Bull by the Horns

Sheila Bair was the Chair of the Federal Deposit Insurance Corporation from 2006 to 2011, a period that spans the heart of the US housing crisis and the start of the Great Recession. This is her account, based on personal notes, of her experience heading the FDIC, particularly focused on the financial crisis and its immediate aftermath.

Something I would like to do in theory but rarely manage to do in practice is to read more thoughtful political writing from people who disagree with me. Partly that's to broaden my intellectual horizons; partly it's a useful reminder that the current polarized political climate in the United States does not imply that the intellectual tradition of conservatism is devoid of merit. While it's not a complete solution, one way to edge up on such reading is to read books by conservatives that are focused on topics where they and I largely agree.

In this case, that topic is the appalling spectacle of consequence-free government bailouts of incompetently-run financial institutions, coordinated by their co-conspirators inside the federal government and designed to ensure that obscenely large salaries and bonuses continued to flow to exactly the people most responsible for the financial crisis. If I sound a little heated on this topic, well, consider it advance warning for the rest of the review. Suffice it to say that I consider Timothy Geithner to be one of the worst Secretaries of the Treasury in the history of the United States, a position for which the competition is fierce.

Some background on the US financial regulatory system might be helpful here. I'm reasonably well-read on this topic and still learned more about some of the subtleties.

The FDIC, which Bair headed, provides deposit insurance to all of the banks. This ensures that whatever happens to the bank, all depositors of up to $100,000 (now $250,000 due to a law that was passed as part of the events of this book) are guaranteed to get every cent of their money. This deposit insurance is funded by fees charged to every bank, not by general taxes, although the FDIC has an emergency line of credit with the Treasury it can call on (and had to during the savings and loan crisis in the early 1990s).

The FDIC is also the primary federal regulator for state banks. It is not the regulator for federal banks; those are regulated by the Office of the Comptroller of the Currency (OCC) and, at the time of events in this book, the Office of Thrift Supervision (OTS), which regulated Savings and Loans. Some additional regulation of federal banks is done by the Federal Reserve. The FDIC is a "backup" regulator to those other institutions and has some special powers related to its function of providing deposit insurance, but it doesn't in general have the power to demand changes of federal banks, only the smaller state banks.

This turns out to be rather important in the financial crisis: bad state banks regulated by the FDIC were sold off or closed, but the huge federal banks regulated by the OCC and OTS were bailed out via various arranged mergers, loan guarantees, or direct infusions of taxpayer money. Bair's argument is that this difference is partly due to the ethos of the FDIC and its well-developed process for closing troubled banks. The standard counter-argument is that the large national banks were far too large to put through that or some similar process without massive damage to the economy. (Bair strenuously disagrees.)

Bair's account starts in 2006, by which point the crisis was already probably inevitable, and contains a wealth of information about the banking side of the crisis itself and its immediate aftermath. Her story is one of consistent pressure by the FDIC to increase bank capital requirements and downgrade risk ratings of institutions, and consistent pressure by the OCC, OTS, and Geithner (first as the head of the New York branch of the Federal Reserve and then as Treasury Secretary) to decrease capital requirements even in the height of the crisis and allow banks to use ever-more-creative funding models backed by government guarantees. Bair fleshes this out with considerable detail about how capital requirements are measured, how the loan guarantees were structured, the internal arguments over how to get control of the crisis, and the subsequent fights in Congress over Dodd-Frank and how TARP money was spent.

(TARP, the Troubled Asset Relief Program, was the Congressional emergency measure passed during the height of the crisis to fund government purchases and restructuring of troubled mortgage debt. As Bair describes, and has been exhaustively detailed elsewhere, it was never really used for that. The government almost immediately repurposed it for direct bailouts of financial institutions and provided almost no meaningful mortgage restructuring.)

This account also passes my primary sniff test for books about this crisis. Fannie and Freddie (two oddly-named US government institutions with a mandate to support mortgage lending and home ownership) are treated as bad actors and horribly mismanaged entities that made the same irresponsible investments as the private banking industry, but they aren't put at the center of the crisis and aren't blamed for the entire mortgage mess. This disagrees with some corners of Republican politics, but agrees with all other high-quality reporting about the crisis.

Besides fascinating details about the details of banking regulation in a crisis, the primary conclusion I drew from this book is the power of institutions, systems, and rules. One becomes good at things one does regularly. The FDIC closes failing banks without losing insured depositor money, and has been doing that since 1933, often multiple times a year. They therefore have a tested system for doing this, which they practice implementing reliably, efficiently, and quickly. Bair states as a point of deep institutional pride that no insured depositor had to wait more than one business day for access to their funds during the financial crisis. Banks are closed after business hours and, whenever possible, the branches was open for business under new supervision the next morning. This is as important as the insurance in preventing runs on the bank that would make the closing cost even more.

Part of that system, built into the FDIC principles and ethos, was a ranking of priorities and a deep sense of the importance of consequences. Insured depositors are sacrosanct. Uninsured depositors are not, but often they can be protected by selling the bank assets to another, healthier bank, since the uninsured depositors are often the bank's best customers. Investors in the bank, in contrast, are wiped out. And other creditors may also be wiped out, or at least have to take a significant haircut on their investment. That is the price of investing in a failed institution; next time, pay more attention to the health of the business you're investing in. The FDIC is legally required to choose the resolution approach that is the least costly to the deposit insurance fund, without regard to the impact on the bank's other creditors.

