Review: Bairing the strain of failed regulation

October 12, 2012

By Antony Currie
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

There is one clear and simple message from “Bull by the Horns,” Sheila Bair’s account of her five years in charge of the U.S. Federal Deposit Insurance Corp: financial regulators still need a good kick up the backside. Bair is not one to pull her punches – she delivers her poor opinion of several financial CEOs in the first couple of pages of her tell-all, and doesn’t stop there in her critiques of America’s banking system.

Much of her ire, though, is reserved for fellow watchdogs, almost all of whom she regards as too chummy with their charges. Tim Geithner, the Treasury secretary and former head of the New York Federal Reserve, receives much of her scorn – not least for appearing to put Citigroup’s survival above most other considerations during the height of the financial crisis that began in 2008. The most troubling part of her argument is the contention that not enough has been done since the crisis to remedy such biases.

Of course, as America’s credit-fueled housing and private equity bubbles inflated in 2006, most financial regulators looked pretty supine, including the FDIC. Bair bypasses most of this, preferring to concentrate on what she seems to feel she and her organization got right. That’s to be expected from an autobiography, especially one written by a long-time Washington insider – she was an adviser to Senator Bob Dole in the 1980s and made an unsuccessful run for a seat in the U.S. Congress in 1990.

But as the primary regulator – or from the vantage point of failing institutions the grim reaper – for thousands of banks the FDIC arguably failed to quell the rapid rise in real-estate lending or the growing tendency among some banks to seek out less secure forms of balance sheet funding. That could have avoided the regulator having to seize some 450 banks since 2008. In one telling example, she confesses that neither she nor her senior staff knew what structured investment vehicles were until they collapsed in 2007 – despite a number of banks having sizable SIV operations for almost two decades.

That, though, is a symptom of how lax supervision of America’s banks had become, regardless of which of the many – too many – regulators was ultimately responsible. Recall this was an era in which the hapless Office of Thrift Supervision, which was supposed to keep tabs on big failures like Washington Mutual and IndyMac, called the banks it was supposed to oversee “customers” and allowed some of them to backdate capital infusions so they looked healthier than they in fact were.

What distinguished Bair from other watchdogs was her quick adaptation to new realities as the crisis afflicting the financial services industry grew more apparent. According to her account, she was one of the few to try to tackle both the ever weakening mortgage-lending standards in the early days of the crisis, and to reject the groupthink mentality that convinced some of her peers, not to mention many bank CEOs, to ignore obvious problems.

That was apparent, in Bair’s telling, in the failure of two big retail banks during the crisis, Washington Mutual and Wachovia. The FDIC was convinced that both were in trouble, while their primary regulators – the OTS and the Office of the Comptroller of the Currency, respectively – were adamant that both were just fine. The absurdity of their position hits home most obviously when, just hours after a joint regulators call in which OCC staff repeat their absolute faith in Wachovia, the agency’s boss John Dugan calls Bair to tell her that his team was wrong: Wachovia was going under.

Worse, Bair doesn’t just accuse other regulators of allowing banks to arbitrage their regulators – that is, allowing them to choose the most pliant watchdog. She also describes how they fostered this race to the bottom themselves by proposing rules or alterations to rules that would, on the surface at least, leave their banks looking fine while penalizing those falling under other agencies’ purview.

Some of Bair’s heroics, of course, are due to the FDIC’s unique structure as the only regulator that principally relies on self-funding rather than taxpayers. It charges banks a fee for insuring their deposits, and uses those levies to finance the cost of failing banks, giving it skin in the game. Bair cites this as a source of some tension as Geithner and his predecessor at Treasury, Hank Paulson, enviously regarded the FDIC’s reserves during the crisis. Bair relates how the two of them essentially forced onto her agency the plan to guarantee bank debt and to offer financial support for Citi’s ultimately failed bid for Wachovia. Wells Fargo later trumped Citi in a deal brokered by Bair herself.

Bair’s tell-all has some faults. She adopts a rather simplistic view of securitization, appearing not to understand that players were taking risks, but simply ignoring them. Her contention that Bear Stearns did not need saving appears at odds with her more sanguine take on Lehman Brothers. Still, Bair has laid out a convincing manifesto that bank regulators need to be mindful of their priorities to protect taxpayers and the system over the needs of bankers. Above all, she raises the bar for the inevitable accounts of the historic crisis to come from Geithner, Fed Chairman Ben Bernanke and others.

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