

Imagine a nationwide bank run in a $4 trillion economy. Imagine millions of little old ladies losing their life savings because they couldn’t get to the bank before it ran out of money and closed.
rockmom on September 22, 2009 at 11:49 AM

Didn’t that happen to one of Britain’s largest banks about a year and a half, maybe two years ago? “Rolling Rock” or whatever it was?

Blacksmith on September 22, 2009 at 2:43 PM

BO?

singer on September 22, 2009 at 2:39 PM

Still not sure what you are referencing, if you think I’m Barak Obama, then you would be very much incorrect. If you are thinking something else, then I appologize for the comment suggesting that you are suggesting that.

TKSnider on September 22, 2009 at 2:45 PM

TKSnider on September 22, 2009 at 2:45 PM

It is my mistake entirely. Thought you were another TSnyder from another site, Broker Outpost.

singer on September 22, 2009 at 3:59 PM

No worries, I used to have to joke that I flew to NYC every night to host a TV show and that make up could age me like nothing else could :)

TKSnider on September 22, 2009 at 4:06 PM

“…I blame CONgress and the regulators, the NY FED in particular (Geither), for failing the American people.” flyfisher on September 22, 2009 at 12:03 PM

Interesting, I might have ventured that the complacency, laisser-faire attitude and yes, perhaps even dereliction of duty may have actually begun, during Hank Paulson’s tenure at Goldman Sachs [1994-98].

“…In 2004, at the request of the major Wall Street investment houses—including Goldman Sachs, then headed by Paulson—the U.S. Securities and Exchange Commission agreed unanimously to release the major investment houses from the net capital rule, the requirement that their brokerages hold reserve capital that limited their leverage and risk exposure.”
“…Creating the collateralized debt obligation (CDO’s) forming the basis of the current crisis was an active part of Goldman Sach’s business during Paulson’s tenure as CEO.”
During Mr. Paulson’s later stint [2006-09] as Geither’s counterpart in the Bush administration…

“… Paulson told bankers that they would be forced to accept government bailout money, whether they wanted it or not. One of the documents, a talking points memo, gave bankers the ultimatum: “If a capital infusion is not appealing, you should be aware that your regulator will require it in any circumstance.”
All water under the bridge, right?
This is Obama’s and Geither’s baby now…!

Geezer on September 22, 2009 at 1:18 PM

I’m just now back to my pc and able to read your comments. I definitely lay blame on Hank Paulson. He lobbied hard to lift responsible capital requirements. And I blame President Bush for having him, or anyone else associated with Goldman, near his administration.

flyfisher on September 22, 2009 at 4:35 PM

Oh, I blame Bush, Clinton and Carter for this mess.

Carter for creating CRA, which was later used by ACORN to push banks (some willing, some not so) into making extremely risky loans.

Clinton for relaxing the standards under which FNMA and FHLMC loans were underwritten, thus giving ACORN all the ammo they needed to push banks on loans that noone in their right mind would of made.

Bush for not undoing it all when he had a chance, then for pushing it even further into the funding/bailing out of banks that should of been allowed to fail.

And now Obama for not only not stopping the process, but damning the torpedos and going full speed ahead in an attempt to further the crisis.

TKSnider on September 22, 2009 at 4:42 PM

TK, I can’t argue with anything you said.

flyfisher on September 22, 2009 at 4:50 PM

Gentlemen, gentlemen…

As we spread blame and retribution…
Blame is fore the philistines…

May we … my dears Sir’s have some…

“Enlightment?”

Geezer on September 24, 2009 at 5:12 PM

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