by Sheila Bair
By pushing an 8 percent standard with a meaningless buffer, I don’t think Tim was trying to strengthen the United States’ position. I think his real agenda was to blow up the GHOS meeting, with the U.S. delegation being the spoiler. In that event, the question would be bucked up to the G20 finance ministers, who were scheduled to meet in Seoul in November. At that meeting, Tim, not the Fed or the FDIC, would be leading the United States.
The Fed stuck with the game plan. We went to the September 12 meeting in Basel, still knowing there would be a fight. Predictably, France was pushing for a 6 percent standard but Germany was moving our way, due to the good influence of Axel Weber, who headed the Bundesbank. On September 8, Weber publicly refuted the industry’s charges that the new capital standards would slow economic growth, saying that the new rules would “reduce the probability234 of individual banks failing and will represent a first line of defense against systemic crises.” Weber was also a member of the ECB board and was in a running competition with Mario Draghi, the governor of the Bank of Italy, Italy’s central bank, to replace Jean-Claude Trichet when Trichet’s term expired in 2011. There was some speculation that Weber felt that supporting stronger capital requirements would enhance his prospects of replacing Trichet. Whatever his motivations (and I tend to think they were sincere) at the GHOS meeting, Weber played a positive role in reaching agreement, in stark contrast to his colleagues, the droners Zeitler and Sanio. The French proposal went nowhere. It was a long, intense meeting, but Jean-Claude held everyone’s feet to the fire. As Nout and Stefan had predicted, we achieved agreement on 7 percent as the baseline and were able to shorten the phase-in to the end of 2018.
But the language in the Basel Committee/GHOS press release was squishy on the question of a surcharge to apply to the megabanks, the SIFIs. It simply stated, “Systemically important banks should have loss absorbing capacity beyond the standards announced today.” I requested, and the Fed agreed, that the U.S. regulators would issue a separate press release235 strongly committing to even higher capital standards for the largest institutions. We all trooped upstairs to a suite of offices the BIS reserved for the Fed’s use. Jason sat at a computer and typed while Tarullo, Dudley, Walsh, and I dictated the statement. For once, Tarullo, Dudley, and I were all on the same page with a clear statement on higher capital requirements for SIFIs, while Walsh kept trying to soften it.
In a bad development for the FDIC, the GHOS also decided to fold the issue of the SIFI surcharge into the work of a sister group called the Financial Stability Board (FSB). The FSB was working on a variety of issues associated with too big to fail. I viewed the FSB as an unwieldy bureaucracy, made up not only of bank regulators but also of securities, insurance, and futures regulators and finance minister representatives. It met interminably and achieved consensus only after endless meetings, and then the decisions were generally watered down to accommodate the group’s diverse membership. Involving the FSB in the SIFI surcharge discussions was an unexpected setback for the FDIC. The Fed and Treasury were members of the FSB; we were not.
The FSB was headed by Mario Draghi, a smooth, articulate former managing director at Goldman Sachs. I had been trying to build a working relationship with him for several months. With the Fed’s and Treasury’s blessing, the FSB had taken over the work on developing international resolution mechanisms. The FDIC cochaired a Basel working group on cross-border resolutions along with the Swiss. However, since we are not members of the FSB, Draghi put the United Kingdom in charge of the FSB’s work on resolutions. Our Basel group supported the FSB’s work, but we were no longer in the driver’s seat on resolution authority. That was unfortunate, because the FDIC clearly had the most experience in resolving failing banks. Indeed, in the wake of the crisis, most other countries were in the process of setting up resolution regimes similar to ours, and they were coming to us for technical help and training. In a twist of irony, a few years prior, Mervyn had asked me to detail FDIC staff to the Bank of England to help it set up its own resolution authority. Now it was running the process to develop standards for international resolutions, with us playing a secondary role.
Ever the gentleman, Mario reached out to me for counsel on addressing resolution issues and asked me to join an FSB steering committee meeting discussion of resolution issues on September 13. The timing was good because it would also give me an opportunity to weigh in on the SIFI surcharge. Mario seated me in between Dan Tarullo and Adair Turner. The meeting started with other agenda items, and I felt like a schoolkid, waiting to be called on for my turn to talk. When the agenda turned to resolution authority, I gave my presentation but then also took the opportunity to express my view (out of turn) that the SIFI surcharge should be high and made up of tangible common equity. I was delighted to hear Dan Tarullo say the same thing emphatically and unequivocally (unusual for the Fed).
The FSB discussions dragged on and on. A few months into 2011, I was watching the clock run out on my tenure as chairman. At the end of June, I would be stepping down. I was afraid that the SIFI surcharge would not be finalized before my departure. I called Stefan Walter, complaining that the FSB process was “a big mush” in contrast to the decisive actions taken by the Basel Committee and GHOS in 2010. Couldn’t the Basel Committee recapture the process and drive the decision making? I openly confessed to him that once I was gone, I did not know how resolute the U.S. delegation would be on a high surcharge.
