From her powerful position as Chairman of the FDIC, Sheila C. Bair benefits from superior inside knowledge and a wide-angled view of the world of US banking.  She is also a person with strong views on the future direction she hopes this sector will follow. In her speeches she regularly stresses the need to reduce government intervention to allow the natural interaction of free market forces to once again dominate the credit markets.

Shelia Bair

On October 14th, 2009, Sheila Bair made a statement to the U.S. Senate Subcommittee on Financial Institutions, Committee on Banking, Housing and Urban Affairs. For anyone interested in what is happening in US banking, her statements make for essential reading.  Here some of the key points made are summarized and discussed. Anyone interested in reading the speech in full can find it on the FDIC’s Website.

Hopeful Signs, But Be Patient

The FDIC Chairman’s address to the Senate Subcommittee reflected the cautious optimism she has expressed on previous occasions. In her opinion US financial markets are stabilizing and there are signs of renewed growth in the economy. The fact that these signs of recovery have not yet found expression in the banking sector is only because more time is required before the benefits start to filter down.

Skeptics might comment that the FDIC Chairman is almost duty bound to find the silver lining in the every dark economic cloud since she is well aware of how projecting a positive outlook can help boost business confidence. Even if the evidence justifies a more negative impression of the state of US banking, would she dare to present it? However, a case could just as well be made that someone in such a responsible financial position would not deliberately suppress or distort negative trends with all the risks involved in such manipulations. A look through the Chairman’s statement shows that she does not hesitate from describing the challenges facing US banking while at the same time stressing her belief that the worse is over.

Despite Distress, Might Be A Light at the End of the Tunnel

On the surface the banking scene looks bleak with FDIC-insured institutions reporting an aggregate net loss of $3.7 billion in the second quarter of 2009.  Credit problems in consumer and commercial loans and the collapse of the property market have been major factors behind these worrying statistics.  For example, the FDIC Chairman noted how “There has been a ten-fold increase in the ratio of non-current construction loans since mid-year 2007.”

Without negating their seriousness Sheila Bair views these losses as part of the inevitable process of financial house cleaning as banks coming to term with delinquent loans and sort out their balance sheets — “as insured institutions work through their troubled assets, the list of ‘problem institutions’ — those rated CAMELS 4 or 5 — will grow.”  This trend is expected to continue into 2010 as the industry finds its equilibrium. In particular smaller FDIC-insured institutions have been hard hit and seem likely to remain the most exposed to damage.

In the securitization markets there continues to be a distinct difference in fortune between the markets for government-guaranteed debt and the private securitization market; while the former is operating at its normal level the latter shows very low activity levels. In the first nine months of 2009 the issuance of other types of private asset-backed securities (ABS) declined by almost 15% compared with the first nine months of 2008. This is another indication of the long journey the economy must travel before recovery becomes evident.

Evidence of American Economic Recovery

Evidence of recovery presented in the FDIC Chairman’s statement includes:

  • August 2009 was the fifth successive month where the index of leading economic indicators rose.
  • Experts agree that the economy should grow by at least 2.4% in the last two quarters of 2009.
  • A tapering off in consumer loan defaults.
  • FDIC and other government initiatives promoting a revival of the credit market with increased inter-bank lending and a healthier corporate bonds market.

Nevertheless, given the severity of damage caused by the present recession, a substantial recovery is likely to take longer than the recovery from previous crises. Under the impact of rising unemployment and declining house values, since the start of 2008 American households have lost almost a fifth of their net value. In the first half of 2009 almost 1.5 million foreclosures were executed and unemployment has reached almost ten percent — the highest in a quarter of a century.

The FDIC Continues to Rise to the Challenges

The Chairman described the FDIC’s response to the challenges facing America’s financial sector as “a balanced supervisory approach that focuses on vigilant oversight but remains sensitive to the economic and real estate market conditions.” In addition to the FDIC’s Temporary Liquidity Guarantee Program (TLGP) and other well-known initiatives, they carry out many other activities designed to booster insured financial institutions. For example, they continually urge banks to raise their loss reserves against borrower credit problems. FDIC inspectors assist banks to make a balanced review of credit risk concentrations with a particular emphasis or real estate. Their objective is to make sure that banks have the “right resources in place to restructure weakened credit relationships and dispose of other real estate holdings in a timely, orderly fashion.” In the course of 2009 an additional 440 FDIC examiners have been hired and there are almost another 200 trainees.

Concurrently with the extra staff engaged and improvements in inspector training, the FDIC makes every effort to avoid placing onerous restrictions on the banks’ freedom of action. Thus the Chairman vigorously denied allegations from Congress and businesspeople that bank regulators are ordering the banks to cut back on their lending and limit credit to existing borrowers. She also rejected allegations that the FDIC has been encouraging banks to cut back lines of credit in response to the falling values of real estate collateral. She contended that they give the banks considerable freedom handling current loan portfolios although advances of new funds need to be appraised. Regarding collateral, this is only considered a secondary source of loan repayment and changes in its value are not the chief factor determining the authorization of credit extensions. Rather than forcing banks to cut back on lending, “the FDIC has been vocal in its support of bank lending to small businesses in a variety of industry forums.”

It Won’t Be Easy, But We’ll Make It

The FDIC Chairman is clearly not expecting any quick and dramatic improvements in the state of US banking. According to FDIC predictions failures of insured banks over the next four years might cause them a loss of about $100 billion.  Yet the majority of these losses are anticipated to fall in the 2009-2010. An expected $63 billion in revenue over the coming five years should enable the FDIC to weather these losses and they also have power “to borrow additional working capital up to 90 percent of the value of assets we own.” Thus the Chairman is assured that the FDIC is going to be able to keep its obligations to depositors and can play an effective part in steering US finance through this difficult concluding period of our severe financial crisis.

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