You stabilize the banks to support the economy. But you don’t stabilize the banks for the sake of stabilizing the banks.

TO BE NOTED: From Bloomberg:

"Bair Attacks Too-Big-to-Fail as Enforcer Geithner Must Trust

By Alison Vekshin

May 29 (Bloomberg) -- Sheila Bair, chairman of the Federal Deposit Insurance Corp. and a lifelong Republican, boarded Air Force One for the first time in February. Neither President George H.W. Bush nor his son, President George W. Bush, had invited her on the world’s most famous jet in the five years she worked for them. It was a Democratic president, Barack Obama, who asked her to fly to Washington after the two had unveiled his administration’s foreclosure relief plan in Mesa, Arizona.

“Sheila, come on back. I want to talk to you,” Obama told Bair, who was seated in the plane’s conference room. He then escorted her into his airborne Oval Office for their first private meeting, where they discussed the government’s role in alleviating the worst financial crisis since the 1930s.

“It was great,” Bair says of her meeting with the president. “He’s got an agenda which we share. Banks are a means to an end. You stabilize the banks to support the economy. But you don’t stabilize the banks for the sake of stabilizing the banks.”

After being left out of big decisions by Bush administration officials, such as the push last year for the $700 billion bank bailout, Bair, 55, has become one of the most powerful policy makers in Washington. Driven by a combination of circumstances and her own candor, Bair has presided over the biggest expansion of the FDIC’s authority since its founding in 1933 to insure bank deposits.

‘Bites Like Jaws’

“She looks like Bambi and she bites like Jaws,” says Wade Henderson, president of the Washington-based Leadership Conference on Civil Rights, who has known her for 27 years. “There’s a quiet intensity about her. She’s idealistic in spite of her 30 years in Washington.”

Under Bair, the normally invisible agency was the prime mover behind Obama’s $75 billion program to curb foreclosures. Last year, the FDIC became the go-to agency to insure hundreds of billions in bank debt to boost liquidity, and it’s currently spearheading half of the initiative to encourage investors to buy up to $1 trillion in troubled assets.

The FDIC head isn’t done expanding her influence over Wall Street. An opponent of the “too-big-to-fail” policy for firms like Citigroup Inc., Bair is lobbying Congress to give the FDIC authority to wind down bank and thrift holding companies -- a move she says is necessary to protect taxpayers. And she wants lawmakers to include the agency in a systemic risk council to prevent future financial shocks.

Populist

As Bair builds her power, soaring bank failures are jeopardizing her agency’s deposit insurance fund, which had dwindled to $13 billion in the first quarter, the lowest amount since 1993 following the savings-and-loan crisis. She requested more funding from Congress, which on May 19 more than tripled the FDIC’s borrowing authority from the Treasury Department to $100 billion. Lawmakers also approved a temporary boost of the credit line to $500 billion.

A self-described “populist,” Bair has won allies in the Democratic Party, such as Representative Barney Frank of Massachusetts, in muscling the FDIC into prominence. She has also fought battles with the Independent Community Bankers of America, representing 5,000 banks, and the Bush administration.

In 2008, Bair says, her struggle with midlevel Treasury Department officials turned tense as they stonewalled her proposal to use federal funding to prevent foreclosures. And she tussled with Timothy Geithner, then the president of the Federal Reserve Bank of New York, over the request last year that the FDIC guarantee all debt issued by lenders -- a move she rejected because it would expose her agency to big losses.

Geithner’s Respect

“I’m from Kansas; I’m not from New York,” Bair says. “I’m a lot of things that are different. So maybe that does give me some more independence of thought and daring to not care who I offend.”

Following Obama’s election in November, Geithner tried to have her ousted for not being a team player, according to people familiar with the matter. Through a spokesman, Geithner declined to say whether he sought to remove Bair from office.

“I have great respect for her,” Geithner told Bloomberg TV on May 21. “She’s a strong advocate for her agency and a strong advocate for her points of view.”

In May, after the FDIC assisted the Federal Reserve in stress testing 19 lenders, Bair put their executives on notice. She said some of them could lose their jobs in the next few months after the companies submit capital-raising plans to the government, according to an interview with Bloomberg TV and a statement from the FDIC on May 15. Bair didn’t say that the government would oust the chief executive officers of the banks.

$4.8 Trillion in Deposits

Bair says she’s seeking more authority over banks because her agency has so much at stake -- $4.8 trillion in insured deposits.

“There is some perception we want these programs, we want all this power,” Bair says. “That is not the case. We want a cleanup. This agency was born of a crisis and made for a crisis.”

Congress created the FDIC in 1933 at the depths of the Great Depression during President Franklin D. Roosevelt’s first term. As thousands of customers rushed their lenders to withdraw funds, toppling about 4,000 banks that year, Congress gave the new agency the powers to insure deposits and liquidate failed lenders.

Set up as an independent authority like the Federal Reserve, with a chairman serving a five-year term, the FDIC has been quiescent during most of its history. Then, in the 1990s, the agency expanded its staff to liquidate banks during the S&L crisis, when 124 insured institutions went down in 1991 alone.

1,000 Bank Failures

Now facing the largest number of bank failures since the S&L debacle, Bair has been fighting with bankers to protect the solvency of her deposit insurance fund. As many as 1,000 banks will go down from 2009 to 2012, says Gerard Cassidy, managing director of bank equity research at RBC Capital Markets in Portland, Maine.

The FDIC’s insurance fund, which covers deposits up to $250,000 after Congress temporarily boosted the amount from $100,000, is financed by banks. Most of them pay an annual fee of 12 cents to 16 cents per $100 in deposits. In February, Bair proposed an additional, emergency one-time charge of 20 cents per $100 in deposits, which ignited a firestorm of criticism from small banks.

Camden Fine, president of the Independent Community Bankers of America in Washington, sent a letter to more than 35,000 bankers in early March.

Hiking Bank Fees

“Shake the walls of the FDIC and Congress until they reverse this and other misguided policies,” Fine wrote. Bankers barraged the agency with letters complaining that the levy would wipe out profits.

After Congress agreed to boost the FDIC’s credit line to backstop the insurance fund, Bair moved to reach a compromise with the banks. On May 22, the FDIC approved a one-time fee on banks of 5 cents per $100 in assets, minus Tier 1 capital. By basing the fee on assets rather than deposits, the FDIC is putting more of the onus on larger institutions.

As the FDIC gains more regulatory clout, Republican lawmakers say the agency is stretching itself too thin in veering from its main job of insuring deposits.

“I’m very concerned ultimately about the core function of the FDIC, which is the cornerstone of our financial system, which is the safety and soundness of the insurance fund,” says Representative Jeb Hensarling, a Texas Republican.

ABA Opposition

The American Bankers Association, which represents banks of all sizes, is lobbying to stop the FDIC from gaining more turf. Bair’s proposal to give her agency the power to dismantle huge financial companies would have included government-controlled American International Group Inc. before the government took control of it, according to the Washington-based ABA. It says Congress shouldn’t give the wind-down authority to the FDIC because the financial burden of liquidating the large companies would likely fall on fee-paying banks.

“We think it would be a calamity for the country because the FDIC insurance of bank deposits has been so important,” says Edward Yingling, president of the trade group. “Why should a community bank in the middle of Iowa be paying for AIG? We pay insurance premiums to cover insurance on banks, not on everybody.”

As Bair’s stature rises, so does the number of hostile e- mails she receives from depositors who have suffered losses because their amount of money at failed banks exceeded the insurance limit. For the first time, starting in early 2009, the FDIC assigned a security detail to its chief. After speeches, Bair is often swarmed by crowds of reporters and citizens who sometimes jostle her 5-foot-4-inch (1.6-meter) frame.

Independence, Kansas

“She’s a very recognizable face now,” says Fine of the banking trade group. “All it takes is one disgruntled banker or depositor and bad things can happen.”

Bair’s populist politics were shaped in Independence, Kansas, a rural town of about 10,000 people where she grew up. Her mother, Clara, a nurse, and her father, Albert, a doctor, were children during the Great Depression and swayed her views about the importance of being thrifty.

“The culture out there is one of being in touch with the people and grassroots,” says Fine, who’s from Jefferson City, Missouri.

A classic overachiever, Bair graduated from Independence High School a year early and earned a degree in philosophy in three and a half years from the University of Kansas in Lawrence in 1975.

“I like to get things done quickly,” she says.

Robert Dole

Hoping to work in public service, she entered a law program at the same school and graduated three years later. Bair interviewed at several law firms that in the 1970s were mostly hiring men.

“They couldn’t compete with men for jobs in the law firms,” says Fred Lovitch, a professor at the law school who taught Bair in a securities regulation course. “She did what our best women students did then, which was to get as good a job as they could in the federal government and work their way up from there.”