I had growing confidence in Dan Tarullo as a capital hawk, but I wasn’t sure about Bill Dudley and some of the Fed staff, and I suspected that Tim was working behind the scenes to water down the surcharge. Those suspicions were confirmed when John Walsh, who had been keeping a very low profile, suddenly announced his view that the SIFI surcharge should be 1 percent maximum. That was a far cry from the 3 percent surcharge needed to reach the 10 percent TCE ratio we wanted to apply to the megabanks, as had been discussed in countless meetings at the Treasury.
Walsh refused to sign a letter drafted by the Fed endorsing the 3 percent that we had all previously agreed to. Tarullo and I had to send the letter without his signature. Dan asked him if at least he would refrain from sending a letter to the Basel Committee endorsing 1 percent as a maximum. He thumbed his nose at Dan and did just that. The Fed went ballistic, as did we. He was purposefully trying to undermine our negotiating position.
I suspected that Tim was behind it. It didn’t make sense that Walsh would go so far out on a limb without some encouragement from Tim, his patron. My suspicions were heightened236 when a career Treasury staffer let it slip to a member of our FDIC Basel team that the Treasury Department’s position on the FSB steering committee was to support a maximum surcharge of 1.5 percent. I forwarded the information to Dan Tarullo, who confirmed that that was the position the Treasury had been taking. I went ballistic. “Why weren’t we in the loop?237” I angrily asked. “There should have been a principals-level discussion. We insure these banks. I’m sick and tired of being kept out of key decisions after everything that we have been through.”
Stefan and Nout were successful in wresting the SIFI surcharge issue away from the FSB and back to the domain of the Basel Committee/GHOS. I waited anxiously for word from them as to whether the decision would be made before I left the FDIC. A meeting was tentatively targeted for the end of June. My term was up on June 26, but I decided to delay leaving by a week to make sure I was still around for the final decision.
In the meantime Walsh238 went public with his outlier position on the SIFI surcharge. Walsh deservedly took a lot of heat in the media and in Congress for his very blatant attempt to protect the megabanks from higher capital requirements. Several influential Democratic senators239 called for his ouster, including Jack Reed of Rhode Island, Carl Levin of Michigan, Jeff Merkley of Oregon, and Sherrod Brown of Ohio. Walsh ignored them.
The industry was going on the offensive. Shortly after the Basel Committee’s September 2010 announcement of the new 7 percent tangible common-equity baseline s
tandard, Vikram Pandit240—whose thinly capitalized Citigroup had received three government bailouts—had the chutzpah to complain to the press that the new rules would hurt lending. Other bankers, including JPMorgan Chase’s Jamie Dimon, supported the 7 percent standard but balked at the SIFI surcharge. During a June 2011 Fed press conference, Dimon challenged Ben Bernanke on whether the regulators had conducted any kind of analysis of the impact of higher capital and other new regulations on economic recovery. Taken by surprise, Ben hesitated, but several days later, during congressional testimony, he delivered a ringing endorsement of higher capital requirements for megabanks. During an interview at the Council on Foreign Relations, The New York Times’ Andrew Ross Sorkin asked me to respond to Dimon’s question. With regard to higher capital requirements, I said, “full speed ahead.” I also scoffed at the big banks’ oft-repeated arguments that higher capital would hurt lending, observing that “Banks are not doing a lot of lending now and the ones who are doing a better job of lending are the smaller institutions that have the higher capital.” Similarly, during numerous241 congressional appearances over my last several months in office, I strongly endorsed higher capital requirements for the nation’s largest banks.
The GHOS meeting on the SIFI surcharge was finally scheduled for Saturday, June 25, a week before my scheduled resignation. I had committed to give a major farewell speech at the National Press Club on Friday, June 24, so I was forced to take an overnight flight out of Washington’s Dulles International Airport, arriving in Zurich at 8 A.M. the day of the meeting. The BIS arranged for car service (a courtesy extended to all GHOS members) for the hour-long drive to Basel. I arrived at my hotel shortly after nine, took a quick shower, and barely made it in time for the 10 A.M. start of the meeting.
I took my usual seat between the OCC, now filled by John Walsh, and Mervyn King. The discussions had already begun, and Zeitler and Sanio were droning on. Axel Weber had unexpectedly resigned as the head of the Bundesbank in April to join the board of the Swiss banking giant UBS, taking himself out of contention to replace Trichet. In his absence, the German position was once again being led by those two, who were determined to lower the SIFI surcharge.
But Germany, at that point, was getting little support from the Japanese, and even the French seemed willing to compromise. I was horrified to hear Sanio openly embrace the OCC position. “My heart is with the OCC,” I remember him saying. Trichet and Nout had corralled just about everyone else to support a top SIFI surcharge of 2.5 percent for the biggest banks, with a punitive 3.5 percent applying if they had any ideas about getting bigger. But Germany kept standing in the way, and Sanio was openly using the OCC for cover.
I whispered to Walsh that the Germans were using him to block any agreement. At that point it was him and the Germans against twenty-six other countries. I asked him if he would at least tell the group he could live with the 2.5 percent as a compromise. That would take the wind out of the Germans’ sails. Otherwise, they were going to drag it out forever. Walsh looked thoughtful and nodded. He signaled that he wanted to speak and pressed his little mike button when Jean-Claude told him it was his turn to talk. Looking across the huge table at Sanio, Walsh smiled, got a laugh when he analogized the situation to Custer’s last stand, and said basically that it was time to surrender. The OCC could live with the 2.5 percent, and he didn’t want to get in the way of an agreement. Walsh never should have gone there with a paltry 1 percent, but at least he did the right thing in the end.
