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In my earlier diary I went over the reason I believed temporary nationalization (or more accurately recievership) could still be on the table.  In this diary I wanted to go over why I think the FDIC, The Obama Administration, and Congress may have been hesistant to nationalize these big banks and why I believe in the future the government may need a superFDIC to break them apart.

Now your question might be:

"Niwind, why do we need a superFDIC?  Isn't the regular FDIC enough?"

And that would be a good question to ask.  The FDIC has taken over more than twenty banks just this year.  Most of these banks are small town banks with assests around 300 million or less.  A good portion of these banks were sold to a bigger bank after they entered into recievership with the FDIC and overall have went smoothly.

But these are smaller banks.  The FDIC has had more difficulty with bigger banks such as Washington Mutual (who is in the process of suing the FDIC for selling it for less than it cost) and IndyMac where the FDIC took a loss for 4.7 billion dollars while still not selling all the assets.  FDIC also took a hit in terms of money because of banks not paying their insurance premiums for ten years.

As of Dec. 31, the FDIC had $18.9 billion in its insurance fund - down from $52.4 billion a year earlier - in addition to $22 billion that it has set aside for pending bank failures. The agency has projected it will need $65 billion to take over failed banks through 2013.

I now want to go into Citibank, or more accurately, Citigroup.  

Citigroup has four major segments in its business group. There is consumer banking, global cards, Institutional Clients Groups (which covers investment banking, private equity, and real estate), and Global Management (which covers private banks, retirement services, and banking services).

Citigroup employs over 300,000 employees world wide and operates in over 107 different countries.  Overall, Citigroup serves over 200 million customers, making it one of the biggest financial companies in the world and Citibank one of the world's biggest banks.

Which brings me back to the FDIC and the article above.

But if the FDIC suddenly had to take over a giant bank such as Citigroup or Bank of America, the fund would be drained "in a flash," said Cornelius Hurley, director of the Boston University law school's Morin Center for Banking and Financial Law.

That does not even go over another hazard in the FDIC handling this by itself.  The FDIC can only take over Citibank, not the entirety of Citigroup.

Sheila Bair explains:

The problems of supervising large, complex financial institutions are compounded by the absence of procedures and structures to effectively resolve them in an orderly fashion when they end up in severe financial trouble. Unlike the clearly defined and proven statutory powers that exist for resolving insured depository institutions, the current bankruptcy framework available to resolve large complex non-bank financial entities and financial holding companies was not designed to protect the stability of the financial system. This is important because, in the current crisis, bank holding companies and large non-bank entities have come to depend on the banks within the organizations as a source of strength. Where previously the holding company served as a source of strength to the insured institution, these entities now often rely on a subsidiary depository institution for funding and liquidity, but carry on many systemically important activities outside of the bank that are managed at a holding company level or non-bank affiliate level.

She then explains that the FDIC is only authorized to take over the banking institution and why this is a huge problem for both the bank and the holding company:

In the case of a bank holding company, the FDIC has the authority to take control of only the failing banking subsidiary, protecting the insured depositors. However, many of the essential services in other portions of the holding company are left outside of the FDIC's control, making it difficult to operate the bank and impossible to continue funding the organization's activities that are outside the bank. In such a situation, where the holding company structure includes many bank and non-bank subsidiaries, taking control of just the bank is not a practical solution.

And what would happen if the holding company is cut off from it's main source of money?

While the depository institution could be resolved under existing authorities, the resolution would cause the holding company to fail and its activities would be unwound through the normal corporate bankruptcy process. Without a system that provides for the orderly resolution of activities outside of the depository institution, the failure of a systemically important holding company or non-bank financial entity will create additional instability as claims outside the depository institution become completely illiquid under the current system.

If a bank holding company or non-bank financial holding company is forced into or chooses to enter bankruptcy for any reason, the following is likely to occur. In a Chapter 11 bankruptcy, there is an automatic stay on most creditor claims, with the exception of specified financial contracts (futures and options contracts and certain types of derivatives) that are subject to termination and netting provisions, creating illiquidity for the affected creditors. The consequences of a large financial firm filing for bankruptcy protection are aptly demonstrated by the Lehman Brothers experience. As a result, neither taking control of the banking subsidiary or a bankruptcy filing of the parent organization is currently a viable means of resolving a large, systemically important financial institution, such as a bank holding company. This has forced the government to improvise actions to address individual situations, making it difficult to address systemic problems in a coordinated manner and raising serious issues of fairness.

So, what Bair is explaining is the fact that the FDIC is only allow to touch, in the case of Citigroup, the bank itself.  Which is like cutting off the head of giant. Sure if feels good, but watch out of that falling huge body that will crush villages underfoot.  Not to mention the other major banks it would  take down with it.  And since Citigroup is a hybrid bank, it would be harder to command and take over with the supplies that the FDIC has.  This also explains why the Obama Administration didn't take Citi, Bank of America, or even AIG into recievership for the FDIC.

