Friday, May 13, 2011

FDIC Chair Sheila Bair's Legacy

FDIC chairwoman Sheila Bair is leaving the agency.  She is stepping on down July 8, although her term officially ends June 30.  We are told that she is staying the extra week to work on the final parts of the agency's "living will" proposal for corporations with over $50 billion in assets.  So in honor of her resignation, I am taking today to highlight a few of Ms. Bair's accomplishments.

1. Changes to the way that the FDIC collects fees for the federal deposit insurance.  Bair pushed the banks to pay a larger share of the insurance fees.  Previously, banks had been assessed fees based on the deposits they held.  Now banks pay fees based on the loans they keep in their portfolio.  Since big banks tend to hold more loans relative to deposits, this increased fees. (However, it might also explain why smaller banks hesitate to make loans now.)

2. The Qualified Residential Mortgage.  This massive change to mortgage lending will codify strict underwriting standards for mortgages into law.  According to testimony last month from the Mortgage Banker's Association, fewer than 20% of the loans sold to Fannie Mae and Freddie Mac over the past decade would have qualified using the FDIC's QRM guidelines.  Bair assures us that we should not worry, because QRMs are only designed to be a very small piece of the mortgage market.  People not qualifying under QRM guidelines will have to seek a higher cost mortgage(some experts estimate 3 times higher) in which the bank retains 5% of the loan in their portfolio.

3. Living Wills for financial firms with more than $50 billion in assets.  Any firm with more than $50 billion in assets is now considered significant to the financial health of the nation under the Dodd Frank bill, and so these companies must have a plan in place for their own dissolution.  The "Living Will" must include information about how the depository institution is sufficiently protected from risks arising from activities of non bank subsidiaries of the company, complete disclosure of the ownership structure,  and assets, liabilities and contractual obligations of the company.  The plan also needs to identify how regulators will determine where major collateral of the company is pledged.  The Federal Reserve and the FDIC may require more disclosure as needed.

Quarterly, companies meeting the "Living Will" standards will submit a credit exposure report to outline all of their credit exposures.  U.S. companies will have to provide information on all domestic and foreign-owned companies.

This is a lot of information for financially healthy private firms to have to disclose to the federal government about their daily operations.  The Pew Financial Reform Project just completed  a report stating that these new "Living Wills" are "crucial" to ending the concept of "too big to fail."  The Report also found that the agencies need to set up clear "triggers" for what would signal the need to wind down a failing firm.

To me. the whole concept of private institutions being forced to file "living wills" with the government so that the Feds can dissolve a private institution is a little like asking someone to dig their own grave.  Even assuming that these steps can be used to prevent another bailout, who is to say that they cannot also be abused? When companies are required to file detailed information about their ownership, affiliations, credit lines, etc., how can we guarantee that an overzealous, powerful bureaucrat will never use that information for personal profit?  How can we be sure that companies will not be dissolved as part of political payback, or to give the assets to a political ally?  Giving that much power over the future of a private business is an extremely dangerous move.

Ms. Bair believes so strongly in financial reform and in "living wills" that she will be presiding over the board meeting in July where some final policy proposals on this issue are on the agenda.  After July 8, Ms. Bair will be gone from the FDIC, but her policy proposals and their consequences will be with us for a long time to come.

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