Too Small to Bail?
As chair of the Federal Deposit Insurance Corporation (FDIC) until last July, Sheila Bair played the role of loyal opposition to the strategy pursued by Treasury Secretary Timothy Geithner of propping up the biggest banks and deferring the issue of systemic reform. Bair argued for helping smaller banks and small businesses as well as breaking up huge banks that were deemed “too big to fail.” Now based at the Pew Charitable Trusts, Bair spoke with Prospect co-editor Robert Kuttner.
How are community banks faring in the financial crisis?
Not enough people recognize that community banks actually weathered this crisis pretty well and that the risks they had taken were much lower than those of the larger institutions. Fewer than 5 percent have failed, and when they do fail, the FDIC follows a strategy of marketing them to other community banks with ties to the same service area. During my tenure at the FDIC, over 90 percent of the community banks that failed were bought by other community banks.
The 5 percent failure rate for community banks stands in stark contrast to the failures of the largest institutions. Two of the four major commercial bank-holding companies needed multiple bailouts. Bank of America, to support its acquisition of Merrill Lynch, needed two bailouts. Citi needed three. And of course, among the five biggest securities firms, three—Bear Stearns, Lehman Brothers, and Merrill Lynch—went down or were acquired in government--assisted transactions.
Community banks’ loan balances remained pretty much constant throughout the crisis, while the big banks really pulled back significantly. That’s changing now, as the economy is improving and the big banks have been able to recapitalize, helped by a lot of the cheap government money. The good news is they’re making more small-business loans; the bad news I’m hearing from smaller banks is that the big banks are in there cannibalizing their best customers.
Given all the money that was poured into the big banks via the Troubled Asset Relief Program and the Federal Reserve, what more should have been done to help community banks?
We suggested that if Congress wanted to appropriate funds to help community banks make small-business loans, the money should be used to help community banks hold reserves against losses for new small-business loans. That way you could make sure that the money directly supported new small-business lending. The TARP capital investments didn’t work in supporting new lending. We know that now. We suggested a 50-50 split, with the community bank putting up 50 percent of the reserve, and the government would put up the other half. Senator Mark Warner pushed it, but Tim Geithner and [National Economic Council Director] Gene Sperling wouldn’t support it. We ended up getting a billion dollars for state pilot programs along those lines. I think North Carolina has launched a reserving program.
Why didn’t Sperling and Geithner support it?
I think that they don’t want to spend money. I think they want to say, “We’re getting a return on our investment as TARP funds are paid back.” By putting up 50 percent of the loan reserves, they would be directly supporting small business, but they’d probably have to take some losses on it. It’s risky to make small-business loans given the uncertain economy. But that is the whole rationale for a government program. The more cynical explanation is that they wanted the new Small Business Lending Fund [SBLF] program to support TARP repayments. If you look at the applications for the new SBLF, a good chunk of that money is being used for TARP repayments so that Tim [Geithner] can say they’re out of TARP.
To the extent that community banks are the mainstay of small businesses, what else might have been done to prevent credit contraction as business collateral lost value?
At the FDIC, we issued guidance to our examiners. We said loans collateralized by commercial real estate should not be criticized just because the collateral values went down, because that would have been highly pro-cyclical. Our examiners told me that OCC [Office of the Comptroller of the Currency] has been much harsher on this. It’s frustrating to me, because I think all the bank regulators get lumped together. We have tried to show a lot of flexibility.
Why do you think OCC took such a hard line, since they are not exactly famous for being a tough regulator?
Not for big banks, but for little banks—at times, they can be really tough on little banks.
Why is that?
There are a lot of good examiners at the OCC, so the approach varies. I think one reason is that small banks are easier; an examiner can come in and can understand the business model. Then they go to these big banks and can’t understand what’s going on anymore. They are intimidated and afraid to challenge management.
How would you address the continuing mortgage crisis?
The loan servicers have been understaffed and poorly funded. The servicers have gotten a lot of blame, deservedly so. But the mortgage bondholders have been a source of a lot of resistance to loan workouts and restructuring, too. We need to simplify loan-modification programs and have a more efficient way of clearing the market that is fair to all concerned. When I was at the FDIC, we had proposed what we called the “Super Mod.” For borrowers who were more than 60 days delinquent by a certain date, the servicers would offer to write down the principal to 97 percent of the appraised value. The homeowner could try to work with a reduced mortgage payment, or they could do a short sale. They would have to share in any profits from subsequent home-price appreciation. If they re-defaulted on their mortgage, they would agree to turn in the keys in exchange for some counseling help and relocation assistance. We saw this as a streamlined way to give underwater borrowers a chance at mortgage relief, but if they still couldn’t make it, it also provided a way to help them move on and bypass the foreclosure process, which is expensive, time consuming, and painful for all concerned.
The complexion of the problem has changed. It’s not just unaffordable mortgages—it’s economically stressed neighborhoods, it’s people losing their jobs or a spouse losing a job, it’s reduced income. So there’s a trap. Even if a lot of people can’t afford the house, a principal reduction and a short sale can allow them to move into another place that’s affordable or to get a different job in another place and not be trapped by their house.
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