FDIC Chair Sheila Bair recently wrote a letter arguing in favor of Susan Collins' amendment to clarify a central provision in the financial-reform legislation: The largest banks must hold on to more capital and take less risk than smaller banks, a key part of reformers' effort to make banking less crash-prone -- and eliminate bailouts.It gets pretty complex, but essentially Bair is concerned that without specifying higher standards, under-capitalized financial companies that own federally insured bank subsidiaries could put the FDIC's insurance fund on the hook for losses in the event of a failure. As an example, she worries about the largest banks relying on their insured subsidiaries in emergencies, rather than the other way around -- some foreign banks with insured U.S. subsidiaries actually have negative reserve capital!
While Bair's argument is narrowly cast to defend her interests as a regulator (her job is protecting the Deposit Insurance Fund so consumers don't get screwed), this has broad implications for preventing future crises. Besides the fact that we don't want banks hiding their risk in federally insured subsidiaries -- pretty much the definition of lemon socialism -- it also speaks to the broader concern that we want banks taking less risk in general and focusing less on trading and more on lending. Keeping Collins' language in the final bill through the conference process will be a major priority for reform-minded legislators, despite opposition from lobbyists and within the Treasury Department.
-- Tim Fernholz
