Bull by the Horns

by Sheila Bair

  CHAPTER 16

  Finally Saying No

  Tim’s zeal for bailouts didn’t stop with the nation’s largest banks. He was equally determined to get the FDIC involved in the bailout of General Motors. That was really a stretch. It was bad enough that we had been dragged into guaranteeing the debt of big securities firms such as Goldman Sachs and Morgan Stanley; now we were being asked to extend our scarce resources to help an automotive company.

  In February 2009, Tim and Larry had hired a New York financier, Steven Rattner, to be the lead in the administration’s bailouts of General Motors and Chrysler, both near bankruptcy. Though it was not made public at the time, Rattner and his private-equity firm, Quadrangle Group, had been the subjects of investigations by both the New York State attorney general and the SEC. The charge was130 that they had paid bribes to New York State Comptroller Alan Hevesi and his political consultant, Henry Morris, in return for lucrative business managing the New York State Common Retirement Fund. In 2011, Hevesi and Morris were sentenced to prison, and Rattner ended up paying substantial fines out of his personal pocket to both the SEC ($6.2 million) and the New York State Office of the Attorney General ($10 million), though he refused to acknowledge culpability. The SEC also banned Rattner from the securities business for two years.

  I didn’t know much about Rattner other than his questionable reputation when I was summoned to meet with him on April 28, in Tim’s office. The meeting was billed as a “principals plus one,” which meant that I could bring one staffer. My choice was Christopher Spoth, the FDIC deputy in charge of overseeing our supervision of some five thousand FDIC-insured state-chartered banks. One of those banks was Ally, the insured-bank subsidiary of General Motors Acceptance Corporation (GMAC), the financing arm of General Motors.

  During the go-go days of the subprime crisis, Ally had not dramatically lowered its underwriting standards and was thus in reasonably good shape as the crisis took its toll. On the other hand, another of GMAC’s nonbank subsidiaries, ResCap, had gotten itself deep into high-risk subprime lending and was teetering on the edge. Similarly, GMAC’s portfolio of automotive loans was not performing well. Chris’s supervisory strategy had been to try to keep the relatively healthy, FDIC-insured Ally Bank insulated from the broader problems of GMAC and GM. Moreover, because GMAC was in such bad shape, we had prohibited it from using the TLGP to guarantee its debt.

  Geithner and Rattner wanted us to allow GMAC to move billions of assets from its other subsidiaries into the insured bank. That type of transfer is explicitly prohibited by a statutory provision known as “23A.” The Federal Reserve Board has the authority to grant exemptions from 23A, and Ben was prepared to exercise that authority, but he didn’t want to proceed over our objections. Hank Paulson had asked me to agree to a 23A waiver for GMAC in December 2008. I had half jokingly told him131 that we would agree to move $6 billion in loans into the bank if he would put $3 billion of capital into the bank to protect it against losses. He never seriously pursued the idea.

  But Tim, unlike Hank, was unable to take into consideration the FDIC’s point of view. He was undeterred by and indifferent to the increased risks to the Deposit Insurance Fund. In addition to the 23A waiver, he was particularly determined that we guarantee several billions of dollars’ worth of GMAC debt. We had already guaranteed about $330 billion in debt through TLGP, and it was keeping me up at night. If we took any losses on that program, I would have to immediately assess insured banks—including thousands of community banks—to cover the losses, placing more stress on fragile banks. Our reserves were declining steadily, and our ability to borrow from the Treasury was limited to $30 billion; it had not been raised since 1991. By that point, we were insuring more than $5 trillion of insured deposits, in addition to the $330 billion in debt guarantees. An unexpected major bank failure would easily wipe out our reserves and the Treasury line of credit. We had no statutory authority to tap the big holding companies such as GE, Citigroup, Goldman Sachs, and Morgan Stanley for cash to cover our losses on the debt guarantee program. Even though they were the big users of it, if one of them defaulted, it would be thousands of community banks that paid. On March 19, at my request, Tim and Ben had given me a “comfort letter”132 saying that the Fed and Treasury would use their best efforts to protect us from losses on TLGP debt guarantees. But it was not clear to me that they had the tools to protect us, and in any event, it was the big financial institutions that needed to be on the hook for losses, not they.

