Bull by the Horns

by Sheila Bair

  We held a press briefing following the bank closings, with Alfred Padilla, Puerto Rico’s top banking regulator. The briefing was packed—six cameras and at least fifty reporters—but I was well briefed and able to assure the media that there was no cause for alarm. Banking services would continue uninterrupted. Our public-education efforts worked. The bank depositors of the three failed banks left their money in the banks. There were no runs and no disruptions in banking services. I went to a late dinner that night at a local restaurant with Bob and Andrew Gray after an exhausting day. I was startled when, after taking our orders, the waiter bent down and gave me a big hug. I thought he was being fresh, but as it turned out, he had seen me on TV and wanted to thank me and the FDIC for protecting him and other bank depositors.

  Though for depositors the failures were a nonevent, attending bank closings provided me with a stark reminder of how painful and frightening bank closings are for bank employees. I generally have little sympathy for senior bank management and board members. They are usually the ones responsible for the mismanagement and mistakes that bring a bank down and deserve to lose their jobs. But many other employees, particularly the bank tellers and administrative staff, are not culpable. Frequently the acquiring bank will keep them on, but not always. In Puerto Rico, for instance, the banking sector was bloated and needed to be smaller, but that meant some employees would be laid off (fortunately, all of the acquiring banks agreed to keep employees on for a six-month transition period). Still, bank closings are an emotional, tear-laden experience for employees, many of whom have loyally served their banks for decades.

  FDIC staff generally call an all-hands meeting the evening of a bank failure to explain to bank employees that the bank has failed and typically introduce the new owner. Bank employees are also instructed to preserve all of the bank’s books and records. (Every bank failure is reviewed by the FDIC inspector general to determine the cause of the failure and whether fraud was involved.) I sat quietly in a large conference room as our FDIC staff talked to the employees of R-G Premier. I could hear quiet gasps and sobs from the back of the room. The Scotiabank representatives did a great job of bucking up the employees and letting them know they were valued, but still, R-G had served Puerto Rico for a quarter of a century. Now it was gone.

  If Puerto Rico was one of the more difficult logistical challenges, surely ShoreBank, a Chicago-based lender established to serve the needs of Chicago’s low-income communities, was one of the most politically challenging.

  Actually, any bank failure in the Chicago area was politically charged, given the red-hot animosity between President Obama and members of the House GOP. No matter what we did in Chicago, it seemed that one side or the other would go after us. A prime example was Broadway Bank, the family bank of Alexi Giannoulias, the Illinois state treasurer and Obama’s favored candidate to fill his Senate seat. Broadway had once been a well-run, profitable bank, but, like many other banks, it had gotten caught up in the real estate craze. In the 2000s, it had started making out-of-area construction loans in overheated markets such as Florida (where it had no expertise) and funded a lot of those loans with brokered deposits. We jointly regulated the bank with the state of Illinois. In January 2010, we issued a tough order against the bank, telling it to raise capital and take other remedial action. The Chicago Sun-Times immediately called our press office, demanding an interview with me. It wanted to know247 if this was “part of Sheila Bair’s war with the Administration” (in reference to my disagreements with Geithner over Dodd-Frank) and also questioned the timing of the consent order just “one week before the Illinois state primary.”

  Four months later, the bank failed, and the Republicans came after me for not closing the bank fast enough! Mark Kirk, the Republican candidate who was ultimately elected to the seat, made a lot of hay out of the bank failure during the campaign, and many feel it was determinative in the race. His close friend Congressman Darrell Issa demanded that the FDIC IG investigate the timing of the failure. Of course, there was not a scintilla of evidence to suggest political influence, but Issa’s well-publicized request kept the bank closing in the newspapers for a bit longer, which helped Kirk. But that is the way people do business in Washington. I just threw up my hands. (The FDIC IG did look248 at Issa’s charges, as he requested, and found absolutely no evidence of political influence.)

