by Sheila Bair
When investors do eventually turn to safer alternatives, interest rates will skyrocket, with devastating consequences for our financial system and our economy. Just about every interest rate on every financial credit product offered in the U.S. is influenced by the rate the U.S. Treasury pays on its debt. Banks and other financial institutions will have to start paying higher interest rates on their deposits and other borrowings to fund themselves, even though the loans they have on their balance sheets are paying lower rates. In making new loans, they will have to charge sharply steeper rates to try to stem their losses, which will hurt the ability of consumers and businesses to access affordable credit. The result will be more bank failures and another economic contraction. That is exactly the scenario being played out in Greece and to a lesser extent in Spain and Italy. It is a glimpse of our future if we do not get our fiscal situation under control.
The problem is made worse by the fact that the U.S. Treasury Department has suffered from its own case of short-termism. It has heavily relied on short-term debt issuances to finance operations. This means that $7 trillion will have to be refinanced over the next five years. The CBO has estimated287 that an interest rate increase of just 1 percent could add $1.3 trillion to the national debt over the next decade.
At the first closed meeting of the FSOC on October 1, 2010, I brought up our fiscal problems as a source of systemic risk. At my last FSOC meeting on March 17, 2011, I brought it up again. Tim and others expressed uncertainty about the FSOC weighing in, worried that it would look as though we were interfering with fiscal policy. Ultimately, however, we convinced our fellow FSOC members to include language in the FSOC’s 2011 Annual Report288 linking fiscal responsibility to financial system stability.
In late 2010, the National Commission on Fiscal Responsibility and Reform came forward with meaningful, credible proposals to reduce our ballooning national debt through a combination of measures. They included reductions and caps on discretionary spending, comprehensive tax reform, and reforms to the Social Security system and Medicare program, including increasing the retirement age and revising cost-of-living increases. Though President Obama appointed the bipartisan commission, led by Erskine Bowles and Alan Simpson, he inexplicably turned his back on the commission’s recommendations. Republicans have done no better in addressing the tough issues that the commission tackled in its report.
It seems that the only time Congress and the administration can work together in a bipartisan fashion is when they are shoveling money out the door through benefit increases or tax cuts. It took nearly a year for the Bowles-Simpson commission to develop its bipartisan recommendations to reduce our national debt by $4 trillion over ten years. Shortly after the report was issued, Congress added another $800 billion over ten years to our national debt. In a devil’s deal, Republicans got an extension of the Bush tax cuts, while the Obama administration secured a cut in Social Security payroll taxes and an extension of unemployment benefits. Neither side made a serious effort to pay for any of it.
The irony is that I think Main Street recognizes the dangers in our government’s excessive borrowing and would be willing to make sacrifices if they are fair and shared equally by all. The problem is that too many well-organized advocacy groups are vested in protecting every tax break or entitlement, whether it is hedge funds fighting for the lower tax rate on capital gains or the AARP opposing any adjustments to future Social Security benefits. Main Street needs to tell its elected representatives that they need a dose of common sense in managing the nation’s finances. They need to ignore the special interests and get our national budget in order.
CHAPTER 27
It Could Have Been Different
As you can tell from reading this book, I had a lot of strong objections and concerns about some of the “financial stabilization measures” (aka bailouts) that we undertook to deal with the financial crisis. Subtlety has never been my strength. Some people have asked me why I didn’t just quit. Throughout 2008, I didn’t feel that resigning was an option for the chairman of the FDIC. When public confidence in the nation’s banking system hung by a thread, my departure would itself have been destabilizing. In 2009, as we moved from the crisis into the cleanup phase, I seriously considered stepping down, particularly as it became clear that that the new administration was going to pursue and expand the same bailout policies. But I decided to stay for two reasons.
First, the FDIC itself had a big job ahead of it with bank failures, which were not expected to peak until 2010. We had done so much to improve morale and our operational capabilities. Given the delicate and challenging task of closing so many banks, I did not feel I could abandon ship. It would have been unfair to the FDIC staff, all of whom were working around the clock.
Second, by sticking with it, I thought I could make a difference.
We forced stabilizing sales of WaMu and Wachovia with no government support of shareholders or creditors, instead of providing the expensive government bailouts that Geithner and others were pressing us to do. We limited our 2008 temporary debt guarantee program to newly issued debt and charged a fee, instead of guaranteeing all of the big financial institutions’ debt free of charge, as we had originally been asked to do. We forced management changes at Citi. We refused to bail out CIT. We forced banks to raise significantly more capital than the other regulators would have required. We tirelessly advocated for loan restructuring for distressed home owners. And even though the government’s loan modification efforts fell far short, hundreds of thousands of home owners were able to stay in their homes because of our efforts.
We fended off implementation of Basel II for FDIC-insured banks, and we successfully pressed the Basel Committee to adopt a leverage ratio and impose a 9.5 percent capital requirement on the world’s largest banks, nearly five times as high as the Basel II standard. If I had not served on the U.S. delegation to the Basel Committee, I’m not sure what would have happened, particularly given Geithner’s and Walsh’s efforts to weaken the standards. And I seriously doubt whether Dodd-Frank would have contained the strong antibailout provisions and new FDIC resolution authority in the final legislation if not for my relentless efforts to include them.
