Bull by the Horns

by Sheila Bair

  The calls worked. Blankfein followed up and nailed down commitments for $153 million of new capital for ShoreBank. So the bank filed an application for TARP money from the Treasury Department. Our examiners presented their analysis of the bank’s condition to the interagency group that voted on TARP applications. They stated their view that the bank would be stable and viable with the $153 million in private capital, combined with the Treasury’s $72 million, and thus it would pass Treasury’s main test for approval. However, the other bank regulators disagreed and refused to support the application. Were our examiners wrong, or had the other agencies been scared off by the political heat associated with doing anything to help ShoreBank? I will never know. TARP applications were handled by career examiners. Neither the chairman nor the board was involved. It might have well been a disagreement among career staff on the bank’s capital needs. But the political controversy tainted the whole process, in my view.

  The denial decision was relayed back to Goldman and the investment group. Most of them ultimately decided to invest in a new bank charter to bid on ShoreBank when we auctioned it off. That was a good result for us. We tried one more time but couldn’t get anyone else to bid. Fortunately, with at least one bidder, we were able to do our standard whole-bank-with-loss-share sale and saved $250 million over our projected losses in a liquidation.

  The new owners renamed it the Urban Partnership Bank, and the new bank continues to provide banking services to Chicago’s poor. I would like to state for the record that whatever else their sins might be, Goldman Sachs and the rest of the big banks that invested in ShoreBank did so for a nonpolitical reason: to support its traditional mission and model of serving low-income populations. They also saved themselves and the Deposit Insurance Fund a lot of money. I certainly never received any pressure from anyone in the administration to help ShoreBank, nor did any of those banks to my knowledge. Indeed, the FDIC inspector general252 went over all of it with a fine-toothed comb and found no evidence of political pressure.

  Whole-bank-with-loss-share transactions were almost always the least costly way for us to resolved failed banks. But occasionally we would have to liquidate a bank because we could not find buyers—or, even if we could find a healthy bank to buy the failed one, the healthy bank would not want to take all of the loans, even with loss-share support. In those cases we would auction the loans separately, using an online process that was open to both banks and distressed-asset purchasers, typically hedge funds and the like. Before auctioning a loan, we would always give the borrower the option of buying it back from us at par. Sometimes it did, but more often it would try to negotiate to buy it back at some type of discount. Under our procedures, we did not negotiate side deals with borrowers. If they did not want to pay off at par, the loan was auctioned off and sold to the highest bidder.

  In auctioning loans, we found that pooling them by type and collateral characteristics was more important than pooling by performance status—although if we had many loans of a certain type, we would do both. So, for instance, we might auction a pool of loans, half of which were delinquent and half still performing. That pool would be sold at some discount to their par value (the amount of the unpaid balance) because of the high number of delinquent loans. So for instance, our best bid on that kind of pool might be 65 cents on the dollar.

  We always disclosed our bids publicly, and here is what would happen. A borrower would see that we had only received 65 cents on the pool, when he might have been willing to buy back his individual loan for 80 cents. So he would complain to his member of Congress that we had sold his loan at a lower price than he had offered, and I would get an irate call from the member of Congress demanding an explanation. Some members would hear us out and drop the matter once our procedures were explained to them. But others really wanted their constituents to get a deal from us, facts be damned. The pressure was bipartisan. Dealing with Congress was one of the more difficult parts of running the FDIC, though looking back, in light of the nature of the FDIC’s work, it is amazing that we didn’t have more confrontation. Because I used to work in the Senate, I had (and still have) great respect for Congress as an institution, though I am appalled, as are most Americans, at its members’ current inability to work together and make decisions for the benefit of the country. I always took their calls, met with them when requested, and testified when asked (even when I didn’t want to), and for the most part, the FDIC maintained good, solid, bipartisan relationships on the Hill. I think that individually, most members of Congress are reasonable, public-service-oriented people (notwithstanding their collective dysfunction in making decisions) who just want openness and answers when they hear of issues or concerns from their constituents. If you explain things to them rationally, they will usually leave you alone to do your job.

  Minimizing losses was a high priority for us at the FDIC. Notwithstanding our innovative strategies, the country was in the worst financial crisis since the Great Depression, and we were taking severe losses. I was bound and determined that we would not turn to taxpayers to cover them. Paying for deposit insurance was the industry’s responsibility. As discussed in earlier chapters, for years industry trade groups had lobbied Congress to prevent us from collecting premiums to build up the fund in good times. When we finally got that authority in 2006, the American Bankers Association blasted us, saying, “There is no requirement253 to boost the revenues of the fund—and no need to given the $50 billion in the fund already. The banking industry is in exceptional health, and there is no indication that large amounts of revenue are needed by the FDIC.”

  The FDIC board unanimously raised254 premiums anyway. I stated at the time that it was in the industry’s interests for us to build up the fund when conditions were good, to avoid the need for steep premium increases in a downturn. Unfortunately, we did not have enough time to grow the fund significantly before the crisis hit. The $50 billion we had started with depleted rapidly.

