Bull by the Horns

by Sheila Bair

  The CEOs of the nine largest banks were summoned to the Treasury Department the next day, Monday, October 13, and ordered to take the TARP capital.

  The meeting concluded with most of the CEOs saying they would check with their boards and get back to Hank by the end of the day. As I exited the Treasury Building after the meeting, I confronted a wall of reporters as well as a handful of protesters standing in a Treasury parking lot, deriding fat cats and bailouts. Apparently mistaking me for a fat cat, one of them shouted at me as I walked past the group, “How much did that suit cost that you have on?” (His jaw dropped when I responded truthfully that it had cost $139 at Macy’s.)

  By the end of the day, all the CEOs had notified Hank that they would participate in the government’s programs. At 7:30 A.M. on the following Tuesday, Hank, Ben, and I, along with the rest of the regulators, met with President Bush in the Roosevelt Room to brief him on the programs and the buy-in by the nine banks. The president actually personally thanked me for offering the debt guarantee program; it was obvious to me that there had been considerable debate within the White House about the legal authority to launch the program and the scope of the FDIC’s authority. After being relentlessly pressured and pushed around, I was gratified that at least the president was acknowledging the brave step the FDIC was taking.

  The meeting with the president was followed by a press conference in the Treasury’s Cash Room, a beautiful room of marble and gilt, styled in the fashion of an Italian palazzo, where, in the late 1800s, banks and members of the public could redeem securities or cash government checks in exchange for the bills and coinage kept in Treasury’s vaults. Hank, Ben, and I were the only three to have “speaking parts.” I was exhausted from the events of the weekend, and the crowds of reporters and glaring lights of the TV crews were daunting. The weight of the decisions I had made and the unknown risks that I had assumed on the part of my agency weighed on me heavily. I had prepared my remarks carefully and decided that the best approach was to express optimism and confidence in our country and our banking system. The FDIC was all about public confidence, and as the head of that agency, I felt it was my job to tell the country that I thought it was going to be okay. The banks they relied upon to keep their money and make them loans were going to hold up and continue to provide those services. The programs we were announcing were designed to make sure that was the case.

  The press conference was followed by the issuance of a joint statement by the Treasury, Federal Reserve, and FDIC, seeking to explain the benefits to the public of supporting bank lending. At our request, the press release also noted that the banks “have also committed67 to continued aggressive actions to prevent unnecessary foreclosures and preserve homeownership.” Consistent with our usual high standards of operational excellence, the FDIC expeditiously and efficiently fulfilled our obligations under the program. By October 23, the program was in place and approved unanimously by the FDIC board of directors.

  Regrettably, throughout implementation, we had to struggle against the efforts, primarily by Geithner, to make the program more generous.

  Tim wanted us to guarantee the debt not only of banks and their regulated holding companies but also of any affiliate organizations within the holding company structure. I flatly refused. There were tens of thousands of such entities, and we had no way of evaluating the risks of such a bold move. Fortunately, the United Kingdom’s debt guarantee program was limited to one entity within each financial holding company structure, which helped us fend off his arguments for broader coverage. But of course, all that was being driven by Citi’s special needs; unlike most banks, which used their holding companies to issue debt, Citi issued its debt through a variety of affiliate structures. Unfortunately, Don Kohn, who was usually helpful to us, supported Tim in his desire to have us guarantee affiliate debt. But Don was willing to compromise, so we agreed to let banks apply for special permission to issue guaranteed debt out of an affiliate if they received approval from the Fed (which, of course, Citi did).

