At the International Institute of Finance Istanbul in Turkey last week, FDIC Chairman Sheila Bair presented a cautiously optimistic view of an America emerging from 2008-09’s financial crisis. She told her audience how the credit markets are now returning to normal and “liquidity is improving”. She also detected clear signs of a “comeback” in the equity markets. The resilience of the American economy she attributed to “extraordinary action by monetary and regulatory authorities”. The recent dramatic increase in the number of bank failures she described as one “of the aftershocks of the financial meltdown” rather than a prime trigger of the crisis.

Sheila C. Bair

Certainly the words of someone who can speak with such authority on the state of US banking should be taken seriously, but at the level of the ordinary citizens still losing their jobs or facing foreclosure on their homes, this talk of stabilization may sound premature. So on what evidence did Chairman Bair base her claims?

FDIC’s Stabilization Activities

Sheila Bair referred to particular FDIC policies that have been helping America pull out of the recession:

  • The Temporary Liquidity Guarantee Program (TLGP) program guarantees newly issued senior unsecured banking debts and it covers non-interest bearing deposit transaction accounts. This measure has bolstered the market for bank debt and supported liquidity in the banking system. Up to the end of July 2009, “$320 billion of new bank borrowing, and some $740 billion of bank customers’ transaction accounts” were covered by TLGP. Now the improvement in the market allows the FDIC to cease issuing new guarantees from the end of October.
  • On May 20th 2009 the deposit insurance coverage limit at FDIC-insured institutions was raised to at least $250,000 per depositor and this measure has strengthened customer confidence in the banking system. In contrast with the TLGP, the FDIC Chairman did not announce any plans to reduce deposit insurance but in fact is now seeking an additional $45 billion in funding from the banks. She recognized that this program needs boosting in the light of the large number of bank failures, high unemployment and continuing problems in the housing market.

Hints at Future FDIC Policies?

A careful analysis of the FDIC’s Chairman’s words indicates her thinking on key issues facing the financial sector, and these are likely to be reflected in future policies. Her preferred approach focuses on improving regulations and the supervisions of financial institutions.

Let the Free Market Work

In a clear commitment to traditional free market values, Sheila Bair spoke of a need to move away from the idea that the biggest banks should not be allowed to fall. She feels that this unwritten law impedes the effective operation of the market, for example, it can give management and investors a license to take more risks in extending credit than they would take if they thought their institution’s survival was not guaranteed by the government. While in the past US government action has served to reinforce this impression, future policy should aim at breaking the sense of complacency in some large financial organizations. The government should cease using the taxpayer’s money to support these large institutions but rather replace their top management and allow stockholders and creditors to bear the consequences of management decisions and the impact of market forces.

Orderly wind-downs

In a similar way that ordinary people are advised to make a will to ensure an orderly resolution of their financial affairs after their death, Sheila Bair would like to see financial institutions draw up wind-down plans to be implemented in the event they fail. These plans would be made available to the stockholders and help the receiver oversee an orderly and speedy wind-down of a failed bank at a minimum cost to the taxpayer. The prominent display of this information could also serve to highlight the risks and encourage both management and investors to exercise greater caution in their decisions. At the same time, the receiver should be given enhanced powers that include “the ability to reject burdensome contracts, sell assets, resolve claims, and establish and operate bridge financial companies.”

Still Too Early for Recovery Celebrations

While Chairman Bair’s address had a distinct tone of cautious optimism, she recognized that while “the worst of the storm appears to be over” appearances can be deceptive. In her opinion, while the signs of recovery are unmistakable, the dangers are certainly not over. The possibility remains that the crisis could come “back with a fury” and so there is an urgent need to proceed with the reforms she advocates.

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