  Our statute required us to keep the Deposit Insurance Fund above a minimum of 1.15 percent of insured deposits. By the second quarter of 2008, we had already breached the minimum. Our statute further required that when the minimum was breached, we had to adopt a plan to restore our fund to 1.15 percent in five years. In October 2008, we approved255 such a plan that included a 7-basis-point increase in the premiums we charged (7 cents for every $100 in deposits). For most banks, that meant a doubling of their premiums, though the assessment was still significantly below the 23 basis points that had been assessed on them during the savings and loan crisis. High-risk banks would pay a premium as high as 50 cents for every $100 in deposits.

  Our staff, at that point, was predicting losses totaling $40 billion through 2013. That projection quickly proved to be overly optimistic. By the end of 2008, the fund had dipped to $17.3 billion, representing .36 percent of insured deposits. However, our total reserves still stood at about $45 billion. (As earlier discussed, we projected our losses twelve months in advance and set aside enough to cover those estimates in a special fund called our contingent loss reserve. The fund held about $28 billion in funds committed to cover those losses.)

  By early 2009, it became apparent that the fund was going to dip into negative territory, though total reserves would remain positive. However, I was concerned that, given the rapid deterioration of hundreds of banks throughout the country, our total reserves could become depleted and we could run out of cash. If we were going to avoid borrowing from taxpayers, we would have to raise assessments again—significantly.

  I held numerous discussions with the senior staff on how to maintain adequate reserves without resorting to taxpayer borrowing. Public confidence in the FDIC meant everything to me. I did not want us to have the taint of a government bailout. I also thought it would be sending all of the wrong signals if we turned to the government for a handout. Industry lobbying had blocked or delayed efforts to tighten lending standards, and the industry had also delayed the congressional authority we had sought to
build the fund in good times. It was true that the vast majority of community banks and many of the big banks had not contributed to the high-risk activity that had brought us the crisis. Yet, frankly, the more prudent banks had sat on the sidelines during our earlier fights with industry lobbyists over tightening lending standards and building the fund. It was their responsibility now, not the taxpayers’. In any event, perhaps I was naive, but I believed that most banks wanted to maintain the integrity of industry funding of the FDIC. They took pride in the fact that they, not taxpayers, funded the FDIC.

  At the same time, a big assessment would stretch a lot of banks. John Bovenzi, our COO, and Art Murton were suggesting a 20-basis-point flat assessment on the industry, with the possibility of another 10 basis points toward the end of the year. That would have brought in256 more than $35 billion in much-needed funds. The banks had plenty of cash to give us. Because of confidence in the FDIC guarantee, they were awash in funds. Insured deposits had increased by a trillion dollars since the crisis had begun, while loan demand was down because of the weak economy. What they didn’t have was earnings, meaning that the 20-basis-point assessment would eat into their capital.

  I asked our staff if we could simply require that the banks prepay their assessments over the next several years, instead of whacking them with a huge assessment that would have to be deducted from their earnings immediately. If they prepaid their premiums, it would be more like a loan to us, but instead of repaying them, we would simply give them a credit for the premium they owed us each quarter until the prepaid amount was used up. In that way, they could deduct the assessment from their earnings over time, instead of having to recognize it as an expense all at once.

  In February, Art sent a memo to me raising all sorts of legal and accounting issues about the prepayment idea. It seemed as though no one on the staff wanted to pursue it. I eventually acceded to my staff’s recommendations, and on March 2, 2008, we proposed a 20-basis-point assessment. A firestorm of controversy ensued. I must acknowledge that Edward Yingling, who then headed the ABA, as well as Cam Fine, who headed the Independent Community Bankers of America, tried to explain and defend the special assessment to their members. But the uproar was deafening, and we immediately started getting inquiries and pressure from the Hill.

  I was not sure I would be able to withstand the political momentum building against us. It was not only from the big banks but from thousands of community banks. We had reached too far, and I was very afraid that Congress would pass an amendment restricting our ability to assess premiums.

  So I decided to take the lemon and make lemonade. During that same time period, we were trying to get our borrowing authority raised to $100 billion. We were insuring nearly $5.5 trillion in deposits, with only a $30 billion line of credit with the Treasury Department. The $30 billion limit had been in place since 1991, when insured deposits had been less than half that amount. We were also trying to get authority to assess large nonbank financial institutions that were using our debt guarantee program for any losses on that program. As discussed earlier, we were having difficulty on the Hill because Geithner was sending mixed signals about whether the administration wanted such legislation to pass.

  If the banks wanted to lobby against the 20-basis-point assessment, I decided to give them something constructive to do instead. I publicly stated that if Congress raised our borrowing authority and gave us new assessment authority over the big financial institutions, I would reconsider the 20-basis-point assessment. My reasoning was that the new authorities would give us additional tools to access funds in the case of an emergency, so we could be a little less demanding of the industry. The nation’s community banks got the message loud and clear and went to work with their members of Congress. On May 20, 2009, the president signed the bill into law, and on May 22, the FDIC adopted257 a final rule imposing a 5-, not 20-, basis-point assessment.