  In truth, neither I nor my board drove any of those decisions. As was always the case, the timing of the enforcement order, as well as the bank’s failure, was determined by our career examiners working with the bank’s primary regulator—here the Illinois bank superintendent. Those decisions were, in turn, based on the prompt corrective action process, which, as I’ve previously discussed, has fairly rigid timelines for closing a failing institution. I did not think political appointees should drive those decisions, so although the staff would report to me and the FDIC board on their enforcement actions and seek our approval to close banks, the decision making and timing were left to them. I can’t think of one case when the board did not defer to the career staff on a bank closing. That is the way I wanted it. It was not our job to go into banks, look at their deteriorating loans, and independently decide whether they were hopeless and at what point they would fail. We trained and paid our examiners and resolutions staff to make those decisions. And they made them very well.

  Nonetheless, I was batted around on bank closings a lot. Closing a bank is never a happy task, and there were always two sides: those who said we had waited too long and those who said we had prematurely closed the institution. But the political maneuvering and finger-pointing reached its apex with ShoreBank.

  All of the bank closings were heart-rending in their own way, but ShoreBank was a particular tragedy. It was a $2.2 billion state-chartered bank whose roots in the Chicago community went back to 1939. In 1973, it had been purchased by an organization devoted to community development and had refocused its mission on providing financing for low-income housing and business development in Chicago’s poor neighborhoods. For the first few decades of its operations, its model was enormously successful; it proved that banks could lend responsibly to economically distressed areas and remain profitable. Its efforts were replicated throughout the country. Indeed, ShoreBank was the inspiration for the hundreds of FDIC-insured community development financial institutions (CDFIs) that exist throughout the country today. It also received a lot of support from larger banks that drew from its pioneering work in serving low-income communities. Frequently, ShoreBank’s model products and services, once proven, were replicated by larger institutions.

  But in the early 2000s, ShoreBank started going astray. It began relying too much on its cachet and glamorous reputation among liberal groups and did not focus enough on the basics of running a bank. It made poorly underwritten loans and forayed into trendy areas beyond its core mission. And, rightly or wrongly, it became viewed as a “Democratic” organization, with a number of high-profile Democrats serving on its board. But I have to say that I never thought of the bank as exclusively “Democratic.” When I served at the Treasury Department in 2001–2002, the bank had a good reputation with the Bush appointees in office at the time, and the Bush administration supported many of its programs.

  Many management mistakes were made at ShoreBank, but it also suffered from the disastrous economic conditions in Chicago’s low-income neighborhoods, where the bulk of its loans were made. Recessions always hit low-income neighborhoods the hardest, and the Great Recession of 2008 was no exception. In July 2009, the bank’s condition had deteriorated enough that our examination staff issued, jointly with the Illinois Department of Financial & Professional Regulation, an order requiring the bank to raise capital. Throughout the remainder of the year, ShoreBank’s board, aided by Eugene Ludwig, the comptroller of the currency under President Clinton, tried to raise new capital to stabilize the bank.

  At the same time, the Treasury Department had established a new TARP specifically designed to help CDFIs,
many of which were experiencing the same problems as ShoreBank. The plummeting housing market and high unemployment rate in low-income areas were hurting the CDFI community badly. Though the usual prerequisite for TARP investments for the smaller institutions was viability, meaning that the bank applying for TARP capital had to prove that it was viable even without the TARP money, this program required the bank to demonstrate only that it would be viable after the TARP capital infusion as long as it had raised an equal amount of capital from the private sector. The Treasury Department also imposed a cap on the amount of capital an individual institution could receive, which in the case of ShoreBank was $72 million.

  The FDIC and Illinois state examiners had determined that ShoreBank needed an additional $175 to $202 million to be well capitalized. Ludwig therefore needed to raise more than $100 million to qualify for the Treasury’s program.