The Department of Health, Education and Welfare in Kansas City hired Bair as a civil-rights lawyer. In 1981, she began her ascent in Washington, landing a job in the office of Robert Dole, a Republican senator from her home state. Dole, 85, says one of the reasons he hired Bair was because he knew her father, a political supporter. In seven years with the senator as a research director and counsel, she worked on civil rights, including legislation making Martin Luther King Jr.’s birthday a federal holiday and extending the Voting Rights Act; judicial nominations; and Dole’s presidential bid in 1988.

Runs for Congress

“She’s a hard worker, one of these people who if you say, ‘Sheila, would you do A, B, C or all three?’ then you didn’t have to worry about it every day,” Dole says.

Eager to make some money, Bair left Dole’s office in 1988 after his failed campaign for the White House and joined the New York Stock Exchange as its legislative counsel in Washington.

In 1990, at Dole’s urging, Bair returned to Kansas to run in the Republican primary in the 5th District for a House seat. The only pro-choice candidate among six contenders, she called for a balanced budget and the revitalization of economically depressed southeast Kansas. She rode around in rural communities on a bicycle with a yellow flag saying “Bair for Congress” before losing by 760 votes.

“She should have gotten married before the race,” Dole says. “At that time in Kansas, I think there were a lot of people, seniors and others, who would like to see young people married before they go to some public office.”

CFTC Commissioner

A year later, in 1991, the first President Bush nominated Bair to be commissioner of the Commodity Futures Trading Commission, an agency that fell under the jurisdiction of the Senate Agriculture Committee that Dole had served on. During her tenure at the CFTC, Enron Corp., the energy-trading company that would blow up in 2001, lobbied the commission to exempt over- the-counter energy derivatives from the agency’s rules banning fraud, says Susan Milligan, a senior vice president at the Chicago-based Options Clearing Corp. who worked for Bair at the CFTC.

Bair was the only commissioner of the three-member panel who dissented on the proposed exemption; she lost the battle.

“There was a lot of pressure to vote for the exemption from the OTC derivatives community,” Milligan says. “Sheila said, ‘Absolutely not. No responsible regulator exempts anyone from their anti-fraud authority.’”

NYSE

Bair returned to the NYSE in 1995, where she ran its Washington lobbying office for six years during the Internet- fueled stock market boom and bust. At the stock exchange, Bair maintained her consumer protection bent, leading the successful effort to include limits in the 1999 Gramm-Leach-Bliley Act to prevent OTC derivatives dealers from offering equity swaps to retail investors. The law repealed part of the Glass-Steagall Act of 1933, which banned companies from acting as both a commercial and an investment bank.

“We didn’t want retail investors to be in a situation where they didn’t understand the product and had losses,” says Milligan, who followed Bair to the NYSE.

In June 2001, as the Standard & Poor’s 500 Index was on course for a 13 percent drop for the year, the second President Bush nominated Bair to the post of assistant secretary for financial institutions at Treasury. After her confirmation in July, she helped create an office to improve the financial knowledge of Americans. The office encouraged banks to open student-run branches in high schools.

University of Massachusetts

Bair departed Washington about 12 months later for a quieter life at the Isenberg School of Management at the University of Massachusetts in Amherst. She raised two children -- Preston, 16, and Colleen, 9 -- with her husband, Scott Cooper, vice president of government relations at the Washington-based American National Standards Institute, a nonprofit group that helps coordinate standards for U.S. products.

“Students were always impressed with how well prepared she was,” says Thomas O’Brien, a finance professor who taught a course with Bair in 2005. “Sheila wasn’t a showoff at all. She does her own homework, and she calls things the way she sees them.”

At the university, some of her research focused on improving financial services for low-income people. In one paper on Latin American immigrants, she recommended that banks provide bilingual documents and staff, open more branches in Latino neighborhoods and offer money transfers along with check cashing.

President Bush

In 2006, Bair published the first of two children’s books, Rock, Brock, and the Savings Shock. It’s a tale about twin brothers -- a spender and a saver -- and how saving makes one brother rich. The second, Isabel’s Car Wash, about investing, tells of a girl with a plan to take $5 from her friends to start a car wash and pay them back with interest.

Bair says she wasn’t seeking a government post when Bush’s personnel director called her in 2006 about replacing Donald Powell, the FDIC head who had left to oversee the Hurricane Katrina reconstruction program. While she enjoyed the freedom at the university to express her own views, Bair couldn’t resist a return to public service. The Senate confirmed her in June 2006 as banks were reporting record earnings and no lender had failed in two years.

Early the following year, Bair became one of the first policy makers to speak out about the coming housing crisis that would plunge the economy into recession. The FDIC chief saw that a rash of subprime mortgages issued at low teaser interest rates a few years earlier were about to adjust to higher rates, boosting monthly payments by more than 30 percent and threatening to spur a wave of defaults.

Early Warnings

Bair wanted lenders to change mortgage terms to reduce monthly payments and help borrowers stay in their homes. But she had no regulatory control over major mortgage servicing companies. So Bair resorted to a series of private meetings and congressional appearances to try to persuade the mortgage industry to voluntarily prevent foreclosures.

In April 2007, Bair organized a summit of lenders and regulators at the seven-story FDIC headquarters in Washington. Representatives from Countrywide Financial Corp., Morgan Stanley Bank and Wells Fargo Home Mortgage were among the about 40 people who attended the eight-hour meeting. During the gathering, the representatives vowed that they would begin modifying loans, Bair says.

“Everybody said they knew these loans were going to be resetting and unaffordable and the loans would be restructured because it was in everyone’s interest to keep people in the house,” she says.

Pressuring Investors

The Bush appointee also collaborated closely with Democratic leaders in Congress. On April 17, the day after her summit, Bair urged servicers to adjust the terms of loans when she testified before the House Financial Services Committee, chaired by Frank. She also said investors in mortgage-backed securities whose returns were guaranteed in contracts would have to take losses too.

“I thing we should hold the servicers’ and the investors’ feet to the fire on this,” she said. “It was clear to investors that these were high risk. So I think everybody needs to share the pain now.”

The following day, she attended another closed-door meeting with lenders convened by Christopher Dodd of Connecticut, the Senate Banking Committee chairman.

Her testimony -- coming three months before two Bear Stearns Cos. hedge funds collapsed under the weight of investments in subprime debt -- made Bair the darling of Democrats and immunized her from criticism by lawmakers who chastised other regulators for their lax oversight of banks.

Admired by Frank

“I admire the fact that she wouldn’t let people shut her up,” Frank says. “The people who’d appointed her were unhappy she was speaking out, and she was right.”

In the months following her summit, Bair was reminded of the limits of her own power: Loan servicers hadn’t begun reducing payments for homeowners because of resistance by investors.

“I was frustrated because everybody was privately singing this song to us, but there was no execution,” Bair says. “A lot of the pushback was coming from the investor community. And you still see it with the investor community.”

As the bankruptcy of Lehman Brothers Holdings Inc. in September 2008 froze credit markets and threatened to take down even bigger securities firms, Treasury Secretary Henry Paulson and Fed Chairman Ben S. Bernanke rushed to Congress to win approval of an emergency rescue plan.

TARP

Just before they went to lawmakers to set up the $700 billion Troubled Asset Relief Program, or TARP, Bair says, she got a perfunctory call from Paulson telling her of their plans and asking her if she wanted anything added to the bill.

“They made the decision to go to the Hill to start this program,” Bair says. “We were never part of any of that.” Paulson, who left office in January, didn’t respond to requests for an interview.

Paulson told Congress that TARP funds would be used to buy troubled bank assets. Bair says the administration included a mortgage modification provision in the bill to try to win votes from the Black and Hispanic caucuses and other Democrats. The provision said that Treasury would set up a program to help struggling homeowners if the department used TARP money to buy mortgages or related securities.

Bair says that although Paulson changed course, opting to use the money to buy preferred bank shares, he still seemed to support the use of some TARP funding to modify mortgages. So the FDIC developed a $24.4 billion plan that soon died because mid- level Treasury staffers didn’t want to use taxpayer money to bail out homeowners, Bair says.

‘Robust Discussions’

“Then it got nasty,” she says. “People started leaking our plan with derogatory comments, so we went public with ours. It was just a kind of classic Washington unpleasant process.”

William Isaac, who served as FDIC chairman under President Ronald Reagan from 1981 to 1985, says Bush officials objected to Bair’s push to modify loans.

“They thought she was way out in left field,” Isaac, 65, says. “I think she was right. Too many foreclosures were driving down real estate values, and if we didn’t address that issue, then the banking and economic problems would only get worse.”

As banks struggled to raise money, Paulson and Bernanke turned to Bair to start the Temporary Liquidity Guarantee Program to insure debt issued by banks -- a sweeping escalation of the FDIC’s role. Bair says she and Geithner had “robust discussions” about how much debt the FDIC would insure under the program.

“There were early discussions about us guaranteeing all bank liabilities, and we weren’t going to do that,” Bair says.

