Bank failure Friday, Bair on TBTF at Buttonwood

October 17, 2009

At Buttonwood, Sheila Bair noted that the DIF’s balance, its net worth, is now negative. They have $20 billion+ of cash on hand, but much is accounted for by the fund’s contingent loss reserve, which is to say the money is spoken for based on failures already in the pipeline.

The plan to accelerate assessments on banks is an accounting gimmick that protects their earnings and capital. That said, it’s good news FDIC will be raising more cash, $45 billion is the estimate.

Remember, because of this accounting treatment, the DIF will have more cash, but its balance will continue to be negative for some time. The $45 billion will be accounted for, not as capital, but as deferred revenue, which is the gimmick to protect bank capital.

Important: expect LOTS of sloppy reporting on this point. Most news articles in future will tell you the DIF is negative without noting that cash is on the balance sheet.


  • Failed bank: San Joaquin Bank, Bakersfield CA
  • Acquiring bank: Citizens Business Bank, Ontario CA
  • Vitals: as of Sept 29, assets of $779 million, deposits of $631 million
  • DIF damage: $103 million

At the conference, I asked Sheila Bair would she support policies to proactively shrink too-big-to-fail banks?

“No. I don’t know how we would do that.”

She said, for instance, she didn’t think anything like a $500 billion cap on assets would be workable. She said we need to articulate that government won’t be there next time so that the market imposes discipline on banks. Hence, her emphasis on the need for broad resolution authority to resolve the biggest financial institutions.

Another specific policy proposal: limit the claims of secured creditors so that they face losses of up to 20% when a bank fails. Presumably, if they were on the hook for losses, it would be harder for banks to raise debt without having a substantial equity cushion and without acting prudently on the asset side of the balance sheet.

She also repeated her suggestion that there be an insurance fund for the biggest banks, statutorily prohibited from bailing out shareholders. That’s an important last point. The risk of creating a new insurance fund for TBTF banks is that it would REDUCE market discipline, that, done wrong, government would effectively be codifying the implicit guarantee that TBTF banks currently enjoy.

So long as a fund stands behind them, depositors and lenders may not demand the most robust risk management. That’s my concern with proposals to designate certain big banks as systemically important. It might just send a signal to markets that these banks are backstopped, so funding would flow to them at below-market rates, allowing them to grow even larger relative to banks not so-designated.

Why did Fan and Fred attract so much capital? The implicit guarantee…

Another proposal: limiting the amount of short-term secured funding banks are allowed to have. That’s why investment banks were dropping like flies over weekends, because much of their funding was short-term. Their lenders could walk away on short-notice. Basically, they were being hit by the up-market equivalent of a bank run.

Asked if we should reinstitute/update Glass Steagall, Bair said no, that’s probably not possible, but she did say insured deposits are being used in risky ways she doesn’t like. She singled out “prop trading.”



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What does threatening the shareholders do? Except for tbtf they already get wiped out in the case of failure… And I’m not sure the shareholders are really all that thrilled at the tbtf anyway.

Let’s be honest: shareholders don’t really run these companies. Management does that, although they tend to overlap a little. Threatening the shareholders only slightly impacts management. A more effective at incenting management to keep long term goals aligned with shareholders would be to implement serious clawbacks on compensation so that if the company busts not only does top managment lose thier stock, bur also loses significant portions of their compensation from the previous 5(for example) years.

Posted by Andrew | Report as abusive

To Andrew,

She is not threatening shareholders… shareholders get wiped out. She is saying debt-holders should take a hit – at least 20% – when banks fail. The ‘moral hazard’ comes from people buying debt secure in the fact they their investments are guaranteed by the gov’t. Banks can run up debts and people keep buyin it up because it’s fully secured. That has to stop – if you invest in something that goes to hell, why SHOULD you get your money back. Puts accountability back in investors hands, so that they can force banks into accountability, and so on. Would it work? Couldn’t hurt, and would save the gov’t (re:taxpayer) next time they decide to bailout.

Posted by the Shah | Report as abusive

Actually most debtholders are totally exposed in the event of bank failure. Ask the people holding debt for bankunited and guaranty financial how much their paper is worth.

Rolfes point is that the shareholders of tbtf banks have benefited from govt supports.

Posted by Andrew | Report as abusive

There would seem to be lots of problems with limiting bank size under the too-big-to-fail scenario.
It would presumably put American banks at a disadvantage in relation to foreign banks–they wouldn’t have the heft to do the same kind of large deals.
Also, how would you limit size? Making rules that assets can only reach this level is an invitation to all kinds of accounting hankie-pankie to stay under the limits.

Posted by jjw | Report as abusive

jjw…agreed. In fact, that’s one of Bair’s arguments.

But because it would be hard to break them up we shouldn’t even try? We’re supposed to live with state-backed banks which engage in highly risky activities?

Posted by Rolfe Winkler | Report as abusive