Politics and bank regulation don’t mix
The Federal Deposit Insurance Corp tried to seize and sell Cleveland thrift AmTrust last January butÂ local politicians intervened. In the end, the bank still went bust 11 months later – a delayÂ that may have increased losses to the U.S. regulatorâ€™s funds.Â 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 downÂ the bankâ€™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 timeÂ FDIC finally seized AmTrust on Dec. 4, its tangible common equity â€“ the capital it has to withstand loan losses â€“ had fallen to $276Â million from $943Â million the year before. The cost of the bankâ€™s failure to FDIC: $2 billion.
The price tag to the FDIC wouldâ€™ve been lower had it acted sooner, according to the Wall Street Journal.Â ThisÂ isnâ€™t a new lesson.Â Congress established the Prompt Corrective Action doctrine in 1991Â because the S&L crisis taught that to limit the cost of bank failures, itâ€™s important to seize troubled institutions quickly, while they’ve still got capital.
AndÂ the importance of speedy resolution is more pronounced with larger firms, whose deterioration can infect the entire system. Remarkably, CongressÂ is poised to erect new political barriersÂ that may delay pre-emptive action to corral systemically dangerous firms.
An amendment offered by Rep. Paul Kanjorski toÂ Barney Frank’Â s Financial Stability ImprovementÂ ActÂ would require Treasury to sign off on corrective actions imposed by regulators on firms with greater than $10 billion of assets. For $100 billion+Â firmsÂ a White House signature would also be needed.
AmTrust was small enough that its collapse didnâ€™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,Â however, the cost of political delayÂ will be much higher.