  I was pushing hard to get our line of credit raised, as well as legal authority to impose an assessment on big bank holding companies to cover TLGP losses. I had had several conversations with Chris Dodd, the chairman of the Senate Banking Committee, about getting the legislation through. He was highly supportive, but he told me point-blank that we would not get it passed in the Senate unless Tim made it clear that the Treasury Department wanted it done. Though Tim had written a letter in support, I took the cue from Dodd to mean that behind the scenes, he was telling senators that it was not an administration priority.

  I was not going to take any more exposure on TLGP until I had a bigger Treasury line of credit as well as the authority to make sure the big institutions covered any losses. I told Rattner and Geithner as much at the meeting. Both were indignant. Rattner clearly thought that he was entitled to whatever help he wanted from the FDIC, and he and Tim both threatened to publicly bash me for getting in the way of the GM deal.

  In a candid back-and-forth, I told them that if the legislation went through, I was willing to work with them to try to help get GM back on its feet, but our examiners’ safety and soundness concerns had to be addressed. That was the FDIC’s bottom line. At the top of our list was a commitment to maintaining the insured bank’s capital at 15 percent, the same commitment that Treasury had given the Fed for holding company capital. It was ludicrous that government support for bank capital should be weaker than holding company capital.

  I held firm, and after some additional negotiations between Chris and Tim’s staff, we got what we wanted. On May 20, 2009133, legislation was enacted with the authority we needed, and we followed through on our end by agreeing to the 23A waiver and guaranteeing about $7 billion in GMAC debt. Shortly before the legislation passed the Senate, Tim called me, still trying to browbeat me into backing down. But I had also put Rahm Emanuel into the loop, and I knew that the White House supported our position. So, with administration support, we got our legislation passed.

  In the end, everyone got what they wanted, but Rattner lived up to his nasty reputation by attacking me in his book Overhaul: An Insider’s Account of the Obama Administration’s Emergency Rescue of the Auto Industry. His version of events was that I was some Washington insider trying to wheel and deal for power and advantage, while he ridiculed Chris, a career public servant with a stellar reputation, as being a clueless bureaucrat. He clearly felt that the government purse was supposed to be readily available to him, and anyone who got in his way was the target of scorn and derision.

  The next bailout candidate was CIT, a commercial lender that owned a small insured bank. We regulated the insured bank jointly with the state of Utah. During the fourth quarter of 2008, the Federal Reserve Board had made CIT a bank holding company and had approved it for a $2.3 billion TARP capital investment. We were surprised by that, because after the nine big banks were approved for the first round of TARP, an interagency process had been set up to handle applications and all regulators were supposed to have a vote in whether the applications were approved. However, with CIT, Chris Spoth and his staff had received only perfunctory inquiries from Fed staff about the health of the bank as part of its review of whether CIT should become a bank holding company. Chris told the Fed that although the small bank was stable, he thought that the holding company was not viable. His staff also notified it that there were unresolved consumer issues at the bank that would ordinarily slow down a bank holding company application. The Fed approved the application any
way, and Treasury followed with the TARP investment.

  In January, CIT filed an application with us to participate in TLGP. Our staff was highly skeptical. Then, in March134, the Financial Times reported that the FDIC was “delaying” approval of CIT’s request that we guarantee about $10 billion of its debt. The story had obviously been fed by CIT officials trying to put public pressure on us to give them their bailout. But the result was the opposite of what was intended. I had no patience for financial institutions trying to lobby us in the media. I met with CIT’s CEO, Jeffrey Peek, and told him that if he wanted to litigate his request in the media, he could withdraw his application then and there.

