Politics and bank regulation don’t mix

December 8, 2009

The Federal Deposit Insurance Corp tried to seize and sell Cleveland thrift AmTrust last January but local politicians intervened. In the end, the bank still went bust 11 months later – a delay that may have increased losses to the U.S. regulator’s funds. As Congress debates banking reform, AmTrust provides a useful warning that the regulatory apparatus needs to be kept free from politics.

Regulators had known for some time that AmTrust was troubled. AmTrust’s chief regulator turned down the bank’s request for TARP money last fall. It also hit AmTrust with a cease-and-desist order, instructing management to change lending practices and boost capital by December 31. When AmTrust missed the deadline the FDIC decided to step in.

But Ohio Congressman Steven LaTourette and Cleveland mayor Frank Jackson convinced Treasury and the White House to keep the regulators at bay. Bythe time FDIC finally seized AmTrust on Dec. 4, its tangible common equity – the capital it has to withstand loan losses – had fallen to $276 million from $943 million the year before. The cost of the bank’s failure to FDIC: $2 billion.

The price tag to the FDIC would’ve been lower had it acted sooner, according to the Wall Street Journal. This isn’t a new lesson. Congress established the Prompt Corrective Action doctrine in 1991 because the S&L crisis taught that to limit the cost of bank failures, it’s important to seize troubled institutions quickly, while they’ve still got capital.

And the importance of speedy resolution is more pronounced with larger firms, whose deterioration can infect the entire system. Remarkably, Congress is poised to erect new political barriers that may delay pre-emptive action to corral systemically dangerous firms.

An amendment offered by Rep. Paul Kanjorski to Barney Frank’ s Financial Stability Improvement Act would require Treasury to sign off on corrective actions imposed by regulators on firms with greater than $10 billion of assets. For $100 billion+ firms a White House signature would also be needed.

AmTrust was small enough that its collapse didn’t pose a systemic threat. At worst, it just compounded losses at FDIC, which may require its own taxpayer bailout before too long. With systemically dangerous firms, however, the cost of political delay will be much higher.


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Rolfe, thanks for highlighting this story. These actions if seen in another country would be seen as crony capitalism but may be ignored due to ethnocentric biases.

I think the separation of regulatory and political power is of vital importance. By allowing regulators to be influenced politically we make a mockery of most regulatory authority which is usually decreed by statute or hearing.

The last thing politicians needs is more power and even more dangerous is foggy power in the form of indirect influence over regulatory action.

Posted by nick gogerty | Report as abusive

[…] Politics and bank regulation don’t mix Rolfe Winkler […]

Posted by Links 12/9/09 « naked capitalism | Report as abusive

[…] Politics and bank regulation don’t mix Rolfe Winkler […]

Posted by Links 12/9/09 | Gulag Blog | Report as abusive

Where were the regulators when Citigroup and Bank of America went bankrupt in September 2008? Instead of applying the law, the Federal Reserve confiscated smaller solvent banks to cover the losses on the “too big too fail” banks that escaped the carving knife of the FDIC.

When government no longer applies the law fairly, we are left with a muddled mess of political conyism choosing who is and isn’t bankrupt (solvent).

In a post September 2008 world, smaller regional banks, community banks and my retail store had to compete with trillions of free dollars provided to bankrupt institutions … I don’t care how brilliant you think you are, you cannot fight the impact that has on the market place. When I bid for an asset, an insolvent Bank of America can out bid me … these zombie banks can outlast anyone else.

Return to the Rule of Law. Elsewise, AmTrust has as much right to exist as the bigger bankrupt companies that are feeding off the trough at the Federal Reserve.

Posted by Kirk Powell | Report as abusive

[…] Politics and bank regulation don’t mix Rolfe Winkler […]

Posted by Links 12/9/09 | Report as abusive

From what I understand, the Fed says it didn’t have the tools to handle the collapse of these firms. They aren’t asking for the authority to do so. But they do point out that because of a lack of any processes to unwind those companies the Fed had to keep the financial system afloat or the resulting defaults would have cause a depression on a global scale.

Mr Bernanke Pointed out that during the depression the banks were allowed to simply fail. And the resulting defaults cascaded causing a global down turn. He said that in order to prevent a repeat, some choices needed to be made to support the banks. If I understand history correctly, there was no financial social safety net in place during that time either.

I think it would have been easier and cheaper to keep the citizens afloat than it has cost us to keep the banks up. It also would have put the banks in a position of accountability to the citizens. Citizens with money can choose what sectors of the economy to support by choosing where to spend. It’s just incomprehensible to me that even though the citizenry is the engine of the economy, the engine is never given any fuel.

It’s like wanting to keep harvesting fruit from a tree that never gets watered. Eventually the tree dies and there is no fruit to be had. We are strangling our people with poverty. We are cutting off our own heads by keeping our people uneducated and sick, while expecting them to labor tirelessly. Our future slips away with each failed generation. It’s time to think about the citizens.

Posted by Benny Acosta | Report as abusive