by Sheila Bair
In addition to being outnumbered, I was as usual operating in an information vacuum. That was because Citigroup’s management information systems were so poor that we really couldn’t be certain which operations were in the bank, and thus subject to the FDIC’s powers, and which were outside the bank, and thus beyond our reach. Tim Geithner, of course, was pushing Citi’s case forcefully. Not only did he want a bailout, but he wanted the FDIC to take the lion’s share of the exposure. It was clear that part of that was payback for his failed Citi-Wachovia deal. At that point, the newly elected Obama administration had announced its decision to nominate him to be the next secretary of the Treasury. Given his pending nomination, he ceased communications with the institution, though he continued to advocate strongly for Citi in our internal discussions.
The conversations were intense and continued nonstop through the weekend. A brief reprieve came during a somewhat heated conversation on Saturday evening. I was on the phone in our upstairs bedroom when our discussion was interrupted by a click and then the sound of someone punching numbers into our touch tone phone. My eight-year-old daughter, Colleen, had picked up the downstairs extension and was trying to call her friend Katherine. We heard her sweet little voice come on the phone: “Hello?”
“Colleen, Mommy’s on the phone,” I replied. She hung up, and after a three-beat pause, we all started laughing. It eased the tension, albeit briefly.
When I was unable even to start a discussion on creating a good-bank/bad-bank structure using our receivership powers, I suggested that we at least set up a facility that would be generally available to all banks to purchase their troubled assets and liquidate them over time. I was tired of the attempts to provide special help to Citi. Both the OCC and NY Fed refused to accept the reality of just how sick the institution was. With the other major failures—Bear, Lehman, AIG, Fannie, and Freddie—the OCC and NY Fed had had no significant regulatory responsibilities, so they could rightfully say, “Not on my watch.” But Citi was a completely different story. It had long been the “premier” charter for both the OCC and the NY Fed. It had a huge international presence, and as such its failure would be not just a domestic but an international embarrassment for those two regulators. What’s more, Tim Geithner’s mentor and hero, Bob Rubin, had served as the chairman of the organization and, as the Financial Crisis Inquiry Commission74 would later document, had had a big hand in steering it toward the high-risk lending and investment strategies that had led to its downfall. I frequently wonder whether, if Citi had not been in trouble, we would have had those massive bailout programs. So many decisions were made through the prism of that one institution’s needs.
If I was going to be stuck with another bailout, I at least wanted the same kind of support available to other banking institutions, large and small. A programmatic approach would address the public perception that the government was just helping the big, politically connected institutions. It would also obviously be more fair. But the other regulators refused to engage on setting up a generally available program as well. I couldn’t even get them to agree to require management changes at Citi.
I finally acquiesced. We were all fearful of what would happen to an uncontrolled failure of Citigroup. I tried to posture a bit, suggesting that we might move to close it (that got a nice rise out of Hank and Tim), but at the end of the day, I couldn’t maintain the bluff. We couldn’t let it slide into a messy, uncontrolled failure à la the Lehman debacle.
We did at least reach agreement on compensation and dividend restrictions, as well as specific requirements that Citi restructure the residential mortgages in the ring fence (but not its other mortgages). With those weak conditions in place, we settled on a bailout package that included the $306 billion ring fence, with a second capital infusion of $20 billion from TARP.
The negotiations over how the losses on the ring fence would be apportioned were difficult, to say the least. Part of the problem was that Citi could not definitively identify the assets it wanted in the ring fence, so it was difficult for our examiners to evaluate the extent of the likely losses. But at that point, all it was looking for was an announcement of the bailout—a signal to its creditors that the government would not let it go down—and it was happy to work out the details later.