  I also had no interest in the FDIC bailing out CIT. After reviewing the facts, it was clear that our examiners were right: the place was not viable. A century old, CIT had once been a safe, stable source of credit for small retailers. However, Peek, a former asset manager at Merrill Lynch, had taken over in 2003 and soon gotten the company into high-risk commercial lending and subprime loans. CIT had grown quickly under Peek—too quickly—its assets increasing by a whopping 77 percent from 2004 to 2008. He also changed the company’s public profile from stodgy to flashy, moving its global corporate headquarters from an office park in Livingston, New York, to the CIT Building, a newly constructed 300,000-square-foot tower in central Manhattan.

  As we had made very clear when we announced it, the debt guarantee program was supposed to be for viable institutions, which CIT was not. The only other possible rationale for supporting CIT was to avoid systemic risk. But CIT was not systemic. It had assets of about $75 billion, and our analysis indicated that its lending activities could be easily picked up by other, healthier institutions. So I was disinclined to help it, and our examiners felt the same way. However, if we didn’t guarantee CIT’s debt, it would likely enter bankruptcy and the $2.3 billion investment that Treasury had erroneously made would be wiped out.

  I was sick of bailouts and wanted to just say no. But a $2.3 billion Treasury loss troubled me. So we continued discussions through July with CIT and Treasury to try to see if we could responsibly guarantee some of CIT’s debt without posing risks to the FDIC. We tried to explore whether CIT could give us collateral against our guarantee, but it insisted that it did not have legal authority to do so. Lee Sachs, Tim’s point person on the bailout programs, had been in contact with me about our plans for CIT but had been careful not to pressure us. In deciding to invest in CIT, Treasury had not gone through the usual interagency process for TARP approvals, and it had not consulted us before making the TARP investment. Thus it was on thin ice. (It should be noted that Lee had not been involved in the TARP approval. That had been done before he arrived at Treasury.) After several discussions, in July, I finally told Lee135 that our first preference was to deny the application, but to try to help Treasury, we would consider granting it if CIT could demonstrate its market viability by issuing at least $1.5 billion in new common stock. We would also need collateral to protect us from risk. And finally, I needed to hear from Tim that it was important to him before I would proceed.

  As I suspected, CIT was too weak to meet our conditions. Potential investors knew how sick it was and would not have committed a dollar of new common equity. So then I suggested to Treasury that it try to find an acquirer. Goldman Sachs seemed a possibility. It was a major creditor of CIT, and it had benefited mightily from all of the bailout programs. It was time for it to give something back. I actually called Goldman CEO Lloyd Blankfein myself to see if he would be interested, but he assured me that Goldman had collateral to cover the loans it had made to CIT and he didn’t think CIT’s business was a good fit for his firm.

  With no other acceptable options, we denied CIT’s application, and at the end of October, it filed for bankruptcy. It had reached agreement with its creditors in advance on how to restructure the company and how much would be paid to claimants—what is known in industry parlance as a “prepackaged bankruptcy.” For an institution the size of CIT with no significant derivatives positions, the bankruptcy process worked just fine. We were right: the failure was not systemic. As other lenders picked up some of CIT’s business, it reemerged from bankruptcy in December. There were no major disruptions in credit availability.

  It appeared that we had finally stopped the bailout mania. Our refusal to throw good money after bad in the case of CIT was hailed as a turning point in the government’s rescue efforts—at last an institution had been left to fend for its own in the private markets, and lo and behold, solutions had been found that salvaged the viable parts of CIT while shareholders and creditors took their losses. Our resistance to GMAC and denial of the CIT application also sent a message to Tim and his team: the gun they had kept putting to our heads—the threat of systemic risk—was no longer loaded. We had let one fail. No big deal.

  Though I couldn’t change the past, I was determined to make sure that going forward, the FDIC would have the tools it needed to put large, interconnected institutions into our bankruptcy-like process. Never again did I want to see the FDIC given the Hobson’s choice of bailing out a bank or “letting the system go down.” In my quest to secure new resolution tools for the FDIC, I would find an unlikely boost in the AIG bailout and a welcome, if unexpected, ally in President Obama.