Looking back, one of the saddest things about the financial crisis is that it could have been so easily avoided with a few commonsense measures. If we had raised capital requirements during the good times, we would have averted many failures, particularly among the investment banks. Instead, the leverage of investment banks and European institutions grew dramatically, and the FDIC had to fight a lonely battle to prevent the same thing from happening with the banks we insured. If the Fed had imposed lending standards for bank and nonbank lenders, so much of the mortgage lunacy could have been averted. And if Congress had not tied the hands of the CFTC, SEC, and state insurance regulators to impose some basic, commonsense regulatory controls on credit default swaps, the trillions of dollars of trading losses would have been much reduced.
This is not to excuse the conduct of the industry and place all the blame on the regulators. It was because of industry pressure that capital standards were lowered, mortgage-lending standards were blocked, and regulators were barred from overseeing the derivatives markets. It makes me very angry when I hear industry representatives try to blame the crisis on the government. Executives and traders at financial services firms are very well compensated for the jobs they perform. It is their responsibility, not that of regulators, to run their operations sensibly, in a way that delivers sustainable profits for shareholders. Yet far too few industry wrongdoers have owned up to their mistakes; far fewer have been held accountable by law enforcement officials. As I heard from the securitization group I spoke to in late fall of 2007, they felt they had a right to make fat profits by any means, and because the regulators hadn’t stopped them, it was all the government’s fault.
That is why I have written this book. I wanted you to see the crisis through my eyes and experience the obstacles that stood in my way as
I tried to push for reform measures that were so obviously needed. Unless Main Street fights back against the nonstop pressure from financial industry lobbyists to eviscerate needed reforms, we are going to be right back in the soup again. Already amnesia has set in to the Washington political landscape. Industry lobbyists are fighting hard against meaningful measures to raise bank capital requirements and reform the securitization market. In the next Congress, I have no doubt that these lobbyists will wage an all-out assault on Dodd-Frank reforms, including the provisions that ban bailouts of failing institutions. Some of those efforts will be visible. Some will be behind the scenes. Some may be supported by public interest groups that should know better. Still others may be led by captive regulators themselves, as we saw with the OCC leadership’s fighting higher capital standards.
Not everyone in the industry is bad, and not all members of the industry will be supporting efforts to roll back reform. After two and a half decades in Washington, I have learned that those who are most active in lobbying the government are generally those with the weakest business practices, as they have the most to lose from regulation. Unfortunately, the good industry players usually remain silent but not always. For instance, Ed Clark, CEO of TD Bank Group, has courageously spoken out in favor289 of the new Basel III capital standards and a return to traditional banking. But precrisis, most responsible banks stood idly by as we fought off Basel II and tried to tighten lending standards. That was the appeal I tried, unsuccessfully, to make to the American Bankers Association: that better-managed banks—like Main Street voters—need to stand up and be counted when regulators take measures to constrain bad practices that risk tainting the entire industry.
Unfortunately, there has been very little discussion of financial reform in the 2012 elections. Jon Huntsman was really the only candidate to try to engage in a meaningful debate over ways to make our financial system more stable. There has been some hyperbole on the political right about repealing Dodd-Frank, using the old industry saw that it is stifling credit availability. To be sure, Dodd-Frank is not a perfect law, but we are much better off having it than not having it. I suspect that the threats to repeal it in total are more campaign hype designed to elicit campaign contributions from financial firms than serious threats to completely undo this important law. But here again, Main Street needs to be engaged lest Congress throws the baby out with the bathwater and repeals the reforms that are essential to financial stability.
Regrettably, Dodd-Frank is a very lengthy, complex law, and too many of the rules being written by regulators are only adding to its length and complexity. That is why I have tried to explain and simplify the reform measures that I think are absolutely essential to keep and why I have suggested that a single council be empowered to write all systemwide rules.
The thing I hate hearing most when people talk about the crisis is that the bailouts “saved the system” or ended up “making money.” Participating in bailout measures was the most distasteful thing I have ever had to do, and those ex post facto rationalizations make my skin crawl. What system were we trying to save, anyway? A system in which well-connected big financial institutions get government handouts while smaller institutions and home owners are left to fend for themselves? A system that allows government agencies unfettered discretion to pick winners and losers with taxpayer money? A system that has created cynicism and despair among honest, average working people who take responsibility for their own actions and would never in a million years ask for a government bailout? A system that has spawned two angry political movements on the left and the right that are united in their desire to end the crony capitalism characterized by too-big-to-fail policies? That is not a system I want to save.
With the millions of lost jobs and lost homes and the trillions of dollars of lost tax revenue, how can anyone try to rationalize what happened by saying that the bailouts “made money”? In point of fact, they did not make money.