We finally agreed that Citi would have to absorb the first $37 billion in losses. TARP would absorb the next $5 billion in losses, followed by the FDIC at $10 billion, with the Fed assuming any “tail” risk for losses above that. We were to be given $3 billion in preferred stock to compensate us for our exposure. The Treasury would get $4 billion in preferred stock. The OCC and NY Fed were happy to let Citi add that $7 billion into its capital base, along with the $20 billion from TARP, to make it look as if it had a higher capital ratio than it actually did.
Late Sunday, I convened my board to approve the systemic risk exception required by law before the FDIC could provide bailout assistance. In presenting the case, our staff dutifully presented the arguments that had been laid out by the NY Fed and the OCC. Those arguments essentially stated the obvious: that Citi was big and internationally active. That wasn’t the issue, to my mind. The question was why Citi’s shareholders and unsecured creditors couldn’t assume some of the burden. During the meeting, John Reich—who was resentful of the fact that WaMu hadn’t received a bailout—had pressed John Dugan on why the OCC still had Citi rated as a CAMELS 3 when it was on the verge of failure. I was incredulous at John Dugan’s response: he essentially said that since the government was bailing Citi out, the OCC did not plan to change its supervisory rating. “Is that the standard now75 that people get a ‘3’ if with government assistance they can have adequate liquidity?” I asked. “Well, I think it has been the actual standard,” he answered. “ . . . [T]hey already have a certain amount of government assistance already, and now they have more.” He was certainly right about that. With the second bailout, Citi had $45 billion in TARP capital, the $306 billion ring fence, about $77 billion in our new guaranteed debt program, and access to hundreds of billions of dollars’ worth of cheap loans from the Federal Reserve. “[W]hat is your supervisory strategy?76” I asked him. “[T]he government’s obviously very deeply on the hook now.” And I continued, “I think this institution has some significant problems and it’s going to require a very aggressive supervisory strategy or we are going to be back in writing some more checks.” His response: “We will continue to work hard to address the problems of Citigroup. We are not committing to a particular strategy now. We don’t know what the situation will be once this gets addressed, and when it is, we are looking at all kinds of alternatives. And we will keep you posted.”
I couldn’t believe it. All those hundreds of billions of dollars of government aid to stabilize this institution, and the OCC had no supervisory strategy—but it was going to keep us posted.
We—the Fed, the Treasury, and the president—all approved the bailout, as required by law, and it was announced at midnight that day. The market reacted positively in the short term, with a 65 percent boost in Citi’s stock price. But it turned out not to be enough. Citi’s toxic assets, combined with its weak management and thin layer of “real” common-equity capital, would later require more extraordinary action by the government to keep it afloat.
Then, of course, as Citi had gotten that “special deal,” Bank of America head Ken Lewis approached Hank and Ben a month later, wanting a similar one. He was having buyer’s remorse over the high price he had agreed to pay for Merrill Lynch, without doing enough due diligence. Though the Fed had already approved the acquisition, it wasn’t scheduled to close until the first quarter of 2009. Hank and Ben felt that if the deal didn’t go through as agreed, it would have a destabilizing impact on the system. I was skeptical. Lewis did not approach them until late December, when the aftershocks of Lehman had subsided and markets had calmed down, soothed by the massive government aid programs we had announced on October 14. Frankly, I wasn’t wild about the idea of BofA buying
Merrill Lynch. I didn’t think its management and board knew much about running a major securities firm, and Merrill had really loaded up on toxic mortgage investments. My view was that holding companies and their subsidiaries should be sources of strength for insured banks, not the other way around. Like so many of the other major securities firms, Merrill had relied excessively on short-term, unstable funding and had taken on extremely high levels of leverage. It needed BofA, with its stable insured deposit base and thicker capital cushion, not the other way around.
Discussions with the Fed and Treasury started on December 21 and continued on through January. On one call, Hank got a big laugh when he referred to the toxic assets BofA proposed to ring fence as “the turd in the punch bowl.” I pushed back, questioning whether there was a need for the bailout and, if so, why the FDIC should be involved since at that point in time, the problem was with Merrill, not BofA, and it was not the FDIC’s business to bail out securities firms. I was also disillusioned by the steps we had already taken. They were not producing the hoped-for lending activity, nor were the big banks doing much to restructure mortgages. There were clear benefits from the bailouts for shareholders, big institutional bondholders, and derivatives counterparties, but not much for Main Street.
