by Sheila Bair
Hank and Ben Bernanke had also started meeting with congressional leaders to seek approval of legislation authorizing $700 billion for the purchase of illiquid mortgage-backed securities and other “troubled assets,” aka the TARP bill. We were not involved in those early discussions and were not consulted in any meaningful way about what needed to be done. However, the bill failed spectacularly on Monday, September 29, and the Dow Jones Industrial Average tanked by 778 points. The congressional leadership told Hank and Ben that they needed to demonstrate a more tangible benefit to “Main Street” depositors if they were ever going to secure enough votes to pass the TARP bill.
So they came back to us with the idea of increasing deposit insurance coverage from the current limit of $100,000 to $250,000. I was not opposed to the idea, but I also didn’t think it would make much of a difference for either Main Street depositors or banks. There were already a number of fairly simple ways for depositors to secure coverage in excess of $100,000, and after IndyMac’s failure, we had seen massive amounts of uninsured deposits being restructured to obtain full coverage. For instance, a married couple could have three separate accounts, each with $100,000—two individual accounts in each of their names and a joint account. They could easily obtain another $500,000 in coverage by setting up a trust account with five different beneficiaries. At that point, the depositors who really needed additional protection were small businesses, whose bank checking accounts would periodically balloon well over our limits when they would deposit large sums to meet payroll or other cyclical obligations. Those business accounts were being pulled from smaller banks and being deposited in too-big-to-fail institutions such as Bank of America. I suggested temporary unlimited coverage for business checking accounts, and others, such as the conservative economist Larry Lindsey, supported that view. However, Hank, Ben, and Tim would not support me; they always thought they knew better. Sometimes I wonder why they even bothered to ask, except for appearance’s sake. Their reasoning was that such a move would lead to “distortions,” with foreign depositors putting their money into U.S. banks to take advantage of the higher limits. I thought that was somewhat ironic, given just a week before, they had been going to give securities firms unlimited coverage for their money market funds (and would later ask me to guarantee the debt of all financial institutions without limit).
I also asked for their support in raising the FDIC’s borrowing limit from the U.S. Treasury. At that point, there was a tremendous amount of focus on our declining Deposit Insurance Fund, and our backup line at Treasury of $30 billion was, I thought, woefully inadequate to provide a credible backstop for guaranteeing more than $5 trillion in insured deposits. We managed our resources carefully during the crisis and, as it turned out, never had to borrow from Treasury. But I was very worried that should we have a very large failure, our short-term funding needs could easily blow through the $45 billion we had in reserves plus the $30 billion credit line. The credit line had not been raised since 1991, when insured deposits had been around $2.4 trillion. It was important to me that we have enough money on hand that depositors would have uninterrupted access to their accounts. We saw the instability that had occurred in the United Kingdom after one of its major mortgage lenders, Northern Rock, had gone down. One of the reasons for the deposit run on Northern Rock was the fact that it could take months for depositors to access their insured deposits in the UK. People expected ready access to their bank deposits; they needed that money for paying bills, loans, medical expenses, what have you. And in truth, I was starting to worry a bit about Bank of America. I thought it had overextended itself with acquisitions, including the planned purchase of Merrill Lynch. BofA’s deposit base was over $800 billion. If the press started seriously scrutinizing our ability to protect the depositors of an institution that size with only a $30 billion credit line, we were going to have a serious public confidence problem on our hands.
But I received only token support for raising the credit line from the Treasury and White House, and in the end it was not included in the bill either. It felt like all they wanted from us was the appearance that they were doing something for Main Street, and raising the insurance limit to $250,000 was an easy sound bite. They weren’t interested in having a serious discussion with us about other measures we felt we really needed. Of course, though I didn’t know it at the time, they had probably already decided that they were going to bail all the big banks out with the $700 billion they were getting from Congress, so BofA failing was not really something they were worried about. But the word I got back63 from the White House was that Congress felt it was already providing enough of a bailout with the $700 billion. I couldn’t believe the mixed-up priorities. Seven hundred billion for a big bank bailout. Zero for the deposit insurance system.
Raising the deposit insurance limit helped Hank and Ben garner the votes they needed to finally get TARP passed on October 3, 2008, but as soon as the bill passed, the plan changed from buying troubled mortgages and mortgage-related investments to guaranteeing the debt of big financial institutions and giving them capital injections. On Tuesday, October 7, Jesse was contacted by Christal West, Hank’s assistant, asking that I attend a meeting at Hank’s office on Wednesday morning. Jesse emailed back, “Do you want to discuss64 TARP? Just want to be prepared.” Christal responded, “I’m not sure. I’ll get back to you once I can raise with Hank,” but she never did.
I showed up at Hank’s office at ten, still not knowing what the meeting was about. He was sitting in a chair. Ben Bernanke was sitting on a couch. In between them was a table with a conference phone. Tim Geithner was on the line. It was an ambush. They told me that they wanted me to publicly announce that the FDIC would guarantee the liabilities of the banking system. They had even already prepared a script for me:
It is the policy65 of our federal government to use all resources at its disposal to make our financial system stronger. In light of current conditions, the FDIC, with the full support of the Fed and the Treasury, will use its authority and resources to protect depositors, protect unsecured claims, guarantee liabilities and adopt other measures to support the banking system.
