The FDIC’s Rose Colored Glasses

Over the past year, we have often come back to critique the performance of the various banking and securities market regulatory bodies during the recent financial crisis.  These would include both Federal and State agencies including the Federal Reserve, OCC, SEC and NYS Banking.  However, our most pointed criticism has been reserved for the FDIC, mostly because their Chairman, Sheila Bair, has been the most vocal about what went wrong and how her agency would have handled things differently.

What gets under our proverbial “skin-in-the-game” the most are the attempts by the FDIC to ignore their own shortcomings during the 8-10 years leading up to the financial crisis.  As a regulator for so many small and medium-sized lending institutions, the  FDIC had perhaps the best opportunity among all the US regulatory bodies to single out the US mortgage market as increasingly out-of-control.

We have before utilized the analogy of the state trooper snoozing on the side of the highway while an increasing number of motorists test the speed limit.  It was the FDIC who had the best view of banks that were failing, why they were failing and how these “smaller experiments” were likely related to their bigger cousins in the banking industry (i.e. the larger regional and “Wall Street” banks). 

However, we are not here to throw more stones at the FDIC for missing the call.  What is galling to us though is the continued lack of any remorse or even acknowledgement by the FDIC that they screwed up and, even if the rules and regulations could have been more transparent, there were enough tools at their disposal to have been a better safekeeper of the public interest.

We would hope that we can stop writing about this topic within the next few months, as Ms. Bair wraps up her farewell tour and slides into the sunset (we assume to run for office).  Nevertheless, last week, she was back on Capitol Hill placing another chapter in the book which attempts to both exonerate and anoint the FDIC.  We can’t help but to note the contrast in the posture of the other regulators, when compared to the self-justification of the FDIC over the past few years.  We sense a significantly more humble and remorseful tone coming out of nearly every other regulatory body in and around the crisis.  Nevertheless, the FDIC has continued to chirp away and last week’s session with the Senate Banking Committee was another opportunity for Ms. Bair to shape history.

There were several key points that the Chairman made in her remarks and we would like to refer to a few of them here.  Of course, we have added our own alternative views, as well:

1- “The Central Cause of the Crisis in the US was Excessive Leverage”:  This is accurate and it applies not only to the banks but to individual consumers.  But wait a minute…… did this happen overnight or were the FDIC and other regulators simply unable or, worse, unwilling to take note?  Maybe it’s us but do you think her testimony could have acknowledged that her agency, with its fingers into so many banks across the Country, should have done a better job identifying these risks and then using the tools available at the time to help mitigate these problems?

2- “There was a Prevailing Assumption that Some Banks were Too Big to Fail”:  If we are following this theory correctly, the reason that the excessive leveraging and lax business standards were allowed to perpetuate was that everyone had this false sense of security that these companies were too big to fail and had the implicit backing of the US Government.  We have heard this “urban legend” told so many times over the last 4 years that it is no wonder that many people now take it as a provable fact.  We, on the other hand, would argue that nothing could be further from the truth.  Even the rating agencies, with their supposedly broken models, were drawing starkly different views of the creditworthiness of the larger financial  institutions in the years leading up to the crisis.  Perhaps the “main street regulators” at the FDIC saw the world that way from their perch in Decatur or Springfield but that’s not what the institutional investors backing Merrill, Lehman and JPM were thinking at the time.

3- “The Answer for Too-Big-To-Fail is SIFI”:  The answer to dealing with large signficant institutional failures is to designate them beforehand as Systematically Important Financial Institutions (‘SIFI”).  Without going into detail, let’s just say that no bank CEO in their right mind would want to have that “Scarlet Letter” hung over their door.  How about this alternative solution….. maybe the regulators could do a better job of understanding the businesses they are responsible for monitoring.

4- “Deeply Flawed Servicing Practices were a Key Contributor to the Crisis”:  Essentially, this theory attempts to place some of the blame for the crisis on how the banks tried to clean up the mess they had created in the residential mortgage industry.  While it is without question that the lack of fair standards in the servicing of mortgages were exposed by the crisis, this phenomenon should not be lumped in with the causes for the crisis itself.  Instead, what we have is many, including the FDIC, trying to alter the conversation.  Let’s face it, the lack of cohesive servicing standards did not cause the financial crisis and, if the negotiations over the Dodd-Frank bill had not dragged on as long as they did, this topic would have become a part of a another important piece of legislation or perhaps just a reinvigorated utilization of the regulations already at the disposal of the banking regulators.  We usually like to remind folks that it’s not the number of rules but how the rules that you have are applied that is most important.

5- “Lack of Skin-in-the-Game”:  No Bair speech would be complete without a rendition of the  most famous “war cry” of the “Great Financial Crisis of 2007” (i.e. Skin-in-the-Game).  How is it that the Chairman continues to misread the impact of a 5% retained interest on someone trying to abuse the system.  Additionally, the failure to understand that any enterprise that regularly utilizes the securitization markets to finance their activities already has their reputation (i.e. their ability to rely on the markets for their next issue) on the line.  The fact remains that if the regulators don’t do an adequate job of monitoring the lenders that originate the underlying assets in the first place, it won’t matter if you set the Retained Spread at 5%, 10% or 25%; abuses will occur.  We prefer to go the source of a problem rather than try to fix it after the fact.  Of course, in this case, this would put the onus on the regulators to do a better job; a result that isn’t quite as attractive to the FDIC, we assume.

About markferraris
Managing Principal Orchard Street Partners LLC

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