I wanted to try a different approach: instead of participating in another ring fence as we had with the Citi deal, I suggested that the FDIC provide debt guarantees beyond the caps imposed on our TLGP program and for longer terms, but only if the debt was used to finance new loans. Our specific proposal was for BofA to create what is called a “covered bond” structure. It could issue new debt, which we would guarantee, but it could use that money only to make new loans, which in turn would be put into a special pool and serve as collateral for our guarantee. With that type of structure, the FDIC’s risk would be reduced (by having collateral to secure our guarantee) and we would be assured that the support we were providing went to new lending.
But Treasury and the Fed were bound and determined to do another ring fence. I think that they had decided months before that that would be their approach, and they weren’t going to entertain any new ideas from the FDIC. I continued to resist, and Hank, reaching the point of exasperation, told me that they would proceed without the FDIC. In retrospect, I wish I had kept the FDIC out of that unnecessary bailout. But he agreed to limit our exposure to $2.5 billion on a ring fence of $115 billion, given that the vast majority of assets subject to the guarantee were coming out of Merrill Lynch, not the insured bank. For our portion of the guarantee, we would receive $1 billion in preferred stock from BofA. He also agreed to support another systemic risk determination that would allow us to offer guarantees on our proposed covered bond structure. He never followed through on that latter commitment.
The bailout was announced on January 16, 2009, but BofA never put the ring fence into place. As I had said, it was unnecessary, though we made it pay a $425 million termination fee, of which $92 million went to the FDIC.
And as we were spending all of this time on big-bank bailouts, not much was happening to help home owners. Two days after the October 14 Cash Room press conference, I gave an interview to The Wall Street Journal’s Damian Paletta to explain the programs and the FDIC’s role. During the broad-ranging interview, I vented my frustration at the massive bailouts for institutions but timid, at best, responses for borrower relief. “Why there’s been77 such a political focus on making sure we’re not unduly helping borrowers but then we’re providing all of this massive assistance at the institutional level, I don’t understand it. It’s been a frustration to me.”
That one quote became an above-the-fold article on the front page of The Wall Street Journal the next day: “FDIC Chief Raps Rescue for Helping Banks over Homeowners.” It would be the opening volley in our continuing battle with the Treasury over getting a comprehensive program into place to deal with the heart of our financial system’s problems: bad mortgages.
Hank did ask the regulators, at our urging, to issue a statement asking banks to use the programs to continue lending. We pushed for language to tell the banks not simply that they needed to use the programs to lend but that if they didn’t do so, it would lead to supervisory action. We also wanted language promising vigorous enforcement action against banks that used the programs inappropriately to pay dividends, as well as language requiring a moratorium on foreclosures where the bank had not first considered a borrower for a loan restructuring. As usual, the OCC and OTS fought us on those changes, but Ben Bernanke personally intervened78 and helped us toughen up the language, though, like most of our interagency products, it was still too weak.
Public outrage over the bailouts helped elect a Democrat to the White House, one calling for profound change in the special-interest ways of Washington. Even though I am a Republican, I was hoping that the new administration would bring in some fresh perspectives. The relationship between Washington and Wall Street had become too cozy, and too many of the people involved in handling the crisis—at both the senior and staff levels—had been responsible for some of the regulatory errors and missteps that had brought us the crisis to begin with. They weren’t bad people, but they were human, and instead of looking forward to needed reforms, many were still looking backward, trying to justify and rationalize their past mistakes.