So, after failing to support my efforts to get our line of credit raised, now they wanted me to stand up and say that the FDIC was going to be guaranteeing everybody against everything in the $13 trillion banking system—and the Treasury and the Fed would be right behind me.
It was an overreach of the worst sort, and there was no doubt in my mind that Tim Geithner was the instigator. For months, he had been arguing that the federal government should guarantee all the debt of U.S. financial institutions, but no one had taken him seriously—until now. I decided to play for time. Yes, of course, I wanted to work with them on financial stability, but a step of this magnitude would have to be discussed with my board.
I took the language back to my office and shared it with my two internal board members, Marty Gruenberg and Tom Curry. They were as incredulous as I. On the other hand, how could the FDIC turn down a direct request from the chairman of the Federal Reserve and the secretary of the Treasury? I reviewed the proposal with our staff to see if we couldn’t come up with an alternative program that would help stabilize funding in the financial markets without requiring that the FDIC take such a huge amount of risk.
On the following Friday66, October 10, I sent Hank a counterproposal. We would guarantee the newly issued debt of the banks we insured at 90 percent of face value. Current bondholders did not need our protection. They had already made their investment and were stuck with it. We acknowledged that there was a problem for banks in being able to reissue debt as outstanding bonds matured, and we were willing to address that problem, but for only 90 percent of the obligation; we still wanted bondholders to take some risk. We also wanted to charge a fee for the guarantee, as we did with deposit insurance. We weren’t going to give away that government benefit for free.
For viable insured banks, we also proposed a variety of other measures. First
, we wanted to launch a program of temporary, unlimited deposit insurance for business transaction accounts; that had not been addressed in the TARP bill, but a lot of otherwise healthy community banks were under distress due to trying to meet the deposit withdrawal demands of those valuable business customers. That was serving the purposes of the too-big-to-fail banks that were getting the deposits, and I was still angry that Treasury had not supported us during the congressional consideration of TARP. In addition, we proposed our own troubled-asset relief program for viable banks: we would set up a “bad bank” to acquire their assets at a steep discount and restructure them as needed. Finally, we were willing to provide capital injections, so long as they were accompanied by management changes and increased supervision. All of those programs would support FDIC-insured institutions and would be paid for through assessments on the industry. We were willing to take on the task and the attendant risks of cleaning up the insured banking sector, which was our responsibility, but we did not think we should be stretched to bail out investment banks and insurance companies, particularly now that Treasury had its $700 billion in TARP funds.
Hank called me and, after some discussion, agreed to our guaranteeing only new debt and charging a fee, but he pushed back hard on limiting the guarantee to FDIC-insured banks and then guaranteeing only 90 percent of the principal. He told me that the Europeans were moving toward guaranteeing holding company debt at the full amount and that we needed to coordinate our actions with the global community. Pointedly, if the Europeans provided full guarantees and we provided only partial guarantees, it would put our financial institutions at a big disadvantage. He invited me to attend a dinner he was hosting that night of the G7 finance ministers and central bank heads. All of the world’s leading financial powers would be there.
It was a smart move on Hank’s part because it helped me understand the broader, global dynamic and fears among the world’s central bankers and finance ministers. Like Congress, I had been expecting Treasury to use TARP to buy troubled assets, Treasury’s stated purpose. But during the G7 meeting, it became clear that no one had a plan to put a troubled-asset program together quickly enough. Debt guarantees and capital investments, however, could be put into place within a matter of days. It was also clear that the Europeans were going to be providing full guarantees for bank holding company debt. Since Treasury had requested that Congress give it the authority to buy troubled assets, the legal authority for Treasury to make capital investments was ambiguous at best and nonexistent for debt guarantees. The FDIC, with our authority to provide systemic risk assistance, was the Treasury’s best bet.
We continued wrangling over the issue throughout the weekend. During marathon meetings in the Treasury Department’s large conference room, my team—Jesse; John Thomas, our deputy general counsel; Jason Cave, my senior adviser; and Art Murton, our head of insurance and research—went back and forth with lawyers from Treasury, the Fed, and the OCC. As was typical, we were surrounded; it was amazing how eager and willing other agencies were to expose us to risk. Lawyers at the Treasury Department and Federal Reserve insisted that we did have the authority to guarantee holding company debt; our lawyers thought their interpretations were a stretch but couldn’t definitively determine that we were legally prohibited from doing so. After a weekend of negotiations, we finally achieved agreement on a debt guarantee program that would be limited to reissuance of expiring debt and for which we would charge a fee. Amazingly, Tim Geithner argued for minimal fees, his reasoning being that we were trying to save the system, so financial institutions shouldn’t have to pay for system stability. My view was that many of them were responsible for the crisis and that since they were on the ropes, we should make them pay dearly for that government benefit. At the same time, I realized that if we charged too high a fee, it could undermine the economics and effectiveness of the program.