  We also excluded most thrift holding companies from our guarantee program, because the OTS could not give us an accurate count of all its thrift holding companies and frankly, we did not have confidence in the quality of the OTS’s holding company supervision. For instance, we had no intention of guaranteeing the debt of AIG, which was a thrift holding company. However, that also excluded GE Capital from the debt guarantee program, and GE—which was heavily funded with senior, unsecured debt—quickly found itself at a huge competitive disadvantage to bank holding companies, which could now offer an FDIC guarantee to bond investors. GE CEO Jeffrey Immelt called and came to see me, explaining the disadvantage his company confronted. And of course, he had the strong backing of his regulator, as well as Hank Paulson. I asked our examiners to take a look at our credit exposure. The report back was favorable on both GE’s capital position and its risk management and information controls. I decided to approve it once Immelt agreed to have the commercial side of GE—the one that makes everything from lightbulbs to jet engines—guarantee us against loss. Both its financial arm and its commercial arm were triple-A-rated. It was inconceivable that we would take losses on the guarantee except in an Armageddon scenario. And the fee revenue from GE promised to be substantial, which would bolster our reserves against the higher risk of losses from weak institutions such as Citi.

  The Temporary Liquidity Guarantee Program (TLGP) was the least controversial of the initiatives announced on October 14, probably because it was industry funded (unlike TARP) and the amounts involved, though substantial, paled in comparison to the trillions of dollars the Fed was throwing at financial firms. Trying to be the good soldier, I got out there with Hank and Ben in an effort to explain the public benefit of the programs. But the public backlash was substantial. Public ire was trained primarily on TARP, because of its use of taxpayer money. Antibailout sentiment continues to influence the political landscape in the United States. This anger is justifiable. Participating in those programs was the most distasteful thing I have ever done in public life. But we clearly had to do something, and they did achieve their intended short-term objective of stabilizing the system.

  Looking back, I don’t think the capital investments would have been necessary if the government had had the legal tools to wind down the truly sick institutions in an orderly fashion. Citi, Merrill, and AIG (which was being bailed out in a separate effort run by Treasury and the Fed) were insolvent and should have been put into our bankruptcy-like resolution process, but we didn’t have the legal authority at the time. The Lehman experience demonstrated that bankruptcy was not an option for the orderly resolution of large, interconnected financial institutions. The government needed a process similar to the one we had for insured banks. Later, largely through the FDIC’s advocacy, we would secure resolution tools in the Dodd-Frank financial reform law to resolve both bank and nonbank systemic entities. We also secured a statutory ban on bailouts of insolvent institutions.

  But we did not have the resources, clout, or response time to try to push Congress in that direction in the fall of 2008. Frankly, from where we sat—looking primarily at what was going on inside insured banks—things didn’t look that bad. Yes, we had our weak institutions, but, with the exception of Citi, they had been successfully resolved through acquisitions or the FDIC’s resolution processes. As I stated in an October 9, 2008, email to Hank and Ben, “Our best available information68, gathered in consultation with other bank regulators, is that projected bank failures remain manageable and within the capabilities of our industry-funded resources.” Citi was a problem, but the FDIC’s direct exposure was limited, given Citi’s small insured deposit base. Unfortunately, we did not have a good picture of what was going on in the nonbank sector, and the Fed and Treasury—to the extent that they had better information—were feeding it to us in spoon-sized portions, and only when they needed our participation in the bailout efforts. Some of our staff strongly suspected that Tim’s push for us to gua
rantee all bank holding company debt was more about protecting derivatives dealers from having to pay out huge sums on credit default protection than the protection of bondholders.

  To this day, I wonder if we overreacted. Like the rest of the country, I was appalled that all of those institutions paid out big bonuses to their executives within months of receiving such generous government assistance. The Treasury would eventually invest $165 billion in nine institutions (most of it going to Citi and to BofA to support the Merrill acquisition) and that doesn’t count all of the indirect assistance provided to them through the hundreds of billions in government support given to AIG (which was a counterparty to most of them) and plowed into Fannie Mae and Freddie Mac, which protected them from losses on their GSE debt securities. The FDIC would guarantee $330 billion of their debt, and they would receive trillions of dollars in special programs set up by the Federal Reserve to provide them with loans on terms far more generous than those available in the market. Were we stabilizing the system, or were we making sure the banks’ executives didn’t have to skip a year of bonuses?

