Richard Drew/AP Photo
Bank regulators might have looked hard for other options; instead, they partnered with JPMorgan.
The government’s chummy use of America’s biggest bank, JPMorgan Chase, to take over failed First Republic Bank last Monday was supposed to restore confidence. Yet a day later, there was a different sort of bank run—on the stocks of other regional banks. Those stocks have since rebounded somewhat, but confidence in the banking system is far from high.
There were alternatives to the comptroller of the currency’s sweetheart deal with JPMorgan, lubricated by a hefty $13 billion in FDIC funds. But they were foreclosed by both the Treasury’s earlier reliance on JPMorgan as a white knight and an overly literal reading of the law governing FDIC rescues.
The FDIC is required to resolve failed banks with the least cost to FDIC funds. During the frantic weekend of April 30, when the comptroller and the FDIC chose JPMorgan over other suitors, other alternatives seemed to pencil out at more than $13 billion.
However, the “least cost” standard can be waived when the regulators find that an impending bank failure poses a systemic risk. In the case of two other recent failures, those of Silicon Valley Bank (SVB) and Signature Bank, regulators invoked systemic risk and came up with resolution strategies that did not increase concentration of the nation’s largest bank.
With SVB, the FDIC took over the bank on March 13 while it sought suitors. Then on March 27, the FDIC sold it to First Citizens Bank and Trust Co.
With First Republic, by contrast, the die was cast several weeks ago when JPMorgan, as a favor to the Treasury, put together a pool of $30 billion in deposits, including $5 billion from JPMorgan and $25 billion from nine other banks, to shore up the cash position of First Republic.
The others included Citigroup, Goldman Sachs, Wells Fargo, and Morgan Stanley. (Did somebody say cartel?) Why would these worthies possibly want to do Treasury a favor?
“This show of support by a group of large banks is most welcome, and demonstrates the resilience of the banking system,” the Treasury Department said in a joint statement with the Federal Reserve, Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency.
But regulators knew that restoring confidence in First Republic was a long shot. As the bank’s impending insolvency played out in public view over several weeks, regulators might have looked hard for other options; instead, they partnered with JPMorgan.
So when the collapse predictably came, JPMorgan was well positioned to take over the leavings. Since the government owed JPMorgan a favor, the FDIC’s bargaining position over the terms was fatally weakened. JPMorgan was able to call the shots.
As Columbia University law professor Kathryn Judge observes, current standards for the FDIC—the “least cost” solution—are too rigid, and having to certify a systemic risk is too blunt an instrument for waiving the rules. “We need to weigh the cost to the FDIC fund against other objectives such as maintaining a healthy level of competition and give the FDIC more flexibility to take other objectives into account,” says Judge.
One suspect aspect of the JPMorgan deal was the unusual guarantee that the banks that had deposited the $30 billion in now-insolvent First Republic would get their money back at 100 cents on the dollar, with no “haircut.” A good chunk of the FDIC’s $13 billion presumably goes to make good on that promise.
If the comptroller and the FDIC had struck a deal with a different consortium of suitors, that might have included a haircut for the JPMorgan group, which would have cost the FDIC less money. But having blessed the earlier (doomed) effort to save First Republic with $30 billion in quickie deposits, the government couldn’t very well stiff the JPMorgan cartel when the collapse came.
This, of course, is the deeper problem with cozy relations between the Treasury and behemoth banks.