When the Treasury Department states that the bailouts “made money,” they are referring to the dollar amounts that were invested in the financial sector offset by the amounts that were paid back. Thus, the department does not count as a “cost” the very generous subsidies taxpayers provided financial institutions. As one distinguished group of academic experts has pointed out, this cash flow method of measuring bailout costs is inconsistent with government accounting rules:
During the height of the crisis290, few institutions were willing to commit funds in large amounts even on overnight terms. Acting on behalf of taxpayers, government agencies created new FDIC guarantees, TARP funding, and Federal Reserve lending and guarantee programs. Those programs supported extremely large amounts of financing at below-market terms for substantial periods of time. If those funds and guarantees had been priced at or near their true market value, taxpayers would have been entitled to substantially higher rates of return.
Even though on a cash-flow basis the TARP investments so far have made a profit, the government is not yet off the hook. It still has $45 billion at risk in AIG, another $27 billion in GM, and $147 billion and counting291 plowed into the GSEs, money that again supports the financial sector. In addition, the Treasury Department gave Citi, AIG, and GM special tax breaks to help them back to profitability. Those tax subsidies are worth tens of billions of dollars. And what about the less tangible but equally real costs of the moral hazard we created when we gave a helping hand to highflyers and boneheaded risk takers? I’m sure that with a wink and a nod, they would love to restart the party, figuring that the government will step in once more if things get too far out of hand. Hey, the bailouts made money, so what’s the big deal? Let’s do it again!
The bailouts, while stabilizing the financial system in the short term, have created a long-term drag on our economy. Because we propped up the mismanaged institutions, our financial sector remains bloated. The well-managed institutions have to compete with the boneheads. We did not force financial institutions to shed their bad assets and recognize their losses. Lingering uncertainty about the true extent of those losses made previously profligate management more risk averse when prudent risk taking and lending were most needed, particularly by small businesses. Only in 2012 are we finally seeing some meaningful pickup in lending by the big financial institutions. Economic growth is sluggish, unemployment remains high. The housing market still struggles. I hope that our economy continues to improve. But it will do so despite the bailouts, not because of them.
In my farewell remarks to the FDIC, I expressed amazement at the conduct we tolerated in the years leading up to the crisis. I said:
Looking back, how could we rationalize letting big firms take on leverage at 30 or 40 to 1, giving millions of people mortgages they couldn’t afford, a mortgage finance system which divorced the decision to make the mortgage from the responsibility if the loan went sour, the trading of hundreds of trillions of dollars’ worth of derivatives without any ability of the government to police it?
I also quoted a favorite passage of mine from Robert Frost’s poem “The Black Cottage”:
Most of the change we think we see in life
Is due to truths being in and out of favor.
The “truths” that form the bedrock of our democratic culture fell out of favor in the first decade of the twenty-first century. Personal accountability, honest dealing, the right to reap the rewards of your hard work and entrepreneurship, the obligation to suffer the consequences if you fail—those were the kinds of ideals most of us grew up with, but they were forgotten in the shortsighted avarice that consumed our financial markets. The role of government in a free society—not to protect us from ourselves but to protect us from one another, as Ronald Reagan once described it—was lost as Washington deluded itself into thinking that self-correcting markets could somehow substitute for basic common sense. It would be hard to find anyone on Main Street who was not in one way or another hurt by the horrible debacle. Government fundamentally failed in its role of protecting us.
Robert Frost once said, “In three words I can sum up everything I’ve learned about life: it goes on.” Unfortunately, that succinct phrase could also describe the kind of greed, short-sightedness, and misbehavior that brought us the 2008 crisis. It goes on.
Over a year has passed since I left the FDIC. It’s getting so I don’t even want to open up the morning papers. Let me highlight just a few of the more egregious parade of horribles.
In October of 2011, MF Global, a $41 billion securities and futures broker, went bankrupt, taking about $1.6 billion of misappropriated customer money with it. Still-weak capital and accounting rules allowed it to take on leverage of 40 to 1, and use the same kind of book-keeping gimmicks Lehman Brothers used to hide its bad assets. Eight months later, another big futures broker, Peregrine Financial, failed, taking about $200 million in misappropriated customer money with it. With both failures, the firms flagrantly violated the most sacrosanct of CFTC rules, those requiring futures firms to segregate and protect their customers’ money.
In May, JPMorgan Chase was profoundly embarrassed by a projected $2 billion trading loss on risky credit default swaps, trades which Jamie Dimon himself characterized as “stupid.” By the end of June, those losses had climbed to nearly $6 billion and counting. Though Chase’s balance sheet is more than strong enough to absorb these losses and still produce a profit, they underscore the impossibility of managing complex mega-banks from the top, even at an ostensibly well-run institution like Chase. Indeed, both Chase’s management, and its regulators, failed to grasp the risk of the outsized derivatives bets even after they were exposed several weeks earlier in the Wall Street Journal. Chase has at least announced that they will fire the traders and supervisors responsible for the losses and claw back up to two years’ worth of compensation from them. Chase’s regulators, on the other hand, have done nothing so far but hand-wringing.