Insuring Debt

If the FDIC suffered losses, they would have to be recouped by charging fees to already battered banks. Bair did agree to temporarily insure new senior unsecured debt, such as commercial paper. And she insisted the agency charge banks that use the program a fee for the guarantee.

The program, which started in November, allows banks to issue debt with a top, AAA credit rating. Bair has said she doesn’t want to extend the program, which had insured $342.7 billion in debt and raised $8 billion in fees without incurring any losses as of mid-May, beyond its scheduled end on Oct. 31.

Lou Crandall, chief economist at research firm Wrightson ICAP LLC in Jersey City, New Jersey, says the program has been one of the government’s most successful responses to the financial crisis.

“It’s contributed to the funding stability of a large number of issuers and eased immediate concerns about their access to cash,” Crandall says.

President Obama

After the November election, Geithner, then Obama’s nominee for Treasury secretary, sought to push Bair out of office, according to people familiar with his thinking. Geithner said Bair was too focused on protecting the solvency of her deposit insurance fund rather than the financial system as a whole, the people said.

“He’s never indicated to me in any way that he had any problem with working with me or anything else,” Bair says. “President Obama has made clear he wants people to work together.”

As the head of an independent agency whose term overlapped two administrations, Bair could have kept her job without being reappointed by Obama. Bair says she would have stepped down if the president had requested it. Instead, Obama sent signals that he wanted her to stay.

Troubled Assets

Bair says the transition team, co-chaired by John Podesta, whom she’s known for years, reached out to her to discuss mortgage modifications. Dodd and Frank also wrote a letter to Obama in December asking him to keep Bair, stressing her willingness to buck the Bush administration.

“I wasn’t sure whether there would be a carryover of the friction with the Bush people, so that’s why I wrote that letter,” Frank says. Bair’s flight on Air Force One in February suggested to her that the new president wanted her to continue leading the agency. “With the new administration, the president has been very inclusive, and that’s helped us,” Bair says.

Early this year, as public hostility over Wall Street bailouts and bonuses reached a fever pitch, Bair says she played a significant role with Geithner and Bernanke in devising the Public-Private Investment Program to buy illiquid mortgage- backed assets from banks. Paulson’s decision in 2008 not to use TARP funds to buy these assets hurt the prices the FDIC was getting when it liquidated failed banks. Congress wasn’t about to hand the Treasury more money to acquire bad debt while unemployment soared, reaching 8.9 percent in April.

Buffett’s Idea

So Bair says the trio decided to create incentives for private investors -- an idea that billionaire investor Warren Buffett had proposed to Paulson in 2008 -- since they were better suited to establish market prices for the debt. The Treasury and Fed told her that the FDIC would have to provide financing to get the loan program for banks off the ground.

“They basically said, ‘If you want it, you’ll have to ante up too,’” says Bair, who agreed. Bair told the Treasury that her agency should operate the auction of assets since it had experience selling off failed banks. “Treasury was fine with that,” Bair says. “They are not really equipped to run a program like this.”

Under the PPIP, which was announced in March and will use up to $100 billion of TARP funds, the FDIC will oversee the sale of distressed loans. The Treasury will provide half of the equity to buy a pool of loans from banks, with private investors putting up the other half. The FDIC will offer debt guarantees to investors of up to six times the capital provided.

Reluctant Banks

“The debt guarantee by the FDIC is a huge sweetener,” says Mark Tenhundfeld, senior vice president at the ABA.

While investors have expressed a lot of interest in buying the assets, banks are reluctant to sell them.

“The troubled assets are still there, and the need is still there to clean that up,” Bair told Bloomberg TV on May 15. “Some need to be told that they need to deal with their troubled assets.”

Most banks may decide to keep the assets and take writedowns rather than sell them at a steep discount, says Christopher Rupkey, chief financial economist at Bank of Tokyo- Mitsubishi UFJ Ltd. in New York.

“I’d be surprised if you’re going to get many banks who feel their assets are worth 90 cents on the dollar right now selling at 60 cents to a hedge fund,” Rupkey says.

Dwindling Insurance Fund

At a May 27 news conference, Bair pointed to additional obstacles to getting banks and investors to participate. She said they may be hesitant because of concerns that Congress could change the rules governing the program. She cited an amendment lawmakers approved this month that requires the Treasury to write rules guarding against conflicts of interest in the PPIP, a process that could delay a test run of the program that had been scheduled for June. Banks also have been able to raise capital and may have less incentive to sell assets, Bair said.

With bank failures rising -- 36 have folded this year -- Bair is struggling to keep the deposit insurance fund solvent. In the first quarter, bank collapses had reduced the fund to $13 billion from $17.3 billion in the previous period.

The FDIC classified 305 banks as “problem” institutions in the first quarter, the highest total in 15 years and an increase from the 252 on the agency’s list in the fourth quarter. Banks are rated on measures including asset quality, earnings and liquidity.

“The banking industry still faces tremendous challenges,” Bair said on May 27. “Going forward, asset quality remains a major concern.”

Emergency Fee

Last September, Bair was still bullish about the fund. “Despite the recent drawdown to cover losses, the insurance fund is in a strong financial position to weather a significant increase in bank failures,” Bair told the Florida Bankers Association in Sarasota, Florida.

In moving to replenish the pool, Bair made a major misstep, says Fine of the community banking group. Her emergency fee proposal on Feb. 27 of 20 cents per $100 in deposits was immediately met with outrage from bankers. They deluged her office with protests, saying it would take a large chunk out of their 2009 profits at a time when they could least afford it.

The assessment would cost Citizens Bank of Ada more than 10 percent of its net earnings, Kassie Cothran, the Oklahoma-based bank’s senior vice president, wrote the agency.

Battle With Bankers

“Without these assessments, the deposit insurance fund could become insolvent this year,” Bair wrote in a letter to bank CEOs on March 2. That didn’t quell the brouhaha. The next day in his letter to bankers, Fine likened the proposal to “Japan’s sneak attack on Pearl Harbor.”

A day later, Bair called Fine on his cell phone to make peace while he was dining with two bankers. “You’re going to have to call the dogs off,” Fine says Bair told him. “You’ve got to tone down the rhetoric. We’re just getting bombarded.”

When Bair asked if sharply reducing the fee would help, Fine said it was a step in the right direction. On March 5, she turned to Congress for funding, sending a letter to Dodd urging lawmakers to expand the agency’s credit as a contingency and so the FDIC could reduce the bank fee. Two months later, Congress overwhelmingly approved the massive increase, including a $500 billion credit boost through 2010, and the president signed the measure on May 20.

Dismantling Giants

The FDIC has tapped this credit only once in its history, when the S&L crisis left the fund insolvent by $7 billion in 1991. The agency repaid the loan with interest two years later using industry fees.

Fine says the protests from bankers caught Bair flat-footed and taught her a lesson. “I believe if she had it to do over again, she would have explored alternatives and laid some groundwork before,” he says. “She, to her credit, adjusted very rapidly.”

The FDIC boss doesn’t think she misplayed her hand by proposing the fee.

“I don’t know if it was a mistake,” she says. “The 20 basis points -- we thought about that very carefully. I don’t think I had any choice.”

As financial behemoths such as Citigroup live off bailouts -- it’s received $45 billion in taxpayer funding -- Bair is asking Congress to give her agency the power to dismantle large bank holding companies. Currently, the FDIC can only unwind thrifts and banks such as Citibank, a division of Citigroup that operates retail outlets. The agency can’t disassemble the entire Citigroup, which also has trading and investment banking units.( NB DON )

Risk Council

“Done correctly, the effect of the resolution authority will be to increase market discipline and protect taxpayers,” Bair told the Senate Banking Committee on May 6.

While lawmakers begin the biggest regulatory overhaul since FDR, they’re split on who should get the power to contain systemic financial risk. Last year, Frank and Paulson pushed for the Fed to gain the authority to prevent shocks such as the one caused by the collapse of Lehman Brothers. In March, after the public outcry over government-funded AIG’s payout of $165 million in bonuses, lawmakers blamed the Fed because the New York Fed is the insurer’s main overseer while under government control. Following that flap, Bair told lawmakers on May 6 that they should divide the super-cop job among the FDIC, the Fed, the Treasury and the Securities and Exchange Commission.

While SEC Chairman Mary Schapiro backs Bair’s proposal to prevent concentration of power with a single regulator, Geithner opposes it.

Congress’s Priority

“Geithner believes that we need a single independent regulator with responsibility for systemically important firms,” Treasury spokesman Andrew Williams said in a May 8 e- mail. “He does see a role, however, for a council to coordinate among the various regulators.”

Ronald Glancz, chairman of the financial services group at Venable LLP, a Washington law firm, says Congress won’t let the debate over who gets authority prevent the creation of a super regulator.

“It is going to happen,” Glancz says. “This is the No. 1 priority in Congress for dealing with future financial crises.”

