Wednesday, October 01, 2008

Our Bair Necessity

The FDIC chairman is the bank system’s ultimate backstop.

You know what? Hank Paulson may not be the most powerful financial person in the country right now. That honor goes to Sheila Bair, the chairman of the FDIC.

In recent weeks, Ms. Bair has held the banking system together, coordinating smooth takeovers of distressed banks in deals run and controlled by her agency. I wouldn’t exactly say she’s flying under the radar screen since these bank takeovers are front-page news. But without holding the center-stage attention that Paulson has, she has seamlessly closed and reopened IndyMac, Washington Mutual, and Wachovia.

IndyMac was in fact taken over by the FDIC, becoming the IndyMac Federal Bank, while WaMu was acquired by JPMorgan Chase and Wachovia by Citigroup. So far as I know, not a single depositor at these banks has lost money. This is huge. And it suggests to me that if the Congress is unable to craft a deal for Treasury purchases of toxic assets, the nation is still in good hands as a result of the good offices of the highly professional, credible, and trustworthy Federal Deposit Insurance Corporation, run very well by Ms. Bair.

Who is Sheila Bair? Forbes just ranked her the second-most powerful woman in the world, behind German chancellor Angela Merkel. Before coming to the FDIC, Ms. Bair was a professor at the University of Massachusetts. She has served at the Treasury Department, the New York Stock Exchange, and the Commodity Futures Trading Commission, and was chief counsel to former Senate majority leader Robert Dole. Just as important, she has written two children’s books, showing the kids good examples of money management.

And now she’s showing the whole nation good examples of money management on a grand scale.

An editorial in Tuesday’s Wall Street Journal, called “Preemptive Plumbing,” walked through the details of the Wachovia takeover by Citigroup. The FDIC will backstop close to $300 billion of Wachovia assets while Citigroup is on the hook for the first $42 billion in potential portfolio losses from Wachovia. And Citi will give the FDIC $12 billion in ownership of preferred stock and warrants. This open-bank transaction flows from the emergency powers written into the FDIC Improvement Act of 1991. Systemic risk to the financial system provides that authority.

But each of these takeovers reveals the real FDIC glue that’s holding our banking system together, even in the absence of Paulson’s big-bang, toxic-asset purchase plan.

I think the Paulson plan is still essential. It will unclog the banking system and reopen the door to Main Street loans that are necessary to grow the economy. And taxpayers will wind up turning a profit since they will own the assets purchased by the Treasury, the roughly 10 percent yield on those assets, and the profits from the eventual Treasury sale of the bonds. And all these revenues will be used to pay down the national debt. But if there is no Paulson plan, the FDIC can carry the ball alone — certainly through year end and until a new government comes into power.

Incidentally, as the FDIC crafts its preemptive takeovers of distressed banks, doing so before the banks crash, it is in effect injecting public capital to bolster sagging private bank capital. Former Reagan FDIC commissioner William Isaac suggests the agency can put even more capital into banks through a net-worth certificate program used in the 1980s for the troubled savings bank industry.

In addition, both presidential candidates are supporting at least a doubling of the FDIC’s deposit insurance program for banks. And this provision will likely be added to a new Paulson plan coming up in a day or two.

Hopefully, if there is a plan-B vote on the Paulson program, it will include a suspension of the so-called mark-to-market “fair value” accounting of assets, and replace that either with a net-operating-loss (NOL) carry-back or carry-forward, or at least a five-to-seven year amortization of loan losses incurred by banks that are selling their distressed assets.

NOL is used in many heavy industries where current losses can be offset by past or future profits for both tax and accounting purposes in order to smooth the profit cycle. Without this accounting relief, banks selling loans to the Treasury at a deep discount will further impair their already weak capital positions if they have to immediately post the losses. Congressman Paul Ryan had this provision in the House version of the first Paulson plan, but it was apparently taken out by Barney Frank. Former FDIC man Bill Isaac also supports this.

Tuesday’s stock market comeback — with the Dow up nearly 500 points following Monday’s unbelievable plunge — suggests that investors believe the politicians will deliver some relief. But my message to the investor class is this: If Mr. Paulson strikes out again, Ms. Sheila Bair is the ultimate backstop.