  But we were not out of the woods yet. I was skeptical that the board’s May actions would be sufficient to sustain our resources through the next few years. The bad economy was taking its toll. As we moved deeper into 2009, bank failures were being driven as much by economic conditions as by bad lending. Toward the end of the year, it became apparent that we would have to go back to the industry for another assessment or swallow hard and borrow from taxpayers.

  I revisited the idea of a prepaid assessment with the staff. It seemed like a good third way—an alternative to hitting the industry with another assessment or a taxpayer bailout. I pushed them again on the perceived legal and accounting issues. Except that this time, I had added to my staff a markets expert and former Senate Banking Committee aide, Joe Jiampietro. I gave Joe the task of pushing the prepaid assessment idea, and he was able to cut through a lot of the issues with the staff. Ultimately, we did find a way to do it that was compatible with our legal authority and accepted accounting rules. People frequently assume that the heads of government agencies have unfettered power to work their will, but the truth is that you have to have staff acceptance and support of an initiative to get it done. Staff resistance can fell even the best of ideas. A prepaid assessment was something we had never done before, and, in retrospect, I think the fear of the unknown was causing discomfort. But we talked it through and built consensus that it was our best option among a lot of bad choices.

  In late September 2009, the board proposed a three-year prepaid assessment for comment, and on November 12, we unanimously258 approved the measure. Requiring banks to prepay three years’ worth of deposit insurance premiums brought in about $45 billion in cash. For the most part, the prepaid assessment was lauded as a creative way to handle a very difficult problem. But we took some ribbing in the press about “borrowing” from the industry. I remember speaking on a panel with President Bill Clinton and Jamie Dimon at a New York conference and wasn’t sure how to take it when Dimon announced that he viewed259 the FDIC as “creditworthy” and would be happy to lend us money anytime.

  As I predicted, the Deposit Insurance Fund was negative for several quarters, though our total reserves always stayed positive and we never had to borrow from taxpayers, nor did we have to impose additional assessments on the industry. The $45 billion was more than ample to cover our needs through the remainder of my tenure and beyond. I was very pleased that in my final months in office, the Deposit Insurance Fund moved into positive territory again, and our financial position has steadily improved since then.

  CHAPTER 24

  Squinting in the Public Spotlight

  Former FDIC Chairman Bill Seidman warned me when I first became chairman of the FDIC that managing the media would be a big part of the job. He was absolutely right. There were a number of reasons why.

  First, we could not be successful in our public mission if people did not have confidence in us. And to have that confidence, the public needed to know who was in charge. Faceless bureaucracies don’t do much to engender trust. People needed to hear from the person responsible for running the FDIC that their hard-earned cash was safe. That had to come from the person at the top.

  Second, because of the unique, cyclical nature of our work, there just wasn’t a lot of public understanding of the FDIC and our process. Nearly two decades had passed since the last banking crisis, with only sporadic failures during that time period. Nearly three years had passed without any bank failures at all. To convince the public that we were capable of protecting it, we had to get out there publicly, tell how we funded ourselves, and explain the mechanics of our process in a bank failure. That was all the more important, given some of the frankly irresponsible media and analyst coverage that exaggerated the number of banks that were in trouble and unduly questioned the adequacy of our financial resources to protect depositors.

  Finally, I personally attracted a lot of media attention for a variety of reasons. I was the only female agency head during the crisis, and regrettably, it is still rare for women to hold senior financial positions in either the government or the private sector. In a
ddition, I had had some well-publicized disagreements with my colleagues at other agencies, and I wasn’t afraid to publicly articulate my views when necessary. Moreover, for the most part, the members of the press liked me because I was open with them and tried to explain things in a way that was understandable to the broader public. People were scared, and someone needed to tell them what was going on and reassure them. I tried very hard to do that.

  I think one of the smartest (and potentially riskiest) things we did from a media standpoint was to agree to a request from 60 Minutes to let one of its news crews accompany us on a bank failure. It was risky because even though I had utmost confidence in our bank-closing staff, it’s impossible to control for all variables. If there were any missteps in our handling of the failure, the 60 Minutes crew would be right there to film it all. (Indeed, they ended up shooting more than a hundred hours of footage for an eleven-minute segment, providing ample opportunity to film something going wrong.) In addition, there were plenty of media critics out there saying that we weren’t up to the job and that we didn’t have enough money to handle all of the upcoming failures. What if 60 Minutes decided to take that tack in covering our resolution process? In that case, instead of instilling confidence, the 60 Minutes coverage would undermine it.

  I discussed 60 Minutes’ request at length with Andrew Gray, the head of our press operation and public education program, as well as my chief of staff, Jesse Villarreal. In addition, Scott Pelley came down to Washington from New York to discuss the proposal with me. After the IndyMac experience, I was particularly concerned that we might have panicked depositors rushing to the bank after it closed to withdraw their money. I had no desire to once again see frightened people on TV, banging at the doors of their bank trying to get their cash. But we had quickly learned our lessons from IndyMac and had handled two dozen closings since then without incident.