After trying to rescue struggling homeowners for almost two years, Bair says she felt vindicated standing with Obama in February as he announced his foreclosure plan in Arizona. It uses $75 billion to coax banks to make payments affordable for up to 4 million borrowers. The government will share in the cost of reducing the borrowers’ monthly payments to 31 percent of their monthly income.

JFK Award

The program hasn’t permanently altered any loans yet. Fourteen participating loan-servicing companies had extended trial modification offers to more than 55,000 homeowners, according to a May 14 Treasury release. At least 10,000 borrowers are making lower payments as part of a three-month trial, a requirement before borrowers can have their loans permanently modified, the Treasury said.

On May 18, Bair accepted the John F. Kennedy Profile in Courage Award at his presidential library in Boston for “sounding early warnings” about the subprime lending crisis. She shared the honor with Brooksley Born, former chairman of the CFTC, who in the late 1990s fought to regulate OTC derivatives in a losing battle against Robert Rubin, a former Treasury secretary and Citigroup executive committee chairman.

Bair says she’s not seeking the Treasury secretary post or any other higher position in Washington.

“I have no aspirations other than to return to academia after this job is over and have more time with my family again,” she says from her office, located a block away from the White House.

Bair’s legacy will mostly ride on the effectiveness of her new initiatives, from foreclosure relief to asset sales. As results are tallied, Bair’s friends and critics can then judge whether the idealistic populist from Kansas who ventured to Washington three decades ago has helped put America’s banks back on stable ground.

To contact the reporter on this story: Alison Vekshin in Washington at avekshin@bloomberg.net."

These numbers as large as they are, vastly understate the problem of fraud.

TO BE NOTED: From Bill Moyers Journal:

"April 3, 2009

BILL MOYERS: Welcome to the Journal.

For months now, revelations of the wholesale greed and blatant transgressions of Wall Street have reminded us that "The Best Way to Rob a Bank Is to Own One." In fact, the man you're about to meet wrote a book with just that title. It was based upon his experience as a tough regulator during one of the darkest chapters in our financial history: the savings and loan scandal in the late 1980s.

WILLIAM K. BLACK: These numbers as large as they are, vastly understate the problem of fraud.

BILL MOYERS: Bill Black was in New York this week for a conference at the John Jay College of Criminal Justice where scholars and journalists gathered to ask the question, "How do they get away with it?" Well, no one has asked that question more often than Bill Black.

The former Director of the Institute for Fraud Prevention now teaches Economics and Law at the University of Missouri, Kansas City. During the savings and loan crisis, it was Black who accused then-house speaker Jim Wright and five US Senators, including John Glenn and John McCain, of doing favors for the S&L's in exchange for contributions and other perks. The senators got off with a slap on the wrist, but so enraged was one of those bankers, Charles Keating — after whom the senate's so-called "Keating Five" were named — he sent a memo that read, in part, "get Black — kill him dead." Metaphorically, of course. Of course.

Now Black is focused on an even greater scandal, and he spares no one — not even the President he worked hard to elect, Barack Obama. But his main targets are the Wall Street barons, heirs of an earlier generation whose scandalous rip-offs of wealth back in the 1930s earned them comparison to Al Capone and the mob, and the nickname "banksters."

Bill Black, welcome to the Journal.

WILLIAM K. BLACK: Thank you.

BILL MOYERS: I was taken with your candor at the conference here in New York to hear you say that this crisis we're going through, this economic and financial meltdown is driven by fraud. What's your definition of fraud?

WILLIAM K. BLACK: Fraud is deceit. And the essence of fraud is, "I create trust in you, and then I betray that trust, and get you to give me something of value." And as a result, there's no more effective acid against trust than fraud, especially fraud by top elites, and that's what we have.

BILL MOYERS: In your book, you make it clear that calculated dishonesty by people in charge is at the heart of most large corporate failures and scandals, including, of course, the S&L, but is that true? Is that what you're saying here, that it was in the boardrooms and the CEO offices where this fraud began?

WILLIAM K. BLACK: Absolutely.

BILL MOYERS: How did they do it? What do you mean?

WILLIAM K. BLACK: Well, the way that you do it is to make really bad loans, because they pay better. Then you grow extremely rapidly, in other words, you're a Ponzi-like scheme. And the third thing you do is we call it leverage. That just means borrowing a lot of money, and the combination creates a situation where you have guaranteed record profits in the early years. That makes you rich, through the bonuses that modern executive compensation has produced. It also makes it inevitable that there's going to be a disaster down the road.

BILL MOYERS: So you're suggesting, saying that CEOs of some of these banks and mortgage firms in order to increase their own personal income, deliberately set out to make bad loans?

WILLIAM K. BLACK: Yes.

BILL MOYERS: How do they get away with it? I mean, what about their own checks and balances in the company? What about their accounting divisions?

WILLIAM K. BLACK: All of those checks and balances report to the CEO, so if the CEO goes bad, all of the checks and balances are easily overcome. And the art form is not simply to defeat those internal controls, but to suborn them, to turn them into your greatest allies. And the bonus programs are exactly how you do that.

BILL MOYERS: If I wanted to go looking for the parties to this, with a good bird dog, where would you send me?

WILLIAM K. BLACK: Well, that's exactly what hasn't happened. We haven't looked, all right? The Bush Administration essentially got rid of regulation, so if nobody was looking, you were able to do this with impunity and that's exactly what happened. Where would you look? You'd look at the specialty lenders. The lenders that did almost all of their work in the sub-prime and what's called Alt-A, liars' loans.

BILL MOYERS: Yeah. Liars' loans--

WILLIAM K. BLACK: Liars' loans.

BILL MOYERS: Why did they call them liars' loans?

WILLIAM K. BLACK: Because they were liars' loans.

BILL MOYERS: And they knew it?

WILLIAM K. BLACK: They knew it. They knew that they were frauds.

WILLIAM K. BLACK: Liars' loans mean that we don't check. You tell us what your income is. You tell us what your job is. You tell us what your assets are, and we agree to believe you. We won't check on any of those things. And by the way, you get a better deal if you inflate your income and your job history and your assets.

BILL MOYERS: You think they really said that to borrowers?

WILLIAM K. BLACK: We know that they said that to borrowers. In fact, they were also called, in the trade, ninja loans.

BILL MOYERS: Ninja?

WILLIAM K. BLACK: Yeah, because no income verification, no job verification, no asset verification.

BILL MOYERS: You're talking about significant American companies.

WILLIAM K. BLACK: Huge! One company produced as many losses as the entire Savings and Loan debacle.

BILL MOYERS: Which company?

WILLIAM K. BLACK: IndyMac specialized in making liars' loans. In 2006 alone, it sold $80 billion dollars of liars' loans to other companies. $80 billion.

BILL MOYERS: And was this happening exclusively in this sub-prime mortgage business?

WILLIAM K. BLACK: No, and that's a big part of the story as well. Even prime loans began to have non-verification. Even Ronald Reagan, you know, said, "Trust, but verify." They just gutted the verification process. We know that will produce enormous fraud, under economic theory, criminology theory, and two thousand years of life experience.

BILL MOYERS: Is it possible that these complex instruments were deliberately created so swindlers could exploit them?

WILLIAM K. BLACK: Oh, absolutely. This stuff, the exotic stuff that you're talking about was created out of things like liars' loans, that were known to be extraordinarily bad. And now it was getting triple-A ratings. Now a triple-A rating is supposed to mean there is zero credit risk. So you take something that not only has significant, it has crushing risk. That's why it's toxic. And you create this fiction that it has zero risk. That itself, of course, is a fraudulent exercise. And again, there was nobody looking, during the Bush years. So finally, only a year ago, we started to have a Congressional investigation of some of these rating agencies, and it's scandalous what came out. What we know now is that the rating agencies never looked at a single loan file. When they finally did look, after the markets had completely collapsed, they found, and I'm quoting Fitch, the smallest of the rating agencies, "the results were disconcerting, in that there was the appearance of fraud in nearly every file we examined."

BILL MOYERS: So if your assumption is correct, your evidence is sound, the bank, the lending company, created a fraud. And the ratings agency that is supposed to test the value of these assets knowingly entered into the fraud. Both parties are committing fraud by intention.

WILLIAM K. BLACK: Right, and the investment banker that — we call it pooling — puts together these bad mortgages, these liars' loans, and creates the toxic waste of these derivatives. All of them do that. And then they sell it to the world and the world just thinks because it has a triple-A rating it must actually be safe. Well, instead, there are 60 and 80 percent losses on these things, because of course they, in reality, are toxic waste.

BILL MOYERS: You're describing what Bernie Madoff did to a limited number of people. But you're saying it's systemic, a systemic Ponzi scheme.

WILLIAM K. BLACK: Oh, Bernie was a piker. He doesn't even get into the front ranks of a Ponzi scheme...

