Sheila Bair, the chairman of the FDIC, today spoke on regulatory reform. Her comments were nothing surprising or new. She called for the creation of a resolution mechanism for large failing institutions, more sharing of information between regulators, and strengthening consumer protections.
But one interesting statement:
The FDIC’s deposit insurance fund balance, an expression of its net worth, is -$20.9bn, because of provisions taken against failing banks. (To be scared further on that subject, see Calculated Risk.)
Toxic assets will be sold with a AAA guarantee from the US government under one of the options put forward by the Federal Deposit Insurance Company.
The FDIC has more than $36bn in toxic assets on its books, ready to sell. And apparently the corporation is seeking a decent return. Scared?
There appear to be two main differences between this plan and the one that nearly brought down capitalism: first, it’s the US government issuing the guarantee and not some special legal entity that can conveniently go bankrupt. Phew. Oh no, hang on. The second difference is that we know most of these assets are toxic, or worth less than initially thought. At least the first time round, they were bought in good faith.
In the wake of the financial crisis, the Federal Reserve has made much of the dangers of using interest rates to “lean against” asset bubbles, such as the one in the housing market whose collapse brought the US economy to the brink. Fed governors have implied that this was their only practical tool. (There have been quieter on the influence they may have wielded by warning of the bubble). The problem, several Fed governors have said recently, lied in a failure of regulation.
At today’s Financial Crisis Inquiry Commission hearings, Sheila Bair, chairman of the FDIC, had a response: the Fed, she said, should have regulated.
The new US bank levy will fall on uninsured debt – ie assets minus insured deposits minus equity. That makes a lot of sense.
Banks paid a premium to insure the insured deposits – these liabilities were always supposed to be insured against loss by the government via the FDIC.
In short, no. The new proposal would shift some responsibility for bankers’ risk-taking onto bank management. And that idea is bang on time.
Banks offering big bonuses for high risk trading would have to pay more to insure deposits, under a proposal passed by a US regulator yesterday. Banks with more cautious pay policies, such as bonus clawbacks, would pay less.
Thanks to Big Picture blog, which keeps us posted on the weekly death count in the world of banks. The same data, viewed as a cumulative chart, shows an upward trend in US bank failures. Indeed, for the geeks among you, the bank failures (red line) so closely mirror the exponential trendline (black), the R squared is 0.9948.
That does not mean, of course, that bank failures will continue along their current exponential path. But it does mean they haven’t slowed down in any significant sense – yet.
I have a good deal of sympathy for Sheila Bair’s idea that secured creditors should take a hit when a financial institution fails. But there are two problems with her proposal. First, it would kill the triparty repo market, where lenders assume secured really means secured. Second, it is not clear to me why we should want a standardised 20 per cent haircut. Better to estimate the haircut in normal bankruptcy and apply that to any special resolution process.
Moreover, it looks to me like the most promising way of getting some effective discipline from bank creditors is to focus on the more junior categories of debt – sub-debt and potentially reverse convertibles (I like the idea of requiring banks to hold debt that converts into equity when certain thresholds are breached).