Is FDIC's Sheila Bair Starting to Get It?

by: Karl Denninger

Bair starting to 'get it'? One wonders....

Oct. 29 (Bloomberg) -- Federal Deposit Insurance Corp. Chairman Sheila Bair, breaking with the Obama administration, said U.S. financial companies should prepay into a fund the government would use to unwind large failed firms.

Congress should set up a Financial Company Resolution Fund and force institutions with more than $10 billion of assets to pay before a firm collapses, Bair said in testimony prepared for a House Financial Services Committee hearing today. Investors in failed companies also should take losses, she said.

Getting a little religion here, Sheila?

Let's review, however, history. Recent history.

Preservation of the legal strictures of capital structure is very important in order for investors to have a reasonable expectation of consequence in the event of a failure - and thus be able to price risk.

But this foundational principle - the sanctity of contract and capital structure - has been roundly abused and flatly ignored by the government since this crisis began.

Chrysler, GM, a plethora of banks including Lehman, Bear and others - in exactly none of these circumstances has the capital structure remained unmolested. The abuses in GM and Chrysler's cases, in particular, were ridiculously egregious that one simply can't make the argument that there is in fact a distinction between "Senior" or "Secured" and unsecured bondholders any more.

Never mind events such as Indymac Bank's failure - the bank holding company and bank itself were effectively asset-stripped by government fiat, leaving the supposedly-super-senior claims - those of depositors who had more than the insured limit on deposit with the bank - with absolutely nothing against which to recover.

The draft legislation creates a council of regulators, including the FDIC, to monitor companies and the economy for systemic risk. While Bair supports the concept, she said the proposed council “currently lacks sufficient authority to effectively address systemic risks.”

Congress should require a presidential appointee as the council’s leader to ensure its independence and set an odd number of members to avoid deadlocks, Bair said.

I agree. That appointee needs to be a publicly-vetted and appointed person with Senate confirmation. Since this is inherently a function of protecting the public purse, it must NOT fall to an unaccountable person such as Bernanke, who has shown repeatedly that he has not and will not enforce the regulatory strictures even when so demanded by black-letter law, and that Congress will not place him - or you - in the dock when you willfully and intentionally ignore the law.

Bair and lawmakers have said a lack of a mechanism for shutting large firms in an orderly way led to ad hoc programs, such as the $700 billion taxpayer bailout used by lenders including Citigroup Inc. and Bank of America Corp.

There is such a system - you just don't like it and therefore have willfully and wantonly ignored it. It is called bankruptcy and in fact the regulation of same is one of the enumerated powers in The Constitution delegated to the Legislature (Art 1 Section 8)-

To establish a uniform rule of naturalization, and uniform laws on the subject of bankruptcies throughout the United States;

How can appointed Federal Officials manage to be installed in their offices without reading the Constitution, say much less understanding it?

This is a good start, Sheila - now let's see you enforce "Prompt Corrective Action" and close each and every bank that has a negative ratio of assets to liabilities on a market-price basis, so that the disasters we've seen over the last two years with 20, 30, 40% or more losses to the Deposit Insurance Fund stop happening.

Oh wait - that would mean you'd have to close some of those "really big banks" here and now, wouldn't it? It would also mean you'd have to take out that pile of trash called "GMAC", which after huge infusions of taxpayer capital is still trying to grab more to remain alive, while running national advertisements under their name "Ally Bank" for above-market rate CDs!

Hmmmmm...