BILL MOYERS: But you're saying our system became a Ponzi scheme.

WILLIAM K. BLACK: Our system...

BILL MOYERS: Our financial system...

WILLIAM K. BLACK: Became a Ponzi scheme. Everybody was buying a pig in the poke. But they were buying a pig in the poke with a pretty pink ribbon, and the pink ribbon said, "Triple-A."

BILL MOYERS: Is there a law against liars' loans?

WILLIAM K. BLACK: Not directly, but there, of course, many laws against fraud, and liars' loans are fraudulent.

BILL MOYERS: Because...

WILLIAM K. BLACK: Because they're not going to be repaid and because they had false representations. They involve deceit, which is the essence of fraud.

BILL MOYERS: Why is it so hard to prosecute? Why hasn't anyone been brought to justice over this?

WILLIAM K. BLACK: Because they didn't even begin to investigate the major lenders until the market had actually collapsed, which is completely contrary to what we did successfully in the Savings and Loan crisis, right? Even while the institutions were reporting they were the most profitable savings and loan in America, we knew they were frauds. And we were moving to close them down. Here, the Justice Department, even though it very appropriately warned, in 2004, that there was an epidemic...

BILL MOYERS: Who did?

WILLIAM K. BLACK: The FBI publicly warned, in September 2004 that there was an epidemic of mortgage fraud, that if it was allowed to continue it would produce a crisis at least as large as the Savings and Loan debacle. And that they were going to make sure that they didn't let that happen. So what goes wrong? After 9/11, the attacks, the Justice Department transfers 500 white-collar specialists in the FBI to national terrorism. Well, we can all understand that. But then, the Bush administration refused to replace the missing 500 agents. So even today, again, as you say, this crisis is 1000 times worse, perhaps, certainly 100 times worse, than the Savings and Loan crisis. There are one-fifth as many FBI agents as worked the Savings and Loan crisis.

BILL MOYERS: You talk about the Bush administration. Of course, there's that famous photograph of some of the regulators in 2003, who come to a press conference with a chainsaw suggesting that they're going to slash, cut business loose from regulation, right?

WILLIAM K. BLACK: Well, they succeeded. And in that picture, by the way, the other — three of the other guys with pruning shears are the...

BILL MOYERS: That's right.

WILLIAM K. BLACK: They're the trade representatives. They're the lobbyists for the bankers. And everybody's grinning. The government's working together with the industry to destroy regulation. Well, we now know what happens when you destroy regulation. You get the biggest financial calamity of anybody under the age of 80.

BILL MOYERS: But I can point you to statements by Larry Summers, who was then Bill Clinton's Secretary of the Treasury, or the other Clinton Secretary of the Treasury, Rubin. I can point you to suspects in both parties, right?

WILLIAM K. BLACK: There were two really big things, under the Clinton administration. One, they got rid of the law that came out of the real-world disasters of the Great Depression. We learned a lot of things in the Great Depression. And one is we had to separate what's called commercial banking from investment banking. That's the Glass-Steagall law. But we thought we were much smarter, supposedly. So we got rid of that law, and that was bipartisan. And the other thing is we passed a law, because there was a very good regulator, Brooksley Born, that everybody should know about and probably doesn't. She tried to do the right thing to regulate one of these exotic derivatives that you're talking about. We call them C.D.F.S. And Summers, Rubin, and Phil Gramm came together to say not only will we block this particular regulation. We will pass a law that says you can't regulate. And it's this type of derivative that is most involved in the AIG scandal. AIG all by itself, cost the same as the entire Savings and Loan debacle.

BILL MOYERS: What did AIG contribute? What did they do wrong?

WILLIAM K. BLACK: They made bad loans. Their type of loan was to sell a guarantee, right? And they charged a lot of fees up front. So, they booked a lot of income. Paid enormous bonuses. The bonuses we're thinking about now, they're much smaller than these bonuses that were also the product of accounting fraud. And they got very, very rich. But, of course, then they had guaranteed this toxic waste. These liars' loans. Well, we've just gone through why those toxic waste, those liars' loans, are going to have enormous losses. And so, you have to pay the guarantee on those enormous losses. And you go bankrupt. Except that you don't in the modern world, because you've come to the United States, and the taxpayers play the fool. Under Secretary Geithner and under Secretary Paulson before him... we took $5 billion dollars, for example, in U.S. taxpayer money. And sent it to a huge Swiss Bank called UBS. At the same time that that bank was defrauding the taxpayers of America. And we were bringing a criminal case against them. We eventually get them to pay a $780 million fine, but wait, we gave them $5 billion. So, the taxpayers of America paid the fine of a Swiss Bank. And why are we bailing out somebody who that is defrauding us?

BILL MOYERS: And why...

WILLIAM K. BLACK: How mad is this?

BILL MOYERS: What is your explanation for why the bankers who created this mess are still calling the shots?

WILLIAM K. BLACK: Well, that, especially after what's just happened at G.M., that's... it's scandalous.

BILL MOYERS: Why are they firing the president of G.M. and not firing the head of all these banks that are involved?

WILLIAM K. BLACK: There are two reasons. One, they're much closer to the bankers. These are people from the banking industry. And they have a lot more sympathy. In fact, they're outright hostile to autoworkers, as you can see. They want to bash all of their contracts. But when they get to banking, they say, ‘contracts, sacred.' But the other element of your question is we don't want to change the bankers, because if we do, if we put honest people in, who didn't cause the problem, their first job would be to find the scope of the problem. And that would destroy the cover up.

BILL MOYERS: The cover up?

WILLIAM K. BLACK: Sure. The cover up.

BILL MOYERS: That's a serious charge.

WILLIAM K. BLACK: Of course.

BILL MOYERS: Who's covering up?

WILLIAM K. BLACK: Geithner is charging, is covering up. Just like Paulson did before him. Geithner is publicly saying that it's going to take $2 trillion — a trillion is a thousand billion — $2 trillion taxpayer dollars to deal with this problem. But they're allowing all the banks to report that they're not only solvent, but fully capitalized. Both statements can't be true. It can't be that they need $2 trillion, because they have masses losses, and that they're fine.

These are all people who have failed. Paulson failed, Geithner failed. They were all promoted because they failed, not because...

BILL MOYERS: What do you mean?

WILLIAM K. BLACK: Well, Geithner has, was one of our nation's top regulators, during the entire subprime scandal, that I just described. He took absolutely no effective action. He gave no warning. He did nothing in response to the FBI warning that there was an epidemic of fraud. All this pig in the poke stuff happened under him. So, in his phrase about legacy assets. Well he's a failed legacy regulator.

BILL MOYERS: But he denies that he was a regulator. Let me show you some of his testimony before Congress. Take a look at this.

TIMOTHY GEITHNER:I've never been a regulator, for better or worse. And I think you're right to say that we have to be very skeptical that regulation can solve all of these problems. We have parts of our system that are overwhelmed by regulation.

Overwhelmed by regulation! It wasn't the absence of regulation that was the problem, it was despite the presence of regulation you've got huge risks that build up.

WILLIAM K. BLACK: Well, he may be right that he never regulated, but his job was to regulate. That was his mission statement.

BILL MOYERS: As?

WILLIAM K. BLACK: As president of the Federal Reserve Bank of New York, which is responsible for regulating most of the largest bank holding companies in America. And he's completely wrong that we had too much regulation in some of these areas. I mean, he gives no details, obviously. But that's just plain wrong.

BILL MOYERS: How is this happening? I mean why is it happening?

WILLIAM K. BLACK: Until you get the facts, it's harder to blow all this up. And, of course, the entire strategy is to keep people from getting the facts.

BILL MOYERS: What facts?

WILLIAM K. BLACK: The facts about how bad the condition of the banks is. So, as long as I keep the old CEO who caused the problems, is he going to go vigorously around finding the problems? Finding the frauds?

BILL MOYERS: You--

WILLIAM K. BLACK: Taking away people's bonuses?

BILL MOYERS: To hear you say this is unusual because you supported Barack Obama, during the campaign. But you're seeming disillusioned now.

WILLIAM K. BLACK: Well, certainly in the financial sphere, I am. I think, first, the policies are substantively bad. Second, I think they completely lack integrity. Third, they violate the rule of law. This is being done just like Secretary Paulson did it. In violation of the law. We adopted a law after the Savings and Loan crisis, called the Prompt Corrective Action Law. And it requires them to close these institutions. And they're refusing to obey the law.

BILL MOYERS: In other words, they could have closed these banks without nationalizing them?

WILLIAM K. BLACK: Well, you do a receivership. No one -- Ronald Reagan did receiverships. Nobody called it nationalization.

BILL MOYERS: And that's a law?

WILLIAM K. BLACK: That's the law.

BILL MOYERS: So, Paulson could have done this? Geithner could do this?

WILLIAM K. BLACK: Not could. Was mandated--

BILL MOYERS: By the law.

