In today's installment of former FDIC Chairman Sheila Bair's appearance on C-SPAN last week, Bair responded to more questions from callers and from host Greta Brawner.
Q: Republican from Georgia: Did the government make money from the bailouts, and where did it go?
A: Bair explained that some of the receipts went to the agencies that administered the programs, and money recovered by the Treasury went into the general fund.
In discussing the claim that the government made money on the rescues, she drew a careful distinction between cash receipts and the subsidy cost of the programs. She told the caller that the accepted way to account for the programs is to attach a proper value to the subsidy provided to institutions that got the money, and she admitted, "Some were healthy, some not."
She remarked that some will argue that since the government made a cash profit, the rescues are "no big deal," but in reality, it is a big deal, because they reinforced moral hazard, the assumption by banks that they can engage in risky activities and then get help from the government. She concluded that this sets a bad precedent.
My comment: Of course, the precedent was set decades ago, and the 2008 class of bailouts served to reinforce the perception that the "too big to fail" banks enjoy the backing of the federal government, so the more risk they take, the more they can maximize the value of this subsidy.
Another reason for parsing Bair's words is to emphasize the significance of her statement that some of the banks were healthy, but some were not. This gives the lie to representations by Treasury Secretaries Hank Paulson and Bair's nemesis Tim Geithner that the banks that got the money were healthy, and it exposes, at least in part, the charade that the too big to fail banks didn't need or want the money but rather had it crammed down their throats by the Treasury under threat of enforcement action if they refused.
The bankers knew that traditionally, once a crisis passed, banks that received emergency funding were subject to resolution. This is why an elaborate ceremony had to be staged and a big fuss made over how healthy the zombie banks are. They're "healthy" as long as the government funds them, but the business model of banking is flawed and over the course of a business cycle destroys capital. Therefore, the Treasury plan to keep the game going through an array of subsidies is doomed, and the United States will remain mired in the ongoing financial crisis indefinitely.
Q: Independent from Massachusetts: This caller complained that the Federal Reserve is owned by private banks and asserted the arrangement is unconstitutional, as Andrew Jackson had argued.
A: Bair declared that the Fed is constitutional, and then went on to defend the banks, contending that "not all banks are bad." However, she added, it is necessary to contain the risks banks pose, and the political power they have attained is part of the problem in containing risk.
My comment: Bair's answer would have been more complete if she had said that if one believes the central bank to be unconstitutional, it is necessary to take action before it becomes entrenched. To pose constitutional objections 100 years after the fact, after the Fed has had a century to put down an extensive root system in both the economy and the government, is futile.
The fact that she acknowledged the need to contain risk in spite of the political power of banks is helpful. Unfortunately, she then zagged and argued that bank lending supports the economy. Bair is from Kansas, where community banks are especially prominent, and she is a protege of former Sen. Bob Dole, R-Kan., so she is a true believer who has not come to terms with the fact that changes in technology and in the shape of the agricultural economy are bound to diminish the role of banks of all sizes. The late professor Mancur Olson, a student of bureaucracy, found that when an industry declines and fails, the last element that fails is its political power.
Q: Democrat from Florida: The caller took issue with the assertion by "right wingers" that Fannie Mae and Freddie Mac were responsible for the 2008 episode of the ongoing financial crisis, and he inquired about the effect of proposed legislation on the interest of common shareholders.
A: Bair responded that there is "plenty of blame to go around." Mortgages bear a share of the blame, because of the influence of greed on the private-label securities market. Fannie and Freddie provided a market for the securities and made a lot of money because of their ability to borrow cheaply due to the assumption that they were back by the government, which turned out to be true.
The government-sponsored enterprises had a symbiotic relationship with Wall Street, and in building their securitization business, Fannie and Freddie took homeowners out of traditional mortgages and put them into exotic products that ultimately defaulted. She lamented that there has still been no serious effort to reform the mortgage securitization business.
My comment: Securitization is the process of bundling financial instruments, such as mortgages, into huge packages that theoretically enable global institutional investors to select exactly the type of product, such as principal or interest and the level of risk, that suits them. However, if the issuer either botches this difficult task or, worse, deliberately misrepresents the product, investors lose trust — at least they should — and the originators, issuers and investors can all lose the opportunity to conduct this formerly lucrative business.
The concept of securitization entails that as the securities are traded over time, each owner is a "holder in due course without knowledge of any defects" in the securities. Now, the industry is eager to restore the flow of fees, but who doesn't have knowledge that this market became treacherous as the housing market collapsed in the years preceding the 2008 episode?
Moreover, Josh Rosner, managing director of research firm Graham Fisher & Co., has testified at hearings and other forums that the industry lacks the documentation, such as standard representations and warranties, needed to conduct this business.
Also, the industry is awaiting, and largely opposing, the issuance of so-called "skin in the game" rules that would require participants on the sell side to have something to lose and cannot bilk investors with impunity. This will be one of the most contentious issues in the battle of so-called mortgage finance reform.
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