  CHAPTER 17

  Never Again

  I was driving in to work on Monday, March 16, when my BlackBerry started ringing. I answered (in hands-free mode). It was my assistant, Benita Swann, saying that Tim was on the other line. Would I take the call? Of course. I heard a click as it came through. Tim’s voice was warm and friendly. He could be very charming when he wanted to be. The president wanted to see me ASAP. Could I come to a meeting at 10:30 in the Oval Office? Again, of course. Another click.

  The call took me aback, and I didn’t have the presence of mind to ask what it was about. When I arrived at the West Wing receiving area shortly before 10:30, I was ushered right in. The president was waiting for me in his office, standing by one of two chairs that sat in front of the fireplace. Tim and Larry were there as well, each sitting across from each other on the couches that stood in parallel between the fireplace and the president’s desk, which stood at the other side of the Oval Office. Rahm was also there, standing next to one of the windows several feet away. The president motioned for me to come sit next to him in one of the two chairs. Tim and Larry looked uncomfortable, their eyes downcast. I slowly walked over to the president and took my seat, my mind racing. What was this about?

  “Have you seen the headlines on the AIG bonuses?” the president asked. Yes, of course I had. Everyone had seen them. AIG—the troubled insurance giant that had gotten itself into trouble by selling insurance against losses on high-risk mortgage-backed bonds—had received $170 billion in taxpayer bailout money and was by that time 80 percent owned by the government. On Sunday136, The New York Times had broken the story that AIG management planned to pay out $165 million in bonuses, mostly to the employees of the financial products division—the division that had gotten the company into trouble to begin with. The explanation was that AIG was contractually committed to paying the bonuses. Tim had known about the bonuses and had not objected to them. He had also not given the president a heads-up.

  I was aghast when I read the story. Why hadn’t they just fired those people? There was some suggestion that they needed to pay the bonuses to retain those folks to help them unwind all of the dumb transactions they had previously entered into. Really? Who in the world would want to hire those yahoos, who had brought one of the world’s largest insurance companies to its knees? They should have been working for free to clean up the mess they’d made. I couldn’t believe they had anywhere else to go.

  “Do you have any thoughts on how to stop these bonuses?” the president asked. He was visibly angry. Hmm. I wanted to say, just fire them. But I didn’t have all of the facts, and maybe there were reasons unknown to me why Tim and the AIG management thought they needed to retain those folks
. I decided that I wouldn’t second-guess Tim’s decision; with him sitting there, we would have just gotten into a debate about it. I thought that my precious time with the president could be used more constructively. So I took the opportunity to tell him about our resolution process. A big disadvantage of keeping an institution open, I explained, was that the government preserved all of the legal rights of the employees, creditors, shareholders, and other stakeholders. With our bankruptcy-like resolution process, we could break all of those contracts. We could pick and choose the staff we wanted to keep and decide for ourselves what we needed to pay them. Shareholders and creditors had to get into line to be paid in accordance with an established claims priority. And yes, to keep the franchise operational, key staff frequently did have to be paid to stay and help run the bank until it could be sold. But with our process, the government was in control and the bad apples could be terminated immediately.

  I then suggested that as part of financial reform, the president should push for FDIC-like powers to resolve all large financial entities, not just insured banks, as was currently the case. I told him my view that the AIG bailout had been necessitated because the FDIC lacked the legal powers to resolve big nonbank entities. If he wanted to make sure the government was never again put into that type of position, he should seek statutory changes designed to give us the authority to unwind all of the big institutions.

  He liked the idea, and Larry and Tim were nodding too. Frankly, I had given the president a constructive idea for moving forward in a way that did not criticize or question their actions on AIG. You would have thought they would be grateful, and for a time the Treasury did embrace empowering the FDIC with powers to close down large nonbank firms. But later Tim would backtrack from the understanding we reached in the Oval Office that morning. Fortunately for me, Rahm was there as a witness, and he would help us later on.