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Sheila Bair and FDIC: Inadvertent Sources Of Systemic Risks?

 

Now that President Barack Obama failed to give her a significant role in his new regulation plan, FDIC chairwoman Sheila Bair has gone on a PR campaign to gain public support for "a seat at the table in decision making on systemic risk."  She "argued that with the FDIC insuring more than $6 trillion in bank deposits, the agency had significant enough exposure to a financial crisis to justify participating in any discussions related to systemic risks."
 
I have been extremely critical of Bair because she has continued to endanger our savings by diverting FDIC resources to expand her power and jurisdiction.  All we taxpayers want is for FDIC to safeguard bank deposits.  With most eyes on Paulson, Bernanke, and Geithner, many people failed to notice the government regulator handing out our tax dollars indirectly, via whatever format possible and without any congressional approval, had been Sheila Bair.  Why should FDIC use its already meager reserve to guarantee billions of bank bonds and finance non-recourse loans for legacy assets, when its latest DIF ratio, as of March, 2009, showed it could pay out only about $0.27 for every $100 we saved?
 
 
The fact is, there has been zero transparency from FDIC.  We know nothing about the "how, when, and why" in its bank seizure process and management of receivership.  What are the rules for selecting the best bidder?  Who determines the amount of government guarantee and share loss for the sale of a failed bank? Case in point: Bloomberg reported today that "J.C. Flowers & Co.’s offer for BankUnited Financial Corp. was rejected by U.S. regulators on concern over how to account for future losses, even though it valued the ailing company’s assets higher than the winning bidder."  It is shocking such information was even reported since "all offers [were] kept sealed by the FDIC."  We may never know the reason for this rejection, but we should rest assured that "the FDIC is supposed to select the best deal for failed banks, which involves a complex and relatively opaque determination.”
 
This brings us back to the case of Wamu seizure.  If the process involved were to be so complex, why did FDIC sell Wamu in one evening?  Even more disturbing in the Wamu sale was the missing schedule 3.1a in FDIC's P&A document, where assets sold should have been listed.  How could a government agency sell a bank as big as Wamu without knowing what was being sold?  Why was Wamu being treated this way when it took even more than a month for Bair to find the best deal for a smaller but potentially valuable BKUNA?
 
Without any doubt Wamu management destroyed this hundred-year-old institution with its reckless exposure to the subprime business. However, in my opinion, FDIC's handling of Wamu seizure helped create a number of systemic risks that our administration is trying to prevent with the regulation overhaul, and ironically, Bair now fervently wants to be a part of.
 
By wiping out Wamu bondholders, FDIC helped create the first systemic risk: destruction of the bond market.  "Washington Mutual Inc. bondholders are likely to lose most of their money after the thrift was seized in the largest U.S. bank failure in history... It seems that WaMu's major debt holders have been stranded by regulatory intervention... The deal structure seems to be unprecedented in that it excludes bondholders at the holdco and bank levels from the major assets and liabilities of the operating bank." Investors were scared and it became nearly impossible for banks to raise capital via selling bonds.
 
This was why TLGP (Temporary Liquidity Guarantee Program) had to be launched.  To be sure, program was nothing but a success.  Thus far FDIC already helped Goldman Sachs, JP Morgan, Citigroup, among others, sell more than $300 billion of bank bonds and enabled some of these institutions to pay back TARP and start handing out bonuses and dividends.
 
The second systemic risk FDIC helped create was disruption of bankruptcy rules. By destroying Wamu bondholders, it simultaneously “made the claims of the counter-parties of all the swap contracts, futures contracts senior to those of the bondholders in the capital structure... This is a HUGE deal. Why were the counter-parties given precedence over the debt holders of the firm... The sad part of this is most people are not even aware of this.”
 
Wachovia topped the list as the first casualty from the combination of such ill-conceived FDIC actions.  "'The first thing that happened this morning: credit- default swaps blew out on Wachovia... Wachovia bondholders were wondering if they are next,' Sauter said. Translation: options on Wachovia bonds showed confidence in the securities had collapsed.  'Wachovia is on the ropes now because their financing costs are going through the roof. It's an absolute reaction against how FDIC sold Wamu.'"
 
