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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.


Do we need a super FDIC?

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