Tags: Bair | banks | S&L | regulations

Sheila Bair on State of the Banking System — Part II

By    |   Friday, 30 August 2013 01:09 PM

This is the third is a series of articles based on an event held on Aug. 21 by the National Press Club, convening a panel consisting of Pimco CEO Mohamed El-Erian, Stanford economics professor John Taylor and Pew Charitable Trusts' Sheila Bair, to consider the state of the economy and of the banking system.

This final article will focus on a colloquy between the moderator, Jennifer Schonberger, of The Wall Street Report, and Bair, in which Schonberger walked the former FDIC chairman through a look at the condition of the banking system five years after the 2008 episode of the financial crisis.

Schonberger put to Bair the simple question, "What is the state of the banking system now?"

Bair responded, "I think it's certainly safer than it was in the lead-up to the financial crisis, but it's not as safe as it should be, and so many of the rules that we really need to have for a more stable financial system have really not been finalized yet. We have got more capital into the banks, primarily through the stress-testing process, which is a discretionary process; it's not a rules-based process. So I worry about the sustainability of that over time.

There've been good rules proposed that significantly raise the amount of capital that large financial institutions need to use to fund their risk taking, but these rules have not been finalized yet; they just went out for 60-day comment. So this is still very much a work in progress."

After some more discussion of the pending rules, she admitted, "Those are just getting started, frankly."

This and other presentations by Bair contain a heavy dose of what, for me, is little more than "banka propaganda." In the days following the savings and loan (S&L) episode in the 1970s and 1980s of the ongoing financial crisis, the bank lobby propagated the refrain that the banking system would not be vulnerable to such an event, because banks were "better capitalized, better managed and better regulated" than the S&Ls were.

Upon reflection, the message can be seen as little more than public relations rhetoric. As the S&L crisis unfolded, even as early as 1981, I predicted that whereas the failure of the S&L industry did not take down the U.S. and global financial systems, at least not then, the prevalence of similar, dangerous practices by the banking industry had the potential to do this.

Even Bair seems to recognize this, as her discourse vacillates between assurances that the banks are in better shape than before 2008 and worries that the current circumstance is "unsustainable" and the banks are bent on restoring a system of returning to highly leveraged housing finance.

Banks are highly exposed to a mismatch between overnight funding and longer-term loans and other investments designed to play the yield curve spread between free money conferred on them by manic authorities Treasurys that entail no credit risk but considerable interest-rate risk if rates should rise quickly, as suggested in the previous article.

The panelists, led by El-Erian, expressed concern that the financialization of what used to be the financial services industry has displaced banks from their role in support of the real economy. In Martin Mayer's classic "The Bankers," published nearly 40 years ago in 1975, the author observed that the role of banks had changed as the significance of the agricultural economy had diminished, as banks moved toward funding themselves through the capital markets rather than deposits and as corporate borrowers gained access to the capital markets, frequently at better rates than the banks themselves could borrow.

Eugene Ludwig, the former Comptroller of the Currency who has played the role of "former" to the max and has assembled many other formers to support the banking industry, has testified to the Senate Banking Committee that banks perform the "miracle" of "asset transformation," which turns short-term, even overnight, funding into long-term assets such as residential and commercial real estate.

Perhaps the leaders of the debate over how to extricate the economy from quantitative easing and bailouts of zombie banks need to consider the possibility that the evolution of markets has long since written fine into the useful life of the banking model, and this fact will become manifest if interest rates continue to rise and undermine the values of assets that captive regulators do not require banks to mark to market.

What is most disturbing and challenging for me is the discontinuity between the real state of the banking model and the aggressive campaign by the banking lobby against the implementation of rules that are necessary for the ongoing financial crisis to be contained to any meaningful degree.

Bair is right to chide the bankers for saying that they support completion of the regulatory agenda, but the industry only supports regulations that it likes.

If Bair is wrong in her contention that the banking system is safer than it was in the run-up to the 2008 episode, and if the claimed augmentations of capital, admittedly to be implemented over an extended period while bankers crow that they can meet the requirements by rejiggering their risks among their myriad subsidiaries and other affiliates, a much stronger regulator response is required.

An effective regulatory program would need to be built around principles of transparency, independence and accountability that are almost totally lacking under the current, failed system of captured regulation.

In conclusion, here is another idiosyncratic idea for readers to consider, a troubling one indeed. A column in USA Today by criminologist James Allen Fox of Northwestern University appearing suggests that the underlying cause of the recent horrifying murder of the Australian student Christopher Lane may lie in "group dynamics," where "the inspiration for violence is more about concern for peer approval than a lack of concern for defenseless prey."

Perhaps this phenomenon has taken root in the financial community to the extent that bankers will continue to pursue antisocial activities in order to validate a predatory group ethos.

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This is the third is a series of articles based on an event held on Aug. 21 by the National Press Club, convening a panel to consider the state of the economy and of the banking system.
Friday, 30 August 2013 01:09 PM
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