The first problem I saw was one of adverse selection. The truth is, there were only three major institutions at that time that were clearly insolvent with no options for accessing capital from nongovernment sources: Merrill Lynch, Citi, and AIG. Morgan Stanley and Goldman Sachs were having problems, but they had been able to access additional capital from “deep pockets” (Warren Buffett for Goldman Sachs and the giant Japanese bank Mitsubishi for Morgan Stanley) and probably could have bumbled through. I was starting to worry more about BofA, but the other major financial institutions—JPMorgan Chase, Wells Fargo, Bank of New York, and State Street—were in reasonably good shape. All had remained profitable, even though everyone’s funding costs had spiked after Lehman’s collapse. But if we made the fees too punitive, those healthy institutions would not participate. Thus we would be stuck insuring the high-risk institutions without benefit of fee revenue from the healthy institutions to protect us against losses.
But the other, more important reason for not making the fee structure too punitive was that we were trying to get funding costs down to minimize disruptions to the credit flows supporting the real economy. Credit spreads, which reflect the cost to banks of borrowing to fund their operations, had widened dramatically. If there was a reason to provide the debt guarantee (indeed, the only reason to provide the debt guarantee), it was to keep the banks in a position of continuing to lend. Make the guarantee too high, and you defeat your purpose. So we decided to charge a fee that would replicate banks’ funding costs in a normalized market environment.
The other question was how long the FDIC was willing to take exposure. Views on that question were all over the place. I finally decided on a three-year time frame. A key source of instability for large institutions during the crisis was their excessive reliance on short-term funding. The investment banks and Citigroup in particular had relied heavily on unstable, short-term funding, which had quickly evaporated at the first sign of trouble. I did not want to reinforce that by putting short time limits on the maturity of the debt they could issue. Moreover, we didn’t know how long it would take until the debt markets normalized. If we had tried to cap the maturity at six months or a year, we would have been confronted with the specter of all those major institutions having to replace huge amounts of government-guaranteed debt at the same time. So we settled on a three-year time horizon to provide more stable long-term funding as well as sufficient breathing room for a gradual, orderly transition out of the program.
We were also finally able to convince Treasury and the Fed that something needed to be done to guarantee business transaction accounts. Ironically, some at the Treasury were concerned that an unlimited guarantee for those accounts would destabilize money market mutual funds! We assured them that our target was business transaction accounts and agreed to limit the guarantee to accounts that paid no or nominal interest. Those types of accounts would not be attractive to money market fund customers, who were looking primarily for investment returns, not payroll and other types of transaction services.
We were not, however, able to convince Treasury and the Fed to support a systemic risk exception so that we could provide troubled-asset relief to viable banks via a good-bank/bad-bank structure. At that point, Treasury itself was still mulling over eventually launching a troubled-asset program, and I think turf issues were a factor here—they wanted to run the program, not us. Of course, Treasury never did launch such a program for troubled loans, and I think the lack of a cohesive, centralized government program to effectively deal with troubled mortgages and commercial real estate loans continues to hinder the recovery of the real estate market to this day. In contrast, during the Great Depression, the government launched the Home Owners’ Loan Corporation (HOLC) to buy up and restructure troubled mortgages; similarly, in the aftermath of the S&L debacle, the government had created the Resolution Trust Corporation (RTC), under the direction of the FDIC, to clean up the mess. But it was easier and faster to write fat checks to big banks to stabilize the system in the short term, and the harder work of cleaning up the loans still hasn’t been done.
It was not until that
long weekend that we were formally informed by the Treasury and the Fed that they were going to launch a TARP capital investment program. The first inkling we had of it was a press leak on Thursday, October 8. We were not consulted in the decision to select the banks that would receive the first round of TARP money—that was done by Tim Geithner in consultation with John Dugan—nor were we consulted on the amount. In fact, we were surprised to find out that the program would include mandatory investments in all of the major commercial banks because, with the exception of Citigroup, they had seemingly strong capital levels and were nowhere near being insolvent. My strong suspicion was that they were making those capital injections to provide cover for propping up the investment banks and Citi, though both the Fed and the OCC insisted that all of the nine institutions to receive the TARP money were solvent. (Of course, later, Citi would need more rounds of support, as would BofA as the acquirer of Merrill Lynch’s toxic assets and unstable balance sheet.) Frankly, I was taken aback when I was invited to a meeting on Sunday, October 12, with Tim, Ben, and Hank, where they strategized over how to force all of those banks to take TARP capital. They were particularly worried about the cooperation of probably the two strongest banks, Wells Fargo and Chase. I kept my head down and mouth shut during that prep session except to say that I thought the banks should be required to commit to loan modifications for troubled borrowers. Hank and the group readily agreed to extract a general commitment from them but did not want to go so far as to impose specific obligations.
