Has Sheila Bair Finally Learned Her Lesson?

Includes: KBE, XLF
by: Keith McCullough

Poor Sheila Bair. She is getting kudos from the public – including a smart piece praising her in the current New Yorker magazine (28 June, “The Contrarian: Sheila Bair and the White House Financial Debate”). Bair was just honored with the Profile in Courage Award from Boston’s Kennedy Library Foundation – awarded annually to public officials that the Foundation deems to have “exhibited political bravery.”

Bair, the article reports,

was recognized for her early, though ultimately futile, attempt to get the Bush Administration to address the subprime-mortgage crisis before it became a threat to the entire economy.

Bair is on the move. She has started laying down the law to newcomers, letting them know in no uncertain terms whose territory they are now on (WSJ, 3-5 July, “FDIC Proposes New Bank Rules”). Bair is proposing new standards for firms that want to buy into the banking business, including greatly increased capital reserve requirements, and what many are calling an unreasonable proposal that buyers from outside the banking industry not be given a green light to buy banks merely to flip them.

Bair is struggling to maintain her balance atop a stack of shifting tectonic plates. As private equity discovers banking, Chairman Bair is trying to create rules that will protect the remnants of the banking system from the worst of the private equity abuses. Who would have thought that a US regulator would attempt to inject a note of caution into the business of banking?

As the New Yorker article points out, Bair is hardly your typical Washington insider, and is that much more of an outsider in the current administration. The political process that continues to unfold is highlighted by recent stories about the promotion of William Dudley to the position of president of the New York Fed, the post vacated by Timothy Geithner when he became Secretary of the Treasury.

As reported in the Wall Street Journal (2 July, “Fissures Appear At The New York Fed”), a number of New York Fed directors were not pleased with Geithner’s obvious efforts to push Mr. Dudley into the role. Dudley, it should be noted, is a former Goldman Sachs (NYSE:GS) economist. He stepped into his new role shortly before the eruption of publicity surrounding New York Fed board chairman Stephen Friedman, who had not disclosed his trading in the stock of his former employer – Goldman Sachs – despite requirements that he do so. “Some are calling for more oversight of both the reserve banks and the central bank,” reports the WSJ article. We wonder who shall do this overseeing.

It is clear that Tim Geithner has been given the go-ahead to create a new financial system. Nor do we perceive the influence of Goldman on the wane in the Business As Usual initiatives of the current administration. (Business As “Use You All”?).

In short, FDIC Chairman Bair is facing extremely long odds. She is being set up by the old boys’ network. The Journal article quotes billionaire investor Wilbur Ross as saying Bair’s proposed new requirements are “harsh and discretionary.” Ross, part of the consortium that acquired Florida’s failed BankUnited, now says “I think it could guarantee that there will be no more private equity coming into banks.”

First, given the current model and primary players in the private equity business, we fail to see that as an unmitigated disaster. Add to that the reality that the government is handing out incentives to buyers who neither come from, nor care to understand the banking business, merely to get someone to take the liability off their hands. Finally, the incentives come with a powerful precedent and an implicit guarantee that, if the bank fails again, there will be a bailout.

Which lands these future disasters right in the lap of the FDIC. We note that the Journal article is flanked by a column headed “Tally Hits 52 As Regulators Close 7 Banks.”

In the world of things that ain’t over till they’re over, this ain’t anywhere near over. Chairman Bair is collecting bids to acquire failed banks, and she has already seen a few that didn’t pass the smell test. We are rooting for her to stick to her guns – we just wish the President would give her a much bigger arsenal. We fear Chairman Bair will be beaten from all sides by the fairy tale that she is single-handedly impeding the recovery. That, if not for this meddlesome regulator, the billions sitting idle in private equity coffers would come charging in off the sidelines and win the day.

The fact is that private equity is not the gem of the investment world it once was. There is idle cash lying around because deals are going too cheaply, or because investors are clamoring for the managers to stop screwing up with their money – all while demanding greatly reduced fees. Is it any wonder the private equity guys are looking for new fields to furrow?

The final paragraph of the Journal story tells us “Ms. Bair said she remained open to make changes on most parts of the proposal.” We would hate to think that, now that the crush is coming, Sheila Bair is preparing to bend in the political wind.