The Germans finally relented, and we all agreed on the 2.5 percent for the largest systemic banks. Added to the 7 percent baseline, we were at 9.5 percent, close to the 10 percent we had originally sought—good enough to declare victory. No one but Nout acknowledged my departure from public service, and that hurt. Nout again commended me for my work on the leverage ratio. His term as Basel Committee chairman was also coming to a close.
Nout’s acknowledgment was really all the thanks that I needed. The Basel Committee had already agreed on a leverage ratio, and that 9.5 percent capital requirement was a good going-away present. We had won.
CHAPTER 23
Too Small to Save
My recitation of the financial crisis and its aftermath has focused primarily on the excess risk taking and abuses that led to the crisis, the ensuing bailouts, and the struggle for regulatory reforms that continues to this day. Throughout this period, the FDIC played a critical role in stabilizing the system and influencing the policy debates surrounding the housing market and financial reform that followed. But while the FDIC played a leadership role in these high-profile actions, there was also our day-to-day work of handling small-bank failures.
During my tenure we closed 365 smaller banks representing more than $650 billion in assets. Many of these banks were poorly managed and took excessive risks. Others were caught by the Great Recession, particularly those which served hard-hit, lower-income areas. Whatever the causes of their failures, they were subjected to the discipline of the market. Their shareholders were wiped out, their boards and senior management fired, but their FDIC-insured depositors were always fully and seamlessly protected.
Sometimes I think we made it look too easy. Indeed, the overwhelming majority of these closings went so smoothly that I’m having a hard time thinking of a way to describe our process to you that won’t bore you to tears. It wasn’t glamorous work, it was just hard work, meticulous and painstaking in its execution.
In the early chapters of this book, I described to you the serious morale problems that plagued the FDIC when I arrived in 2006. I’ve always found that the best way to improve morale is to get employees focused on and energized about their core mission. So one of the management reforms I implemented early on was to streamline and focus our annual corporate performance objectives, placing a heavy emphasis on the job we had to do to maintain system stability: we had not only to protect depositors but also to make sure they would have seamless access to their money.
A deposit insurance system is not really effective if the insurer cannot guarantee uninterrupted access to insured funds. How would you like to be denied access to your checking and savings accounts for several weeks or months? When bank depositors ran the United Kingdom’s Northern Rock, it was not because they lacked confidence that the government would pay them; it was because they knew they might have to wait up to six months to get paid. No matter what else we did, we had to convince people that they would have uninterrupted access to their insured money. If they didn’t have that confidence, they would pull their money out of the banks just like those Northern Rock depositors, and the consequences would be disastrous.
To reinforce the point, I instituted something called “stretch” objectives that gave all employees an extra 1 percent in their bonus pools if certain metrics were met. At the top of that list was making sure all insured depositors of failed banks had access to their money within one business day. We never missed that target.
Our corporate objectives also put a heavy emphasis on executing resolution strategies that maximized our recoveries while moving banking assets back into the private sector as quickly as possible. Those two goals were interrelated. Government operation of banks generally leads to a deterioration of franchise value. The longer the government remains in charge, the less the value of the franchise once it is finally sold. That is not to disparage those who run banks for the government; they can be very talented managers. But bank customers generally don’t want to do business with failed banks under government control, given the uncertainty about who will own them next.
Early in the crisis, there were two schools of thought at the FDIC about how to handle failed banks. One school wanted to follow the model used by the FDIC during the savings and loan crisis, which had involved the FDIC taking over and running the thrifts for a time. The advantage of that approach was that it avoided the delicate task of trying to sell a bank before it was under government control. With the FDIC in charge, we had been free to openly market banks
and auction them to the highest bidder.
The disadvantage of that approach was the immediate hit to franchise value, as large depositors and valuable business customers would leave the bank during its government stewardship. That is exactly the phenomenon we witnessed with the IndyMac failure (though IndyMac would have cost us dearly no matter what, given its large amount of toxic real estate loans and weak deposit numbers).
The other alternative—the strategy we ended up using—was to auction and sell the bank before it actually closed. The advantages of that approach were that it would achieve a better price for the bank and immediately return banking assets to the private sector. In addition, our administrative costs would be much lower because we wouldn’t need the staff and contractor support required to manage hundreds of banks for several weeks, if not months, while we looked for buyers.
The problem, of course, was how to run an auction for the bank before it closed without signaling to the market that it was failing and precipitating an exodus of depositors and good-bank customers—exactly the kind of problem we were trying to avoid. In addition, potential purchasers of a failed bank would frequently want to have at least a few weeks to conduct a close inspection of the failing banks’ loan portfolio before deciding how much they wanted to bid. Without sufficient time to conduct that type of due diligence, it was likely that interested buyers would come in with very low bids, given their uncertainty about the quality of the failed banks’ loans.