WILLIAM K. BLACK: By the law.

BILL MOYERS: This law, you're talking about.

WILLIAM K. BLACK: Yes.

BILL MOYERS: What the reason they give for not doing it?

WILLIAM K. BLACK: They ignore it. And nobody calls them on it.

BILL MOYERS: Well, where's Congress? Where's the press? Where--

WILLIAM K. BLACK: Well, where's the Pecora investigation?

BILL MOYERS: The what?

WILLIAM K. BLACK: The Pecora investigation. The Great Depression, we said, "Hey, we have to learn the facts. What caused this disaster, so that we can take steps, like pass the Glass-Steagall law, that will prevent future disasters?" Where's our investigation?

What would happen if after a plane crashes, we said, "Oh, we don't want to look in the past. We want to be forward looking. Many people might have been, you know, we don't want to pass blame. No. We have a nonpartisan, skilled inquiry. We spend lots of money on, get really bright people. And we find out, to the best of our ability, what caused every single major plane crash in America. And because of that, aviation has an extraordinarily good safety record. We ought to follow the same policies in the financial sphere. We have to find out what caused the disasters, or we will keep reliving them. And here, we've got a double tragedy. It isn't just that we are failing to learn from the mistakes of the past. We're failing to learn from the successes of the past.

BILL MOYERS: What do you mean?

WILLIAM K. BLACK: In the Savings and Loan debacle, we developed excellent ways for dealing with the frauds, and for dealing with the failed institutions. And for 15 years after the Savings and Loan crisis, didn't matter which party was in power, the U.S. Treasury Secretary would fly over to Tokyo and tell the Japanese, "You ought to do things the way we did in the Savings and Loan crisis, because it worked really well. Instead you're covering up the bank losses, because you know, you say you need confidence. And so, we have to lie to the people to create confidence. And it doesn't work. You will cause your recession to continue and continue." And the Japanese call it the lost decade. That was the result. So, now we get in trouble, and what do we do? We adopt the Japanese approach of lying about the assets. And you know what? It's working just as well as it did in Japan.

BILL MOYERS: Yeah. Are you saying that Timothy Geithner, the Secretary of the Treasury, and others in the administration, with the banks, are engaged in a cover up to keep us from knowing what went wrong?

WILLIAM K. BLACK: Absolutely.

BILL MOYERS: You are.

WILLIAM K. BLACK: Absolutely, because they are scared to death. All right? They're scared to death of a collapse. They're afraid that if they admit the truth, that many of the large banks are insolvent. They think Americans are a bunch of cowards, and that we'll run screaming to the exits. And we won't rely on deposit insurance. And, by the way, you can rely on deposit insurance. And it's foolishness. All right? Now, it may be worse than that. You can impute more cynical motives. But I think they are sincerely just panicked about, "We just can't let the big banks fail." That's wrong.

BILL MOYERS: But what might happen, at this point, if in fact they keep from us the true health of the banks?

WILLIAM K. BLACK: Well, then the banks will, as they did in Japan, either stay enormously weak, or Treasury will be forced to increasingly absurd giveaways of taxpayer money. We've seen how horrific AIG -- and remember, they kept secrets from everyone.

BILL MOYERS: A.I.G. did?

WILLIAM K. BLACK: What we're doing with -- no, Treasury and both administrations. The Bush administration and now the Obama administration kept secret from us what was being done with AIG. AIG was being used secretly to bail out favored banks like UBS and like Goldman Sachs. Secretary Paulson's firm, that he had come from being CEO. It got the largest amount of money. $12.9 billion. And they didn't want us to know that. And it was only Congressional pressure, and not Congressional pressure, by the way, on Geithner, but Congressional pressure on AIG.

Where Congress said, "We will not give you a single penny more unless we know who received the money." And, you know, when he was Treasury Secretary, Paulson created a recommendation group to tell Treasury what they ought to do with AIG. And he put Goldman Sachs on it.

BILL MOYERS: Even though Goldman Sachs had a big vested stake.

WILLIAM K. BLACK: Massive stake. And even though he had just been CEO of Goldman Sachs before becoming Treasury Secretary. Now, in most stages in American history, that would be a scandal of such proportions that he wouldn't be allowed in civilized society.

BILL MOYERS: Yeah, like a conflict of interest, it seems.

WILLIAM K. BLACK: Massive conflict of interests.

BILL MOYERS: So, how did he get away with it?

WILLIAM K. BLACK: I don't know whether we've lost our capability of outrage. Or whether the cover up has been so successful that people just don't have the facts to react to it.

BILL MOYERS: Who's going to get the facts?

WILLIAM K. BLACK: We need some chairmen or chairwomen--

BILL MOYERS: In Congress.

WILLIAM K. BLACK: --in Congress, to hold the necessary hearings. And we can blast this out. But if you leave the failed CEOs in place, it isn't just that they're terrible business people, though they are. It isn't just that they lack integrity, though they do. Because they were engaged in these frauds. But they're not going to disclose the truth about the assets.

BILL MOYERS: And we have to know that, in order to know what?

WILLIAM K. BLACK: To know everything. To know who committed the frauds. Whose bonuses we should recover. How much the assets are worth. How much they should be sold for. Is the bank insolvent, such that we should resolve it in this way? It's the predicate, right? You need to know the facts to make intelligent decisions. And they're deliberately leaving in place the people that caused the problem, because they don't want the facts. And this is not new. The Reagan Administration's central priority, at all times, during the Savings and Loan crisis, was covering up the losses.

BILL MOYERS: So, you're saying that people in power, political power, and financial power, act in concert when their own behinds are in the ringer, right?

WILLIAM K. BLACK: That's right. And it's particularly a crisis that brings this out, because then the class of the banker says, "You've got to keep the information away from the public or everything will collapse. If they understand how bad it is, they'll run for the exits."

BILL MOYERS: Yeah, and this week in New York, at this conference, you described this as more than a financial crisis. You called it a moral crisis.

WILLIAM K. BLACK: Yes.

BILL MOYERS: Why?

WILLIAM K. BLACK: Because it is a fundamental lack of integrity. But also because, if you look back at crises, an economist who is also a presidential appointee, as a regulator in the Savings and Loan industry, right here in New York, Larry White, wrote a book about the Savings and Loan crisis. And he said, you know, one of the most interesting questions is why so few people engaged in fraud? Because objectively, you could have gotten away with it. But only about ten percent of the CEOs, engaged in fraud. So, 90 percent of them were restrained by ethics and integrity. So, far more than law or by F.B.I. agents, it's our integrity that often prevents the greatest abuses. And what we had in this crisis, instead of the Savings and Loan, is the most elite institutions in America engaging or facilitating fraud.

BILL MOYERS: This wound that you say has been inflicted on American life. The loss of worker's income. And security and pensions and future happened, because of the misconduct of a relatively few, very well-heeled people, in very well-decorated corporate suites, right?

WILLIAM K. BLACK: Right.

BILL MOYERS: It was relatively a handful of people.

WILLIAM K. BLACK: And their ideologies, which swept away regulation. So, in the example, regulation means that cheaters don't prosper. So, instead of being bad for capitalism, it's what saves capitalism. "Honest purveyors prosper" is what we want. And you need regulation and law enforcement to be able to do this. The tragedy of this crisis is it didn't need to happen at all.

BILL MOYERS: When you wake in the middle of the night, thinking about your work, what do you make of that? What do you tell yourself?

WILLIAM K. BLACK: There's a saying that we took great comfort in. It's actually by the Dutch, who were fighting this impossible war for independence against what was then the most powerful nation in the world, Spain. And their motto was, "It is not necessary to hope in order to persevere."

Now, going forward, get rid of the people that have caused the problems. That's a pretty straightforward thing, as well. Why would we keep CEOs and CFOs and other senior officers, that caused the problems? That's facially nuts. That's our current system.

So stop that current system. We're hiding the losses, instead of trying to find out the real losses. Stop that, because you need good information to make good decisions, right? Follow what works instead of what's failed. Start appointing people who have records of success, instead of records of failure. That would be another nice place to start. There are lots of things we can do. Even today, as late as it is. Even though they've had a terrible start to the administration. They could change, and they could change within weeks. And by the way, the folks who are the better regulators, they paid their taxes. So, you can get them through the vetting process a lot quicker.

BILL MOYERS: William Black, thank you very much for being with me on the Journal.

WILLIAM K. BLACK: Thank you so much."

And to Black's point, the real issue is fraud. Why is no one at Treasury willing to use the F word?

From Naked Capitalism:

"Wiliam Black Savages Treasury's Conduct on AIG

William Black, now a professor of economics and law at the University of Missouri (Kansas City) was a senior bank regulator during the savings loan crisis (his claim to fame was his pursuit of Charles Keating of Lincoln Savings, in which he was removed from the initiative and more management friendly investigators were assigned, and events later proved Black correct). Black has seen a lot of bad behavior at close range.