  Yes, action had to be taken, but the generosity of the response still troubles me. We dialed back considerably what the Fed and Treasury had originally asked us to do, and yes, on a cash-flow basis we made money off of our guarantee program. But does that justify the bailouts? How many other smaller businesses and households could also have survived intact if the federal government had been willing to give them virtually unlimited amounts of capital investments, debt guarantees, and loans? Granted, we were dealing with an emergency and we had to act quickly. And the actions did stave off a broader financial crisis. But the unfairness of it and the lack of hard analysis showing the necessity of it trouble me to this day. The mere fact that a bunch of large financial institutions is going to lose money does not a systemic event make. And the rationale—to keep them lending—didn’t meet expectations. Yes, the steps taken prevented a more severe credit contraction, but the big banks still pulled back.69 Indeed, between 2008 and 2010, they pulled trillions of dollars in credit lines and their loan balances fell significantly. Throughout the crisis70 and its aftermath, the smaller banks—which didn’t benefit from all of the government largesse—did a much better job of lending than the big institutions did.

  CHAPTER 10

  Doubling Down on Citi: Bailout Number Two

  October 14 was not the end of it. By November, the supposedly solvent Citi was back on the ropes, in need of another government handout. The market didn’t buy the OCC’s and NY Fed’s strategy of making it look as though Citi was as healthy as the other commercial banks. Citi had not had a profitable quarter since the second quarter of 2007. Its losses were not attributable to uncontrollable “market conditions”; they were attributable to weak management, high levels of leverage, and excessive risk taking. It had major losses driven by their exposures to a virtual hit list of high-risk lending: subprime mortgages, “Alt-A” mortgages, “designer” credit cards, leveraged loans, and poorly underwritten commercial real estate. It had loaded up on exotic CDOs and auction-rate securities. It was taking losses on credit default swaps entered into with weak counterparties, and it had relied on unstable, volatile funding—a lot of short-term loans and foreign deposits. If you wanted to make a definitive list of all the bad practices that had led to the crisis, all you had to do was look at Citi’s financial strategies.

  It had suffered losses of $9.8 billion in the fourth quarter of 2007, $5.1 billion in the first quarter of 2008, $2.5 billion in the second quarter of 2008, and $2.8 billion in the third quarter of 2008. Its head-in-the-sand management was projecting a fourth-quarter loss of $2.8 billion (in fact, it turned out to be $8.29 billion). Even after receiving TARP capital of $25 billion, it was one of the most thinly capitalized big banks in the nation. What’s more, virtually no meaningful supervisory measures had been taken against the bank by either the OCC or the NY Fed. A smaller bank with those types of problems would have been subject to a supervisory order to take immediate corrective action, and it would have been put on the troubled-bank list. Instead, the OCC and the NY Fed stood by as that sick bank continued to pay major dividends and pretended that it was healthy. Indeed, in 200771, Citi was the third highest dividend payer among S&P 500 companies, paying out a whopping $10.7 billion. In 2008, it was still near the top—at number fourteen—paying out $3.5 billion, an outrageous sum given the economic conditions at that time and the bank’s rapidly declining health.

  Citi’s CEO, Vikram Pandit, was a former hedge fund manager. His selection as the CEO had been strongly supported by Citi’s titular head, Robert Rubin, to replace Chuck Prince in late 2007. Prince, Citi’s former general counsel, had served as CEO since 2003. He had done the right thing by resigning (albeit with a $38 million pay package) as Citi’s losses began to mount, but Rubin, who also shared the responsibility, was indifferent to his culpability. Not only did he continue in his role, but he handpicked Prince’s successor. (He finally stepped down from his position with Citi in 2009.) The selection of Pandit simply reaffirmed that Citi was no longer a bread-and-butter commercial bank. It had been hijacked by an investment banking culture that made profits through high-stakes betting on the direction of the markets, in contrast to traditional banking, which focused on making loans to people based on their ability to repay. Pandit had started his career as an investment banker with Morgan Stanley but had been forced out in 2005. He had begun his own hedge fund, Old Lane Partners, which had delivered break-even performance until its purchase by Citigroup in July 2007 for $800 million. Pandit had reaped at least $165 million out of the deal. He was named CEO of Citi in early 2007. A few months later72—and less than a year after Citi had spent nearly a billion dollars to buy his hedge fund—the fund was closed.

