In making the case that the Federal Deposit Insurance Corporation ought to be given more power over financial institutions, chairman Sheila Bair often invokes what she sees as its proud past. “For 75 years, the FDIC has quickly and effectively resolved failed banks,” she said in an April speech. “We are good at this. We have had a lot of practice over the years.”
This address, like others by Bair, received fawning press coverage. Bair is credited with helping to restore public confidence in banks during the financial crisis and preventing bank runs like those of the 1930s. But more negative aspects of her tenure are often overlooked. That the FDIC insurance fund, which guarantees federally insured bank accounts up to $250,000, is, according to the AP, “at its lowest point since 1992, at the height of the savings-and-loan crisis” and may need a bailout from the Treasury Department hasn’t prodded most financial reporters to question Bair’s management. One of the few critics, Bloomberg columnist Jonathan Weil, recently wrote: “The FDIC has been mismanaged, and its credibility as a regulator is in tatters. Its insurance fund wouldn’t be in this position today if the agency had been run well.”
Appointed to head the FDIC by George W. Bush in 2006, Bair has won plaudits from Democrats, such as House Financial Services Committee chairman Barney Frank, and much of the media establishment, both for the populist sentiments she has expressed against big banks and their CEOs and for her initiatives to aid borrowers.
Ranked by Forbes as the second-most powerful woman in the world after German chancellor Angela Merkel (a fact trumpeted in Bair’s bio on the FDIC website), Bair is a Washington fixture. A native of Kansas, she is a moderate Republican who recoils at much of both social and economic conservatism. She recently described her ideology to Ryan Lizza of The New Yorker as “akin to [that of] Teddy Roosevelt’s trust-busting age.” With no formal training as an economist, Bair got her start in Washington working for her famously non-ideological home-state senator, Bob Dole, and was research director for his 1988 presidential campaign.
After Dole lost the nomination, she returned briefly to Kansas, where she ran as a pro-choice moderate for the U.S. House and lost the GOP primary. George H. W. Bush soon appointed her to the Commodity Futures Trading Commission, and in 2001 George W. Bush appointed her assistant secretary of the Treasury for financial institutions. In 2006, for reasons that are still unclear to liberals and conservatives alike, he appointed her chairman of the FDIC.
In many of the stories about Bair, both she and the reporters covering her use the metaphor of the “passbook” to describe ordinary American savers; Time has called her “America’s Passbook Protector” and the “voice of ordinary passbook holders.” In his New Yorker piece, Lizza wrote that Bair, who briefly worked as a teller at a small-town bank in Kansas in the 1970s, “recalls with nostalgia the simplicity of banking in those years, when children learned about the magic of compound interest by using passbook savings accounts, and their parents knew the lenders by name.”
But there is something inapt about this symbol that Bair’s admirers invoke, besides the fact that many of those who manage their finances online have never even heard of a passbook. It’s that saving is very different today. When the FDIC was created in 1933, depository banks were the only place most Americans kept their funds. But by 2001, 52 percent of American families had at least some of their savings in retirement plans such as IRAs and 401(k)s, which consist of investments in stocks and bonds.
In her rhetoric and many of her actions, Bair seems to be in a time warp, in which investors are the fat cats of the 1930s. Her attempts to protect depositors and troubled borrowers have often been at the expense of middle-class investors and the overall financial system.
Bair has at times served taxpayers well, and her non–New York perspective can be valuable. She made the right call this summer in refusing FDIC aid to CIT Group, a New York City–based commercial lender that was recently given bank-holding-company status by the Federal Reserve and money by the Treasury Department. Some financial-industry players argued for a bailout of CIT, but by closing the door on further government help, Bair and others in the Obama administration forced its bondholders to organize a private rescue. The fact that markets continued to climb after this occurred confirmed the belief of some that much of last year’s disruption could have been avoided had the government let Bear Stearns fail, drawing clear lines for other firms that would follow.
At other times, though, a seeming animus against investors has led Bair to take harmful actions that may have contributed to or prolonged the financial crisis. In the FDIC’s September 2008 seizure of Washington Mutual, which was immediately sold to JPMorgan Chase, even depositors above the insurance limit were made whole, yet bondholders were forced to take an almost total loss. Wall Street Journal economics editor David Wessel’s acclaimed new book, In Fed We Trust, describes the WaMu bondholder wipeout, which came just days after the implosions of Lehman Brothers and AIG, as the final nail in the coffin for private investment in commercial banks. A paper by European Central Bank economists states that it was “after the collapse of Washington Mutual” that “the crisis spread outside the investment-banking realm.”
