Regulatory Reality

Jul 27 2009   8:56PM GMT

Let the FDIC lead the way!

David Schneier David Schneier Profile: David Schneier

I can’t think of any more telling comment about where I am in my professional life than what I’m about to offer:

Sheila Bair rocks!

If you don’t know who she is, well, shame on you.  Because over the past year or so as the banking world has been in a near free-falling, tail-spinning heap of confusion, the chairman of the Federal Deposit Insurance Corporation (FDIC) remains perhaps the only reason why we haven’t been experiencing pure panic in the banking sector.  We’ve all watched as she calmly navigates from bank failure to bank failure, never losing her composure or allowing the dire circumstances to consume her or the FDIC.  She routinely offers sound and sensible insight and perspective, framing what’s happening in the banking world and making sure that everyone knows that the FDIC continues to have our back.   From the very first publicized collapse last year (IndyMac) straight through to last week’s speech before the Senate Committee on Banking, she has proven that there’s no substitute for having the right person in the right job.

As to why I’m waving my Sheila Bair banner so vigorously this week you need only read the transcripts from her aforementioned Senate testimony last week.

She was among the very first and remains one of the very few industry leaders to rail against the idea that any financial institution is “too big to fail.”  Last week, she expanded on that considerably.  She discussed how the “notion of too big to fail creates a vicious circle that needs to be broken” or rather, “we need to end too big to fail.”  She highlighted how so much of what’s caused this nightmare stems from “the presence of significant regulatory gaps with the financial system” and followed that up by suggesting that “we need to develop a resolution regime that provides for the orderly wind-down of large, systemically important financial firms, without imposing large costs to the taxpayers.”

Wow!  I mean, like, wow!

So really what she’s saying is that if you’re, say Citigroup or Bank of America, and you’ve managed to paint your institution into a financial corner from which you can’t legitimately escape, the only thing to do is go out of business.  Y’know, sort of like the core principles of a free market economy would dictate, or so we all believed until this past year.  None of this government bailout activity would be allowed that essentially transferred risk from for-profit institutions to us, the taxpayers.  You mismanage your bank, you run out of options, you close; simple and fair.

Chairman Bair further expanded on her proposal by explaining that with a resolution regime “losses would be borne by the stockholders and bondholders of the holding company, and senior management would be replaced.”  Or rather in my own words, accountability would be enforced; those who made the decisions that caused the problem would be forced out and those that were banking on a windfall that until now was almost guaranteed would have to accept the unfortunate risk-side of their investment (no more “sure things”).  And towards that end, she suggested that “each bank holding company with subsidiaries engaged in non-banking financial activities would be required to have, under rules established by the FDIC, a resolution plan that would be annually updated and published for the benefit of market participants and other customers.”   This I’ve come to think of this as a disaster recovery plan of an entirely different nature.

Think about what’s being proposed: accountability, acceptance of risk and the need to plan for all potential outcomes, favorable or otherwise.  What a concept!  And what a breath of fresh air!

Chairman Bair also offered the concept of forming a Financial Services Oversight Council that effectively “should be able to harmonize rules regarding systemic risks to serve as a floor that could be met or exceeded, as appropriate, by the primary prudential regulator.”  But wait, there’s more.  Of the council she also suggested that “primary regulators would be charged with enforcing the requirements set by the Council. However, if the primary regulators fail to act, the Council should have the authority to do so.”  This would eliminate the current design restrictions in which individual oversight agencies could only pursue punitive and/or corrective actions to a point but once their jurisdiction ended so too would their ability to take additional and often necessary steps to address the issues at hand.  Generally speaking, this would eliminate a number of loopholes that currently exist in the system.

I find all of this remarkably refreshing.  It’s so simple and straightforward, it’s all but impossible to reject or ignore (but I’m sure our politicians will try just the same).  And to a very large degree, these proposed changes would work, maybe not completely but certainly enough so that it would be worth our time to at least attempt implementing them.

But does everyone think so highly of Ms. Bair and her proposal?  It’s received pitiful little coverage in the press (I couldn’t find anything on two of the major news sites and on the third it was skewered to look like partisan politics) and none of my contemporaries were even aware that she had spoken.  Frankly, I don’t understand why.

I’ll put it out there right now: If I have a vote that can be cast in support of her plan it’s hers; there’s no need to ask me twice.  And if I need to poke a senator or two from my home state to help inspire them to support her plan, someone only has to let me know and I’ll happily go call on them (at home or in DC, it’s close enough to drive).

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