  Citi had essentially bought into all the gimmicks to generate short-term profits: poorly underwritten loans, high-risk securities investments, and short-term, unstable liquidity. It desperately needed an experienced, traditional commercial banker to right the ship. Pandit had no experience in commercial banking and wouldn’t have known how to underwrite a loan if his life depended on it. But he was the guy Rubin wanted and the NY Fed and the OCC acquiesced, so he got the job.

  With the typical lack of adequate notice, I was not notified by the Treasury and the Fed that they wanted to do another bailout of Citi until Friday, November 21, when the institution was on the brink of collapse. My weekend was spent in a round of conference calls with Hank, Ben, Tim, and John Dugan. Citi wanted the government to ring fence about $300 billion in troubled loans and other investments. It would take losses up to a certain amount, with the government covering the rest. None of us thought that the ring fence by itself would stabilize the institution. To my mind, it was just another example of cluelessness on the part of Citi management. Citi’s share price had dropped to below $4, and its CDS spread (the cost to a creditor insuring against Citi defaulting on its obligations) had grown significantly. Citi officials were getting numerous inquiries from their creditors about their solvency, and foreign depositors were withdrawing their money at an increasing rate. Citi funded about one-fifth of its balance sheet through foreign deposits. That had been a cheap way for it to fund itself, since foreign deposits were not FDIC-insured and thus Citi did not have to pay insurance premiums on them. However, as the institution’s condition deteriorated, those deposits started to run, substantially contributing to Citi’s financial distress.

  Many people have asked why Citi’s foreign deposits were not protected under foreign deposit insurance systems. Not all of them were insured. For instance, China has no deposit insurance system, and even in countries that do have deposit insurance, they are generally weak systems with low insured limits and the prospect of substantial delays before paying out. Another key lesson of the crisis is that many foreign deposit insurance systems need to be strengthened to provide depositor confidence. Indeed, the lack of a strong, central deposit insurer for Eurozone countries has led to massive
deposit withdrawals from banks domiciled in weaker countries, further contributing to instability in Europe’s fragile banking system.

  As our discussions about how best to stabilize Citi began, I took the position that we should at least consider the feasibility of putting Citibank, Citigroup’s insured national bank subsidiary, through our bankruptcy-like receivership process. That would have enabled us to create a good-bank/bad-bank structure, leaving the bad assets in the bad bank, with losses absorbed by its shareholders and unsecured creditors.

  My request that we at least look at using our receivership powers was met with derision by the other regulators. Hank Paulson and Tim Geithner mockingly accused me of saying that Citi was “not systemic.”

  That was a mischaracterization of my views. I did not question that proactive, forceful action was needed to stabilize that badly mismanaged behemoth and prevent a systemic impact. But I did think we should have at least analyzed all of the tools we had at our disposal to mitigate that impact, including receivership authority to impose some of the loss burden on shareholders and creditors. I also wanted them to understand that the FDIC’s exposure to insured deposits at Citi—given its reliance on uninsured foreign deposits—was limited and the FDIC should not be expected to bear the brunt of the exposure. But the other regulators were dismissive. To them, pretty much anything that was big and in trouble was systemic and if it was systemic, that meant it was entitled to boatloads of government money and guarantees. The whole tenor of the conversation was that the government owed it to Citi to get it out of trouble. As Hank said in his book, “If they go down73, it’s our fault.”