Remember the AIG rescue?  At that time, maybe Hank Paulson felt he had to save AIG because in a normal bankruptcy, there might not be enough money left over to pay Goldman Sachs and the rest of the counterparties.  With Wamu, FDIC took the opportunity and set a new precedence by putting bondholders in line with all the general creditors.  Had the public been more informed and demanded a restoration of pay order in the Wamu case with a court ruling, it would be more difficult for our government to continue to hold bankruptcy laws in contempt and violate the rights of GM and Chrysler bondholders.  
 
Third and probably the most devastating effect of FDIC's actions on the Wamu seizure was the death blow to the credit market worldwide.  
 
According to analysts at the financial research division in European Central Bank (ECB), "[t]he amounts deposited with the ECB rise from a daily average of 0.09 billion euros in the week starting September 1, 2008 to a daily average of 169.41 billion in the week of September 29, 2008... The amounts deposited with the ECB start rising after the collapse of Washington Mutual when the crisis spreads outside the investment banking realm."  In other words, FDIC's action on Wamu basically exacerbated "liquidity hoarding [that led] to [an international] market breakdown;" there was no money available to lend.
 
Now, let us take a look at what was happening on this side of the Atlantic:
 
"This is a chart of the excess reserves held at the U.S. central bank. The chart, compiled by the St. Luis Fed demonstrates that banks always lend out nearly every dime they can so as to make a profit.  They do not hold excess reserves at the Fed, sitting around making them no money.
 
But, notice how the blue line is flat near zero and then it spikes up to ridiculous levels close to $300 billion in 2008.  With our reserve ratio of 10%, that’s nearly $3 trillion of lending that isn’t being done. Banks are scared out of their minds and are holding a huge amount of excess reserves…just in case — profits be damned.
 
This chart demonstrates that banks are not lending.  This chart explains why the money multiplier is contracting. This chart explains why we have a credit crisis."
 
So within a few days of each other, FDIC helped wipe out two huge banks, crash the bond market, and challenge the bankruptcy rule on the order of creditors in line for payment.  Worse, institutions started hoarding cash and not even lending to each other because they were unsure of the "rules of failure and seizure" as determined by our government agencies.  All the banks were scared.  They saw how OTS was willing to declare Wamu a failure due to a temporary liquidity problem, even though Wamu had a tier I capital ratio of 8.4% and a TCE ratio of 7.8% around the time of seizure. They also saw how FDIC was willing to protect its own survival and quickly dump a systemically important bank in a fire sale, regardless of how many shareholders, bondholders, mutual and pension funds got wiped out, and in spite of the number of job losses and foreclosures that might result.
 
However, the greatest systemic risk Sheila Bair helped create was her use of $19 billion in FDIC reserve to not only guarantee over $4 trillion of our hard-earned money in deposits, but also billions in TGLP bonds and bllions in the now delayed PPIP.  Taxpayers did not screw up the bond market, FDIC did, and Bair had no right to use the agency's reserve to back bonds for Citigroup or JP Morgan.  There is no reason why any depositor needs to fight bank bondholders for the dwindling FDIC reserve in case of further economic deterioration.  
 
Last but not least, back in mid-2008, we caught a glimpses of FDIC's lack of foresight in this financial crisis.  After the IndyMac seizure, Sheila Bair, in an interview, emphasized that "[t]here will be more bank failures, but nothing compared with previous cycles, such as savings-and-loans days."  
 
Then there was this angry response from FDIC to a Bloomberg article that suggested it might need more money:
 
"Bloomberg reporter David Evans' piece ("FDIC May Need $150 Billion Bailout as Local Bank Failures Mount," Sept. 25) does a serious disservice to your organization and your readers by painting a skewed picture of the FDIC insurance fund.  Let me be clear: The insurance fund is in a strong financial position to weather a significant upsurge in bank failures.
 
The FDIC has all the tools and resources necessary to meet our commitment to insured depositors, which we viewed as sacred.  I do not foresee- as Mr. Evan suggests- that taxpayers may have to foot the bill for a 'bailout.”
 
I rest my case.
 
*imho*