Which is probably why the Obama Administration wants these powers:

A central aspect of the plan, which has already been announced by the administration, would give the government greater authority to take over and resolve problems at large troubled companies not now regulated by Washington, like insurance companies and hedge funds.

That proposal would, for instance, make it easier for the government to cancel bonus contracts like those given to executives at the American International Group, which have stoked a political furor. Under the proposal, the Treasury secretary would have the authority to seize and wind down a struggling institution after consulting with the president and upon the recommendation of two-thirds of the Federal Reserve board.

If Obama gets these power then Treasury can take over any holding and banking company it wants that is deemed "too big to fail" in a crisis.  The only problem I have with this is I think it should be given to a new agency that can take care of hybrid banks while the FDIC stays with the smaller ones.  It should be an independent agency and one that is transparent in its action.  It should also be well funded and that funding should not be used until there is an emergency like a big bank failing. A superFDIC if you will.

I also think Sheila Bair has a point when she says this:

Congress should examine a more fundamental question of whether there should be limitations on the size and complexity of institutions whose failure would be systemically significant. Over the past two decades, a number of arguments have been advanced about why financial organizations should be allowed to become larger and more complex

These companies shouldn't have gotten this big in the first place and have placed the entire system in danger due to their size and the fact that they were running their banks like a corporation.  In the future we need to make sure that this doesn't happen again so that we won't find ourselves in the same spot twenty, forty, or even eighty years into the future.

Originally posted to Niwind on Mon Mar 23, 2009 at 02:28 PM PDT.

Poll

Do we need a super FDIC?

50%7 votes
28%4 votes
21%3 votes

| 14 votes | Vote | Results

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Comment Preferences

  •  I wish that I thought thay the Obama (2+ / 0-)
    Recommended by:
    HoundDog, Niwind

    administration was cleverly planning this out step by step, but I don't. Sheila Bair strikes me as one of the few people in an important regulatory position that I'm inclined to believe. She seems willing to speak her own views whether they are the official admin line or not. She was willing to butt heads with Greenspan over the need for more regulation.

    If she is speaking for the administration in these statements then it is somewhat reassuring, because what she says makes sense. The breaking down of regulatory barriers like Glass-Seagal has allowed financial monsters to spring up that are beyond the authority of existing regulatory systems.

    BTW: The number that I saw for the hit that the FDIC took on IndyMac was $10B.

    •  I don't think it is a chess plan or anything. lol (3+ / 0-)
      Recommended by:
      HoundDog, Richard Lyon, soms

      lol.  But I think the Obama administration is going for something. By even asking for these powers they are saying that they will use them if necessary.

      I've never thought that temporary recievership was off the table but I definately think it is the last big gun they want to use if nothing else works.

      The problem is how much they are going to waste on the toxic asset program before they to this.  By asking for these powers now, I don't think is all that far away.

      •  The whole idea of this new receivership authority (1+ / 0-)
        Recommended by:
        HoundDog

        seems to have only come up last week after the AIG bonus issue blew in their faces. That's what makes me wonder if as far as Obama and Geithner are concerned it is part of a long range plan or an act of short term desperation.

        I have seen a couple of interviews with Bair where she alluded briefly to the problems with the holding companies. This is not something she just thought of last week. Her remarks in her testimony are more fully developed. I hope that Obama and Geithner are listening to her. Nobody in the Bush admin did.

        •  Bair impressed me a great deal in the very few (1+ / 0-)
          Recommended by:
          Richard Lyon

          occassions I've seen her speek.  She certainly is a much more effective voice for the administration than Summers or Geithner have been.

          Team Obama needs to get more folks like Bair out on the circuit advocating their view.

          Nature abhors a vacuum.  If they don't put their viewpoint out in front of the cameras and voters other folks will do it for them.

          From what I've heard so far, I have found Krugman, Stiglitz, Jerome Paris, Gailbraith, and even Bebchuck to have more compelling arguments.  

          But, I'm all in favor of learning and revision, which I hope Obama's team will do.  And even if they don't, at least they should be getting their point of view out for fair consideration.

          Maybe we can forge a hybred that is better than anything single plan we've seen so far.

          I strongly favor much greater use of the FDIC process, and even expanded or expedited procedures, and certainly support the extra powers and dollars for the FDIC that Obama is requesting.  And also extra staff and accelerated training for the FDIC.

          The means is the ends in the process of becoming. - Mahatma Gandhi

          by HoundDog on Mon Mar 23, 2009 at 05:51:20 PM PDT

          [ Parent ]

  •  The FDIC is a Liquidator (2+ / 0-)
    Recommended by:
    phonegery, Fire bad tree pretty

    Their job is not to restructure things.  They take over sell assets, pay off the creditors in varying levels and cover the shortfall.  They would be totally over their head in trying to restructure a major bank.  They are not even that effective in maximizing value from the assets.  Speed is seemingly more important to them than maximum value.

    What they do is fine for what they do.  Expanding their mission would not be a guaranteed good idea.

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