Bank failure Friday, Bair on TBTF at Buttonwood
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.”