  I was very worried about the cost of a ShoreBank failure. The problem was that, given its business model, the only institutions that were likely to be interested in buying it were other CDFIs. However, CDFIs in general were experiencing problems, and most of them were much smaller than ShoreBank, with assets of a few hundred million dollars, not a few billion. There just weren’t any healthy CDFIs out there that were big enough to buy ShoreBank. I was also skeptical that any other bank would want to bid on the bank because of the politically charged nature of its operations and loan portfolio. Indeed, another Chicago institution that had been closed the year before—Park National Bank—had also been active with local community groups and had made significant loans and other contributions to them. A very good, well-run bank, U.S. Bancorp, had bought Park National and was trying to deal with its many troubled loans in a fair and balanced way. Nonetheless, U.S. Bancorp had been subjected to much public criticism from community groups and Democratic members of Congress for not doing enough. It was truly a case of no good deed going unpunished.

  Given U.S. Bancorp’s experience, why would any other bank want to buy ShoreBank and confront the difficult task of dealing with its many troubled loans? Under our loss-share agreements, we had very firm rules about restructuring loans to preserve economic value, but the reality was that some of ShoreBank’s loans would have to go into foreclosure. Foreclosing in those distressed neighborhoods would be a public relations nightmare for an acquirer.

  Not that the Republicans were making it any easier on the right. Many of them basically took the tack that ShoreBank was an “Obama bank” and anyone who tried to help it was doing so under political pressure from team Obama. So, even though many investors wanted to help ShoreBank because they believed in its mission, helping with the recapitalization would open them up to criticism that they were just kowtowing to the administration.

  Every Monday morning, I held senior staff meetings to receive status reports from our senior managers and set our priorities for the week. During the meetings, Sandra Thompson would always volunteer an update on ShoreBank’s capital raising. It wasn’t going well. Given the heat coming from both sides of the political spectrum, Ludwig was having a hard time. So in early 2010, I instructed Jim Wigand and his team to start beating the bushes for possible buyers, as it looked as though ShoreBank would fail. They developed a list of more than two hundred target institutions and started working the phones. Unfortunately, no one was seriously interested in buying the bank.

  Ludwig then contacted me directly and said he had about $70 million in capital investments, just short of what ShoreBank needed to apply for funds under the Treasury program. Most of the major banks were investing, with the exception of Goldman Sachs and a few others, which had refused. I hit the roof. Goldman had made generous use of our debt guarantee program as well as the Fed’s lending facilities and Treasury’s TARP capital investments. Goldman had one of the stronger balance sheets in the industry, and other strong banks, including JPMorgan Chase, Wells Fargo, U.S. Bancorp, and PNC, had stepped up, bid, and purchased failed institutions from us. I felt that Goldman was more interested in taking than giving back.

  Around that same time, the SEC had announced a major enforcement action against Goldman Sachs, based on its failure to disclose important information to investors about the risks of certain complicated securities deals. A few days later249, Warren Buffett was quoted as defending Goldman’s actions. I didn’t know anything about the merits of the SEC’s suit, but I wasn’t feeling too charitable toward Goldman, so, still in a snit, I called Buffett to question his defense of the institution. I was probably out of line, but I told him that I was frustrated with Goldman’s complete lack of interest in helping us recapitalize failing institutions (as Buffett had done with it during the depths of the financial crisis). It had reaped a lot of benefits from having an insured bank and becoming a bank holding company but didn’t seem interested in working with the government to help with the postcrisis cleanup.

  I don’t know what Buffett said or did, but literally, within an hour, Goldman CEO Lloyd Blankfein was calling me, asking if there was something he could do to help me. I recounted to him my disappointment that he had refused to participate in the ShoreBank recapitalization. I explained that the bank was close to raising the required amount, but if the bank didn’t make it, it would be a very expensive failure for us as we had no bidders. To his credit, Blankfein agreed not only to contribute to the ShoreBank recap but also to help recruit other investment interest.