Bair’s pattern of protecting all depositors — banking consultant Bert Ely found that in only a handful of the bank closings of the past two years did depositors with balances over the insurance limit take a hit — is turning her populism on its head. Those with bank accounts of six and even seven figures are protected from any risk, while pensions and other investment vehicles that serve less wealthy Americans have frequently borne the brunt of the loss from a bank failure.
Mortgage modifications are another area where Bair’s populism has hurt middle-class savers. Since April 2007, she has cajoled banks to freeze interest rates and reduce principal on mortgages, a move that led Frank and other Democrats to cheer her for taking on the “big banks.” But among the problems with doing this on as large a scale as Bair advocated, rather than on a loan-by-loan basis, is that banks often don’t own these loans, but act as “servicers” for investors who bought them in packages of mortgage-backed securities. The banks have a fiduciary duty to honor the contracts and get the best returns on these investments, many of which provide the income for pensions and other vehicles that serve middle-class savers.
Bair has made many statements disparaging investors, seeming oblivious to their importance to the financial system. When, in December 2008, the issue arose as to whether the loan modifications she was encouraging would trigger investor lawsuits against banks for breach of contract, Bair said, according to the AP, “Investors should be taking a hard look at what they’re advocating.” She also said: “There’s going to be backlash” if investors move forward with suits, and the AP article paraphrased her as implying the threat that “Congress may step in and change the legal obligations of mortgage servicers toward investors.”
An FDIC spokesman says Bair “never advocated” that Congress do this, and was simply warning that it could happen. But shouldn’t Bair, as a defender of a financial system dependent on the sanctity of contracts, be actively arguing against Congress’s taking such destructive actions? “If she were really doing all she could to guard the financial system, she would be advocating that contracts be honored,” says William Frey, CEO of the Greenwich Financial Services investment firm, who is suing disgraced financial lender Countrywide Financial for breach of contract in the mortgages it sold to investors.
Frey and others say the browbeating, by Bair and other officials, of banks to make loan modifications and of investors to accept them was a significant factor in driving down the value of the mortgage market. John Tamny, editor of RealClearMarkets.com, writes that ever since the government in spring 2008 “asked mortgage lenders to ‘voluntarily’ reduce contractual mortgage rates, the market for mortgage-backed securities has never been the same.”
Tamny is referring to Bush Treasury secretary Hank Paulson’s “Hope Now” initiative, which got lenders to agree to freeze interest rates on some loans. Bair influenced that program, but it did not go as far as she would have liked. Now, with Obama in office, the government is subsidizing banks to the tune of $75 billion to modify mortgages — as Bair has pushed for — but is not compensating investors for losses. And Congress indeed passed a bill in May that limited investors’ right to file breach-of-contract suits, though not to the degree that Democrats like Frank had originally desired. Frey says such contract abrogation will likely further reduce the “value of mortgage instruments because of the uncertainty it creates.”
Bair also helped reduce the value of mortgages and other bank assets through her advocacy of the flawed mark-to-market or “fair value” accounting standards. Set by a quasi-private body, these have been blamed by everyone from Steve Forbes to liberal economist Mark Zandi for accelerating the financial crisis by forcing banks to value assets such as mortgage-backed securities at the “market” price, even if the relevant market is thinly traded and the underlying loans are still performing well. Famed investor Warren Buffett said mark-to-market was “gasoline on the fire in terms of financial institutions.”
When asked on CNBC in February whether something should be done about these accounting rules, Bair said, “I don’t think so. . . . If you don’t like fair-value accounting, what else do you use?” In later comments, she has sounded more critical of the rules. Statutes somewhat restrict the FDIC from setting aside the rules — but the question remains as to why Bair didn’t advocate changes to them when she had Congress’s ear.
Now Bair advocates expanding the FDIC’s reach from banks to financial holding companies. Under her plan, the FDIC would have the authority to seize a broad array of businesses whose failure would pose a “systemic risk,” and would be able to cancel many forms of contract. Given Bair’s history of flawed moves, some due diligence is in order before we make this investment in government authority.
– Mr. Berlau is director of the Center for Investors and Entrepreneurs at the Competitive Enterprise Institute.