CHAPTER 11
Helping Home Owners, Round Two
Treasury was able to secure passage of the TARP legislation through the votes of liberals, as well as a good number of conservatives, who thought the government would use the TARP money to support the restructuring of distressed mortgages. Senate Banking Committee Chairman Chris Dodd—long an advocate of loan modifications—had specifically included language in the law authorizing Treasury to “use loan guarantees79 and credit enhancements to facilitate loan modifications to prevent avoidable foreclosures.” When the Treasury abruptly shifted strategy from loan purchases to capital investments—without specific commitments from recipient banks to do loan mods—key members of Congress began to question whether those expectations would be fulfilled. I wondered too. I had received assurances from Hank that the Treasury would construct a program to help home owners.
Neel Kashkari, Hank’s point man on TARP, had initiated conversations80 with us on October 7 and had received a detailed proposal from our chief economist, Rich Brown. However, as soon as TARP passed and we publicly committed to the debt guarantee program, Treasury’s attitude changed dramatically. Notwithstanding the clear language of the TARP legislation, Hank and Neel questioned whether they had the legal authority to use TARP funds to promote loan modifications! (On Main Street, that might be called a “bait and switch.”)
Members of Congress who had voted for the bill solely because they thought it would provide relief to borrowers were incredulous. Chairman Dodd called Hank to press him on the Treasury’s plans for a loan-restructuring program. During an October 23 hearing before the Senate Banking Committee, Dodd again pressed Neel Kashkari, stating that he had received a commitment from Hank to launch a program and he wanted to know the status of Treasury’s efforts. Unbelievably, to this day, Hank Paulson blames me for stirring up trouble for him in Congress over the Treasury’s failure to do anything under TARP to provide relief for home owners. Either he didn’t know, or his lobbyists failed to tell him, that the only reason TARP was passed was that key members thought it was going to provide comprehensive relief to borrowers.
Treasury’s insistence that it lacked legal authority was followed by a pattern of attacks against the FDIC in the media. After we had in good faith provided a written loan modification proposal to Treasury and the White House, the document was promptly leaked to the press, accompanied by a whispering campaign that our program was really another hidden bailout for the banks! Reporters rightfully viewed the charge against us with some skepticism and called us for a response. Put on the defensive, we went ahead and made our program public, explaining its design and expected impact in some detail. The press leaks backfir
ed, and the coverage was overwhelmingly favorable to our position. Then our opponents at Treasury attacked us for going to the press during negotiations.
What was our initial proposal? It was based on a loan modification program we had successfully launched when we had served as conservator of IndyMac Bank. The only good thing to come out of the IMB failure had been our ability to practice what we preach by pioneering a systematic approach to loan modifications in contrast to the one-by-one negotiations being used by most mortgage servicers at the time IndyMac failed. But the truly pioneering aspect of the IndyMac program was our success in getting mortgage-backed securities investors to support it. Up until that time, servicers’ indifference, coupled with resistance by MBS holders, had impeded wide-scale loan restructurings. But once we obtained control of IndyMac, we were able to make loan mods a higher priority for servicers albeit with some foot-dragging by the IMB staff. To keep the pressure on, I insisted that they personally give me weekly status reports on the number of loans they had modified. We were also able to convince the investors who owned most of IMB’s loans to support our systematic approach.
Regrettably, some compromises had to be made as part of those negotiations. For instance, investors would not agree to principal write-downs. In addition, they initially wanted to keep the debt-to-income ratio at 38 percent—far too high—but we were subsequently able to convince them to lower it to 31 percent. The approach we used was to modify the loan with three different approaches, used in sequence. We would first reduce interest rates, followed by extending the term of the loan, and finally principal “forbearance”—as opposed to forgiveness. That meant we could lower the amount of principal used to calculate the borrower’s monthly payment but the borrower would still have to repay his or her loan in full if he or she sold the house or refinanced. For the problems that we were seeing in the summer and fall of 2008—unaffordable mortgages, as opposed to underwater mortgages—the plan worked well.