  Of course, nothing having to do with ShoreBank ever stayed out of the press. Within a few days250, there was an article in The Wall Street Journal describing Goldman’s leadership role in ShoreBank’s capital raising. Then the public flogging began. A Democratic member of Congress, Jan Schakowsky, lambasted Goldman and the other big banks, saying that they “have a moral251 and economic obligation to step up and make certain that ShoreBank can continue serving Chicago’s low-income communities.” The folks on the right immediately accused Goldman of trying to curry favor with the Obama administration. The worst critic, by far, was Charles Gasparino at Fox Business Network. Gasparino was usually a supporter of the FDIC and its antibailout philosophy. But for whatever reason, in covering this story, he was over the top with unsubstantiated accusations that the White House was putting pressure on all those banks to pony up and even suggested that I—a lifelong Republican—was helping it.

  In truth, I was trying to minimize losses to the Deposit Insurance Fund by reaching out to potential investors, as I had done several times before when bank management and staff efforts had been unsuccessful. Why was this institution having such a hard time finding investors? A big part of the problem was all of the politicization on the left and right. If it had been a bank in Minnesota, we would not have had those issues.

  Blankfein committed Goldman to a $20 million investment and called a number of other CEOs, asking them to invest. But the tenuous condition of the bank, combined with the adverse press and political heat, made his job difficult. By mid-May, ShoreBank’s ninety-day time frame to raise capital under our rules was expiring, and the bank still hadn’t raised the capital that it needed. So Jim Wigand intensified his team’s efforts to find bidders and, keeping his fingers crossed, started soliciting bids, all to no avail. At the end of the week, on Friday, May 14, Jim Wigand and Chris Spoth called me late in the afternoon to deliver the bad news.

  They found me on my cell phone in the backseat of a car heading to the University of Massachusetts, where I was supposed to deliver the commencement speech the next morning. I had thought I was going to enjoy a relaxing weekend in Amherst, where we had lived for four years.

  The bank hadn’t raised enough capital, they told me, and we had no buyers. After a long silence, Wigand said, “You better start making some calls.” I agreed.

  I asked Chris for the list of bank CEOs who had committed to invest in a recapitalization and the list of CEOs whom Blankfein had called but who had not committed. Instead of visiting with friends in Amherst over the weekend, I spent it holed up in a hotel room, “dialing for dollars,�
� as we called it. Chris Spoth, a smart strategist, had suggested that I explain to the investors that there were two possible approaches: they could help ShoreBank raise enough capital to stay open and qualify for additional capital under the Treasury program, or they could form and capitalize a new bank to bid on ShoreBank in our resolution process (the same technique private-equity funds were using to bid on failed banks). I mentioned both options to the CEOs when I called them, but Option 1 was the least complicated alternative, as there were many steps involved in forming a new bank.

  I also asked Jim Wigand to give me our loss estimates if we had to liquidate ShoreBank, as I wanted the CEOs to understand the severity of the situation: if we had no bidders, we would be forced to pay off the depositors and auction the loans separately. Again, because of the bad publicity and political controversy surrounding ShoreBank’s operations, I didn’t expect us to see many bidders for the loans. Losses were always steep in a liquidation, which is why we always tried to avoid them; in that case, they were likely to be catastrophic.

  Jim’s team estimated the cost of liquidation at $400 million or higher. Armed with that information, I started calling the CEOs. I scripted my remarks carefully to let them know I was not putting pressure on them, I just wanted them to have all the facts in making their investment decision. I told them that after months of trying we did not have any bidders and our liquidation costs would be north of $400 million. Since they all paid premiums to cover our losses, ultimately they would bear these costs. Indeed, some of the bigger depository institutions, such as BofA, accounted for 10 percent of our premium revenue, so if our loss was $400 million, BofA would cover $40 million of it. A capital investment of half that, $20 million, by BofA (which is what Blankfein had asked for) would actually save it money by averting a costly failure.