FDIC Regulation: Reason for Alarm

Includes: BAC, C, JPM, KBE, WFC, XLF
by: Troy Racki

If you think our financial regulators need more authority, then you may want to reconsider. Over the past eight months, pieces of a concerning puzzle have begun to come together.

One of these pieces surfaced in October when the FDIC seized Wachovia Bank and tried selling the company to Citibank (NYSE:C) for pennies on the dollar.

Many considered it a steal of a deal. It turns out Wells Fargo (NYSE:WFC) was thinking the same thing and days later offered seven times more than Citibank, and more specifically, without taxpayer concessions.

SmartMoney magazine wrote a piece on the matter stating:

Then Wells came on the scene. It offered to buy Wachovia for $7 a share and told the FDIC that it didn't need any investment or any guarantees. Believe it or not, Citi had the gall to sue to block Wells' offer even though in every dimension it was superior for Wachovia stakeholders and for the American taxpayer.

You have to wonder what the FDIC was thinking in the first place. Citi had to take two huge capital injections from the U.S. Treasury under the TARP program in order to survive, and it had to have the Federal Reserve guarantee $300 billion of its toxic assets. So what was the point in having a bank that screwed up take over Wachovia?

Then in December at Bank of America (NYSE:BAC), CEO Ken Lewis was considering dropping out of the Merrill Lynch merger after billions more in losses had been taken by the investment brokerage since the deal’s original announcement.

But when Mr. Lewis considered pulling out Ben Bernanke and then-Treasury Secretary Henry Paulson pressured him to hold his tongue and follow through, as reported by CNN.

Because of this Bank of America had to swallow those losses, meaning you the taxpayer, through TARP, are the ones left holding the bag.

Meanwhile a perfectly sound private bank worth $250 billion was told by the FDIC and the Treasury that it had to accept TARP money or face the humiliation of having its books dragged across the public stage, as told on air by Fox News.

While its books wouldn't have lost a page, just the act of being in the public eye would have set its business aflame as potential clients would have bailed from a supposed sinking ship.

The on air judge stated that the action taken by the government was extortion. Besides the government not only earning a tidy 5% return on their money, now the government's 2% stake means it can tell the bank how to run its business. Should not a well operated business have the right to run itself without government intervention?

Well FDIC chairwoman Sheila Bair doesn't agree. She wants more power. As reported by the New York Times, besides overseeing the banks themselves, Bair now wants the authority to take over troubled insurers, bank holding companies and other financial institutions deemed by the FDIC as insolvent.

As both taxpayers and private investors we should be concerned. Giving the FDIC the power to declare more businesses insolvent, such as Wachovia, and then pass them along to whomever they please, such as Citibank, is a frightening proposition. As seen by the inability of the FDIC to gauge true market value, one could predict that the FDIC could pass unjustified billions from one entity to another, whether accidentally or not, all while granting guarantees compliments of the taxpayer.

If Chairwoman Bair does receive this vast power, investors are likely going to withdraw from related financial institutions because of the fear for possible abuse. This would result in a very significant and widespread pullback in the market. For example, General Electric would apply to Bair's reach through its GE Financial arm. In fact, the government has thousands of publicly traded businesses classified as being "financials". When a temporary ban on the short selling of financially listed companies was issued in September 2008, the depth of this list became quite clear. Some of those companies on the list included the more obvious names like American Express in addition to more than a few surprises, such as Sears.

Should the FDIC be given more authority when there are significant concerns regarding its track record? Does the Treasury have the public’s best interest in mind? Is either the FDIC or the Treasury trying to protect the investor? Relaxing our sense of caution and ceding more freedom, whether in good times or bad, is a recipe for disaster. Giving our regulators more authority, when they have proven there should be significant concerns on their judgment, is just cause for alarm.

Disclosure: Long WFC.