He is not at all impressed with how the Treasury has handled AIG. Via e-mail:

This is the consequence of six things on the Treasury end of things:

(1) the failure to use Chapter 11 bankruptcy/pass-through receivership to deal with deeply insolvent financial institutions

(2) the failure to expose, and to the extent possible, remedy through restatements the massive accounting fraud that AIG was/is engaged in that triggers the bonuses

(3) the failure to bring criminal charges against the control frauds

(4) the failure of Treasury as negotiators -- they had all the leverage when they bailed out AIG and could have conditioned the aid on at least the VP tier and above giving up their bonuses

(5) the weakness of Treasury's current lawyers who, if press reports are accurate, couldn't think of any way for the U.S. government to take effective action against what it reportedly views as a scandal,

(6) (and I haven't seen this discussed) why was Treasury blind-sided by this? It confirms that they did not conduct even the most obvious due diligence on AIG's assets and contingent liabilities

Given what we know about the lack of due diligence by AIG on underlying assets, particularly nonprime paper, this confirms exactly how dangerous Treasury is to the the nation. It is also consistent with the concern that it faces such a critical staff shortage, particulary in the relevant skills (which the folks it hires from Wall Street lack). I doubt that they have five senior officials that have ever reviewed loan files for a living or conducted meaningful due diligence (which requires cracking the loan files).

On the AIG end we see the perverse incentives of keeping the senior level folks on that caused the crisis. They have every incentive not to be honest about the true extent of the losses. They know the place is dead (hopelessly insolvent) and have strong incentives to loot the corpse, e.g., through bonuses. They do not alert Treasury sufficiently in advance even to bonuses that they should know will be perceived as scandalous (though another problem with keeping these failed elites in power is that they are clueless about the reaction of normal people). They do not work to limit bonuses, e.g., by being honest about past accounting fraud. I believe when the facts come out that we will find that they did not make criminal referrals on the prior senior officials that led AIG's accounting fraud (which would have given AIG and the Treasury a far stronger legal basis for refusing to pay bonuses that were "earned" via accounting control fraud.

I don't oppose bonuses that are actually earned through long term performance. That is not the case with the AIG bonuses. We can offer well designed performance pay if we use bankruptcy or receiverships.

We see tonight another lame defense that the Treasury is trying really hard to claw back the bonuses. Please. Even if Treasury consulted outside counsel, I would strongly suspect it would be a large firm with a big corporate clientele.

Guess what? At those firms, HR is a backwater. The best HR lawyers are typically at boutiques or solo operators because they sue large corporations (that would represent a rather insurmountable conflict of interest for any firm seeking to represent those nice big meal ticket clients). I'm not current, but a decade ago, there was a woman lawyer (I cannot recall her name to save my life) who was an absolute killer, When a wronged executive or employee walked in with her at their side, BIg Co. knew they had a very serious problem on their hands. I am told by people who used her she was also a phenomenal negotiator on deals. It's certain that Treasury did not attempt to secure advice from that sort of attorney.

And to Black's point, the real issue is fraud. Why is no one at Treasury willing to use the F word? Who would it embarrass? There is not reason for NOT pursuing that angle, save that AIG must have the 5x7 glossies on some pretty influential people, or that pursuing fraud at AIG would, via a daisy chain of connections, reveal that fraud was pervasive, and the Treasury is desperate to preserve the false image that the system has integrity.

Posted by Yves Smith at 11:24 AM"

Me:

Don said...

"And to Black's point, the real issue is fraud. Why is no one at Treasury willing to use the F word? Who would it embarrass? There is not reason for NOT pursuing that angle, save that AIG must have the 5x7 glossies on some pretty influential people, or that pursuing fraud at AIG would, via a daisy chain of connections, reveal that fraud was pervasive, and the Treasury is desperate to preserve the false image that the system has integrity. "

I agree. A terrific post. People should read Pizzo's "Inside Job" about the S and L Crisis. It will at least teach them what to look for.

Don the libertarian Democrat

March 16, 2009 11:35 AM

My view is that the crisis that we're in now is precisely the same crisis we've been in since at least the S&L crisis.

From Interfluidity:

"When did the crisis begin?

I like reading James Surowiecki, because he's smart, and because I tend to read exactly the same facts he reads and draw precisely the opposite conclusions.

In two recent Surowiecki posts (here and here), Surowiecki points out that during the banking crises of the early eighties and early nineties, banks were arguably as insolvent as our banks are today, but hey, with a little time and without any radical changes, everything turned out great.

The means by which banks recover their rude health, if you give them time, deserves a critical review. I mean to pen some nasty polemic about that, but for the impatient, Yves Smith tells much of the story (with all too little nastiness). See also here, and think about how much poorer people who run credit card balances have paid over the years on loans tied to the "prime rate".

The fundamental difference between my perspective and Surowiecki's is that I don't think those previous recoveries were real. My view is that the crisis that we're in now is precisely the same crisis we've been in since at least the S&L crisis. We've had a cancer, with some superficial remissions, but fundamentally, for the entire period from the 1980s to 2008, our financial system in general and our banks in particular have been broken. They have profited from allocating capital poorly, from funneling both domestic loans and an international deficit into poor investments (current consumption, luxury housing) rather than any objective that might justify arduous promises to repay. We all got a reprieve during the 1990s, because internet enthusiasm persuaded many investors to fund our consumption via equity investment, which we could wash away relatively painlessly in a stock market crash. Debt investors don't go so quietly. Thanks to the cleverness of our banking system, we have a very great many lenders, both domestic and foreign, who've invested in trash but who demand to be made whole at threat of social and political upheaval. That is the failure of our banks. That they are insolvent provides us with an occasion to hold them accountable, and to reshape them, without corroding the rule of law or respect for private property.

(Incidentally, I don't think that the problem is overconsumption or that austerity is the solution. I think we can afford to throw a perfectly good party, but it has been easier to put everything on the credit card than to come up with smart ways to pay for the economy we want in real time.)

Surowiecki seems to believe that if we could resolve the current crisis in pretty much the way we resolved the previous crises, that'd be okay. For me that's the second-worst-case scenario, after a major social collapse. Because I know that a superficially reformed financial system, both in terms of banking and international architecture, will continue to do great harm, permitting imbalances and injustices that will bring a serious collapse or a dangerous war if they are not addressed. We are fortunate, very fortunate, that things have pretty much held together so far, and for that people whom I usually criticize, Messrs Bernanke, Paulson, and Geithner, deserve some credit. But if they manage to "save the world" like that famous committee did during the LTCM crisis, with a lot of empty talk but no real changes once the crisis had passed, we will be here again, and we won't get lucky forever. This is a very serious business.

There are profound economic problems in the United States and elsewhere that our financial system has proved adept at papering over rather than solving. Those of us who've played Cassandra over the years have been regularly ridiculed as just not getting it, as economic illiterates and trade atavists. Unfortunately, as Dean Baker frequently points out, the people who could never see the problems are the only ones invited to the table when the world cries out for solutions. The solutions on that table are those Surowiecki tentatively endorses, weather the storm, take some time to repair, the temple is structurally sound. But the temple is not sound. We either build a decent financial system, or suffer real consequences, in unnecessary toil and lost treasure, in war and conflict over false promises set down in golden ink.

The banking mess and the high unemployment rate are not the crisis, they are symptoms. This is not "dynamo trouble", it is a progressive disease, and what is failing is the morphine. Those of us who believe that financial capitalism is a good idea, that it could be the solution, not the problem, do their cause no favors by resisting radical changes to a corrupt and dysfunctional facsimile of the thing. We need to approach financial capitalism as engineers, and to largely rearchitect a crumbling design. If we don't, we may be so unfortunate as to suffer yet another superficial remission. But error accumulates, and error on the scale now perpetrated by national and international financial institutions is unlikely to be without consequence."

Me:

"My view is that the crisis that we're in now is precisely the same crisis we've been in since at least the S&L crisis."

That's it. That's why looting is now being understood, finally, to be a cause. It's been a taxpayer funded joy ride for the financial sector. No wonder middle class wages are stuck.I keep referring back to Pizzo's "Inside Job". If you just read that and Fisher's "Debt-Deflation" essay, you'll have a better handle on how we got here and why it's so bad this time. It's working for me.

3.14.2009 12:18pm

and they were promptly hired away from us at substantial raises

From Yves Smith:

"William Black: "There Are No Real Stress Tests Going On"

By way of background, William Black is a former senior bank regulator, best known for his thwarted but later vindicated efforts to prosecute S&L crisis fraudster Charles Keating. He is currently an Associate Professor of Economics and Law at the University of Missouri - Kansas City.

More germane for the purpose of this post, Black held a variety of senior regulatory positions during the S&L crisis.He managed investigations with teams of examiners reporting to him, redesigned how exams were conducted, and trained examiners.