And, finally, when the FDIC takes over a failing bank, one of the first things they do is fire all of the bank management. Bair presents this as obvious and straight-forward common sense, as it should be. These were the people who created the problem. Why would you want to let them continue to mismanage the bank? The FDIC may retain essential personnel needed to continue bank operations, but otherwise gets rid of the people who should bear direct responsibility for the bank's failure.

The contrast with the government's approach with AIG, Citigroup, and other failed financial institutions, as spearheaded by Timothy Geithner, could not be more stark. I remember following the news at the time and seeing straight-faced and serious statements that it was important to preserve the compensation and bonuses of the CEOs of failed institutions so that they would continue to work for the institution to unwind all of its bad trades and troubled assets. Bair describes herself as furious over that decision.

The difficulty in critiques of the government's approach to the financial crisis has always been that it was a crisis, with unknown possible consequences, and the size of the shadow banking sector and the level of entangled risk was so large that any systematic bankruptcy process would have been too risky. I'm with Bair in finding this argument dubious but not clearly incorrect. The Lehman Brothers bankruptcy was rocky, but it's not clear to me that a similar process couldn't have worked for other firms. But that aside, retaining the corporate management (and their salaries and bonuses!) seems a clear indication to me of the corruption of the system. (Bair, possibly more to her credit than mine, carefully avoids using that term.)

Bair highlights this as one of the critical reasons why the FDIC process is legally akin to bankruptcy: these sorts of executives write themselves sweetheart employment contracts that guarantee huge payouts even if their company fails. In the FDIC resolution process, those contracts can be broken. If, as Geithner did, you take heroic measures to avoid going anywhere near bankruptcy law, breaking those contracts becomes more legally murky. (Dodd-Frank has a provision, strongly supported by Bair, to create a legal framework for clawing back compensation to executives after certain types of financial misreporting, although it's still far more limited than the FDIC resolution process.)

A note of caution here: this book is obviously Bair's personal account, and she's not an unbiased party. She took specific public positions during the crisis and defends them here, including against analysis in other books about the crisis. She also describes lots of private positions, some of which are disputed. (Andrew Ross Sorkin's book is the subject of some particularly pointed disagreement.) I have read enough other books about the crisis to believe that Bair's account is probably essentially correct, particularly given the nature of the contemporaneous criticism against her. But, that said, the public position against bailouts had become quite clear by the time she was writing this book, and there was doubtless some temptation to remember her previous positions as more in line with later public opinion than they were. This sort of insider account is always worth a note of caution and some effort to balance it with other accounts, particularly given Bair's love of the spotlight (which shines through in a few places in this book).

Bair is a life-long Republican and a Bush appointee. I suspect she and I would disagree on most political positions. But her position as head of the FDIC was that bank failure should come with consequences for those running the bank, that the priority of the government should be protection of insured bank depositors first and the deposit insurance fund second, and that other creditors should bear the brunt of their bad investment decisions, all of which I agree with wholeheartedly. This account is an argument for the importance of moral hazard, and an indictment and diagnosis of regulatory capture from someone who (refreshingly) is not just using that as a stalking horse to argue for eliminating regulation. Bair also directly tackles the question of whether the same moral hazard argument applies to the individual loan holders and concludes no, but this part of the argument was a bit light on detail and probably won't convince someone with the opposite opinion.

It's quite frustrating, reading this in 2018, how many of the reforms Bair argues for in this book never happened. (A ban on naked credit default swaps, for example, which Bair argues increase systemic risk by increasing the consequences of institutional bankruptcy, thus creating new "too big to fail" analyses like that applied to AIG. Timothy Geithner was central to defeating an effort to outlaw them.) It's also a tragic reminder of how blindly partisan our national debates over economic policies are. You can watch, in Bair's account, the way that Democrats who were sharply critical of the Bush administration handling of the financial crisis, including his appointed regulators, swung behind the exact same regulators and essentially the same policies when Obama appointed Geithner to head Treasury. Democrats are traditionally the party favoring stronger regulation, but that's less important than tribal affiliation. The change is sharp enough that at a few points I was caught by surprise at the political affiliation of a member of Congress who was supporting or opposing one of Bair's positions.

As infuriating as this book is in places, it is a strong reminder that there are conservatives with whom I can find common cause despite being on the hard left of US economic politics. Those tend to be the people who believe in the power of institutions, consistent principles, and repeated and efficient execution of processes developed through hard-fought political compromise. I think Bair and I would agree that it's very dangerous to start making up policies on the spot to deal with the crisis du jour. Corruption can more easily enter the system, and very bad decisions are made. This is a failure on both the left and the right. I suspect Bair would turn to a principle of smaller government far more than I would, but we both believe in better government and clear, principled regulation, and on that point we could easily find workable compromises.

You should not read this as your first in-depth look at the US financial crisis. For that, I still recommend McLean & Nocera's All the Devils are Here. But this is a good third or fourth book on the topic, and a deep look at the internal politics around TARP. If that interests you, recommended.

Rating: 8 out of 10

Reviewed: 2018-05-29