Via e-mail, he has confirmed our suspicions about the bank stress tests announced by Treasury Secretary Timothy Geithner: they simply cannot be adequate, given the number and experience of the staff, and perhaps as important, their relationship with the banks (see detailed comments below).

I also asked him about the fact that bank examiners examine banks (duh) and would not have much (any?) experience in the capital markets operations or sophisticated products that the big investment bank, now banks, participated in. Goldman and Morgan Stanley ought to be subject to these exams; Citi, JP Morgan, and Bank of America have large capital markets operations. These firms are where the biggest risks and exposures lie. Do the examiners what to look for in a even the low-risk operations, like repo desks, much the less derivatives and proprietary trading books? He agreed (as presented below) that it was a near certainty that this was beyond their skill level.

Now this begs the question: why has the Treasury Secretary set in motion an obviously bogus process? It suggests the result is pre-ordained.

One possibility is that even a very quick and dirty look at many of the big banks' books will reveal them to be in very bad shape. In fact, the inadequate staffing could be part of the private conversation: "You know we didn't send in enough bodies to do this right, and even using your numbers, which we can assume in some cases will be flattering, you look like a goner."

But all of Geithner's actions to date are inconsistent with him taking a tough stand. Having a lot of people party to a process that finds that some of the big banks are in trouble would be hard to keep secret (to my knowledge, none of these people have high level security clearances. Government employees and contractors in those cohorts do keep their mouths shut). So I think it is more likely that the banks will get scorecards that show them to be in various stages of peril, but none will be found to be terminal. (They can't be given a clean bill of health, that would call the whole rationale of the TARP and its various injections into question, and also would put Geithner at considerable risk if any bank declared OK fell over in less than 12 months).

But even the designation of "sick but not ready to be hospitalized" carries with it risk to the Administration. If the banks get sicker than anticipated, how can they explain it? They can't say, "oh, things got worse than we contemplated". The whole point of a stress test is to anticipate worst case scenarios. And it is pretty certain a fair number of the big banks will be on such large-scale life support by year end that it will be hard to make a case not to put them in receivership.

Whatever statement Geithner puts out about the results of the stress test is likely to come back to haunt him, as did Colin Powell's "there are WMD in Iraq" speech before the UN did. And Powell had a better reputation going into Iraq than Geithner has in prosecuting his war.

From William Black:

There are no real stress tests going on.

1) If you did a real stress test, as Geithner explained them, you wouldn't just have a $2 trillion hole -- you'd impose regulatory capital requirements of 50%. (FYI, the regulators have the power to set HIGHER individual capital requirements based on unusually large risks at a particular bank.)

Yves here. By implication, the results of anything approaching a true stress test, plus reasonable regulatory responses, would dictate radical action. We have not seen any corresponding groundwork laid for that sort of thing. Back to Black:

2) You can't conduct a meaningful stress test without reviewing (sampling) the underlying loan files and it seems likely that the purchasers of securitized instruments (not just mortgages) do not even have the loan file data. Moreover, loss ratios vary enormously depending on the issuer, so even a bank that originates (or has purchased a bank that originates) similar product cannot simply take its own loss rate and extrapolate it to the measure the risk on the value of securitized credit instruments.

3) The regulators are overwhelmed because of personnel cuts (particularly heavy among their best, most experienced examiners that had worked banks that had engaged in sophisticated frauds. Buyouts were common, because more experienced examiners appear more expensive. This isn't true when you consider effecitiveness and productivity, but management didn't care about that. Treat what I write after the colon as hearing from me at my most serious and thoughtful: it is vastly more difficult to examine a bank that is engaged in accounting control fraud. You can't rely on the bank's books and records. It doesn't simply take more, far more, FTEs -- it takes examiners with experience, care, courage, and investigative instincts and abilities. Very few folks earning $60K are willing to get in the face of the CEO and CFO making $25 million annually and tell them that they are running a fraudulent bank and they are liars. FYI, this is one of the reasons why having "resident examiners" never works. The examiners don't even get to marry the natives. They get to worship God's annoited. Effective examination is good for you, but it is very unpleasant, ala a doctor's finger up your rectum. It requires total independence.

So, the examination force doesn't have remotely the numbers or the relevant experience and mindset to examine the largest banks with the greatest problems.

Yves here. Black is not using the fraud word lightly. He believe that we have Enron-level accounting fraud happening, now, in the financial services industry. And we have asked repeatedly, why has there been no investigation of fraud at Lehman? There was a $100 billion plus hole in its balance sheet, meaning a substantial negative net worth, when its financial statements presented a completely different picture. Back to Black:

4) As Geithner describes the process, NO ONE can conduct reliable "stress testing." It inherently requires testing everything in every way any and all aspects of everything could conceivably interact. It also doesn't provide any meaningful output that can be operationalized (unless you want to force an enormous rise in minimum regulatory capital requirements, which he obviously doesn't want to do).

5) Examiners certainly can't A) do the stress testing that Geithner describes or B) evaluate the reliability of a large bank's proprietary stress test. If they were serious about constructing reliable stress tests, which they aren't, you'd require their analytics to be made public. You'd have the industry fund independent investigations by rocket scientists chosen by a committee selected by the regulators of the soundness of the analytics. You'd also have the industry fund competitions to rip them apart (a bit like we hire legit hackers to test security by trying to defeat it) and show where they produce absurd results. The geeks would have a field day (that would probably last a decade). There are probably zero examiners that have the modeling skills required to evaluate the most sophisticated stress test models. The concept that there are 100 examiners with these skills, suddenly freed up from all other duties, assigned to CONDUCT stress tests is a lie.

6) It is, however, possible to use even the less experienced examiners to conduct a far more useful examination of the quality and value of nonprime loans. My nightmare scenario which I fear is often true is that A) because the biggest originators of nonprime loans were mortgage bankers, B) because every large mortgage banker that specialized in nonprime loans went bankrups, C) because many of them went into Chapter 7 liquidations and even those that went into Chapter 11's had little incentive to hang on to files on mortgage loans they had sold to other entities -- the loan files on many nonprime loans may no longer exist. (My fervent prayer is that the loan servicers have tapes with copies of the underlying loan files, but I fear that this prayer will not be answered.) Under this nightmare scenario it will be extraordinarily hard to determine loan quality and losses and very hard to foreclose against borrowers that can afford attorneys (admittedly a minority) and that claim fraud in the inducement.

Yves again. Remember, aside from the discussion of the bank's risk models, he is still framing the stress test in terms of more or less traditional banking activities, that is, that most of the assets that need examining are loans. I asked for how he thought the examiners would fare with more complicated products, like CDOs, CDS, and derivatives. His comments:

Yes, few examiners understand more exotic products. In my experience, nobody understands all the products. I certainly don't, and if I did I'm sure my knowledge would be out of date within weeks.

The problem is compounded by the fact that understanding how the product is actually used (CDS is a good example) v. how its proponents picture it as being used is essential. Understanding its sensitivity to credit and interest rate risk is well beyond the ken. Understanding the liquidity risks and interaction effects is out of the question.

Examiners rarely know that financial risks are not normally distributed, but have far fatter tails. (Nor do they understand why this makes truncating the VAR a recipe for disaster.) Examiners rarely understand that any econometric analysis undertaken during the expansion phase of a bubble will invariably find the strongest positive correlation with the worst possible business practices (because those practices maximize accounting fraud).

We were, 15 years ago, able to get some strong capital markets people and give them advance training. We sent them out on exams, they impressed the industry -- and they were promptly hired away from us at substantial raises

Some countries have found ways around this problem, but they don't translate well to America. In Japan, the most prestigious jobs are in the top ministries, so they get and hang on to good people. In Singapore, Lee Kwan Yew felt he had to depart from the typical corrupt Asian government norm for Singapore to prosper. Top government bureaucrats are paid like top private sector professionals (think law firm partners). They are well enough paid (or have the prospects of being well enough paid) so as to have an incentive not to screw it up (tough internal audits also help).

Me:( sleepy )

Don said...

My recollection of the S & L Crisis was that a lot of fraud wasn't prosecuted because it was claimed that it mirrored stupidity. In any case, I would have liked his opinion on how well we investigated and prosecuted crimes associated with the S & L Crisis. I see a direct link from that crisis to this crisis, in that these investment crimes tend to be passed over. There are usually a few big name prosecutions, with the emphasis on few.

Felix Salmon has been talking about blogs and papers investigating iffy investments, what about the FBI, SEC, and DOJ? Subprime loans would be a natural place to begin.

We all now that these agencies need resources to deal with these crimes. Is there any hope that they'll get them? The idea that the industry being investigated hires them away is truly dreadful, but makes sense given our system.

If we don't investigate and prosecute Fraud, Negligence, Collusion, and Fiduciary Mismanagement, what good will threats of regulation do?

Don the libertarian Democrat