Review: Bull by the Horns, by Sheila Bair

[Russ Allbery]

Bull by the Horns
by Sheila Bair

Publisher: Simon & Schuster
Copyright: 2012
Printing:  September 2013
ISBN:      1-4516-7249-7
Format:    Trade paperback
Pages:     365

Sheila Bair was the Chair of the Federal Deposit Insurance Corporation
from 2006 to 2011, a period that spans the heart of the US housing
crisis and the start of the Great Recession. This is her account, based
on personal notes, of her experience heading the FDIC, particularly
focused on the financial crisis and its immediate aftermath.

Something I would like to do in theory but rarely manage to do in
practice is to read more thoughtful political writing from people who
disagree with me. Partly that's to broaden my intellectual horizons;
partly it's a useful reminder that the current polarized political
climate in the United States does not imply that the intellectual
tradition of conservatism is devoid of merit. While it's not a complete
solution, one way to edge up on such reading is to read books by
conservatives that are focused on topics where they and I largely
agree.

In this case, that topic is the appalling spectacle of consequence-free
government bailouts of incompetently-run financial institutions,
coordinated by their co-conspirators inside the federal government and
designed to ensure that obscenely large salaries and bonuses continued
to flow to exactly the people most responsible for the financial
crisis. If I sound a little heated on this topic, well, consider it
advance warning for the rest of the review. Suffice it to say that I
consider Timothy Geithner to be one of the worst Secretaries of the
Treasury in the history of the United States, a position for which the
competition is fierce.

Some background on the US financial regulatory system might be helpful
here. I'm reasonably well-read on this topic and still learned more
about some of the subtleties.

The FDIC, which Bair headed, provides deposit insurance to all of the
banks. This ensures that whatever happens to the bank, all depositors
of up to $100,000 (now $250,000 due to a law that was passed as part of
the events of this book) are guaranteed to get every cent of their
money. This deposit insurance is funded by fees charged to every bank,
not by general taxes, although the FDIC has an emergency line of credit
with the Treasury it can call on (and had to during the savings and
loan crisis in the early 1990s).

The FDIC is also the primary federal regulator for state banks. It is
not the regulator for federal banks; those are regulated by the Office
of the Comptroller of the Currency (OCC) and, at the time of events in
this book, the Office of Thrift Supervision (OTS), which regulated
Savings and Loans. Some additional regulation of federal banks is done
by the Federal Reserve. The FDIC is a "backup" regulator to those other
institutions and has some special powers related to its function of
providing deposit insurance, but it doesn't in general have the power
to demand changes of federal banks, only the smaller state banks.

This turns out to be rather important in the financial crisis: bad
state banks regulated by the FDIC were sold off or closed, but the huge
federal banks regulated by the OCC and OTS were bailed out via various
arranged mergers, loan guarantees, or direct infusions of taxpayer
money. Bair's argument is that this difference is partly due to the
ethos of the FDIC and its well-developed process for closing troubled
banks. The standard counter-argument is that the large national banks
were far too large to put through that or some similar process without
massive damage to the economy. (Bair strenuously disagrees.)

Bair's account starts in 2006, by which point the crisis was already
probably inevitable, and contains a wealth of information about the
banking side of the crisis itself and its immediate aftermath. Her
story is one of consistent pressure by the FDIC to increase bank
capital requirements and downgrade risk ratings of institutions, and
consistent pressure by the OCC, OTS, and Geithner (first as the head of
the New York branch of the Federal Reserve and then as Treasury
Secretary) to decrease capital requirements even in the height of the
crisis and allow banks to use ever-more-creative funding models backed
by government guarantees. Bair fleshes this out with considerable
detail about how capital requirements are measured, how the loan
guarantees were structured, the internal arguments over how to get
control of the crisis, and the subsequent fights in Congress over
Dodd-Frank and how TARP money was spent.

(TARP, the Troubled Asset Relief Program, was the Congressional
emergency measure passed during the height of the crisis to fund
government purchases and restructuring of troubled mortgage debt. As
Bair describes, and has been exhaustively detailed elsewhere, it was
never really used for that. The government almost immediately
repurposed it for direct bailouts of financial institutions and
provided almost no meaningful mortgage restructuring.)

This account also passes my primary sniff test for books about this
crisis. Fannie and Freddie (two oddly-named US government institutions
with a mandate to support mortgage lending and home ownership) are
treated as bad actors and horribly mismanaged entities that made the
same irresponsible investments as the private banking industry, but
they aren't put at the center of the crisis and aren't blamed for the
entire mortgage mess. This disagrees with some corners of Republican
politics, but agrees with all other high-quality reporting about the
crisis.

Besides fascinating details about the details of banking regulation in
a crisis, the primary conclusion I drew from this book is the power of
institutions, systems, and rules. One becomes good at things one does
regularly. The FDIC closes failing banks without losing insured
depositor money, and has been doing that since 1933, often multiple
times a year. They therefore have a tested system for doing this, which
they practice implementing reliably, efficiently, and quickly. Bair
states as a point of deep institutional pride that no insured depositor
had to wait more than one business day for access to their funds during
the financial crisis. Banks are closed after business hours and,
whenever possible, the branches was open for business under new
supervision the next morning. This is as important as the insurance in
preventing runs on the bank that would make the closing cost even more.

Part of that system, built into the FDIC principles and ethos, was a
ranking of priorities and a deep sense of the importance of
consequences. Insured depositors are sacrosanct. Uninsured depositors
are not, but often they can be protected by selling the bank assets to
another, healthier bank, since the uninsured depositors are often the
bank's best customers. Investors in the bank, in contrast, are wiped
out. And other creditors may also be wiped out, or at least have to
take a significant haircut on their investment. That is the price of
investing in a failed institution; next time, pay more attention to the
health of the business you're investing in. The FDIC is legally
required to choose the resolution approach that is the least costly to
the deposit insurance fund, without regard to the impact on the bank's
other creditors.

And, finally, when the FDIC takes over a failing bank, one of the first
things they do is fire all of the bank management. Bair presents this
as obvious and straight-forward common sense, as it should be. These
were the people who created the problem. Why would you want to let them
continue to mismanage the bank? The FDIC may retain essential personnel
needed to continue bank operations, but otherwise gets rid of the
people who should bear direct responsibility for the bank's failure.

The contrast with the government's approach with AIG, Citigroup, and
other failed financial institutions, as spearheaded by Timothy
Geithner, could not be more stark. I remember following the news at the
time and seeing straight-faced and serious statements that it was
important to preserve the compensation and bonuses of the CEOs of
failed institutions so that they would continue to work for the
institution to unwind all of its bad trades and troubled assets. Bair
describes herself as furious over that decision.

The difficulty in critiques of the government's approach to the
financial crisis has always been that it was a crisis, with unknown
possible consequences, and the size of the shadow banking sector and
the level of entangled risk was so large that any systematic bankruptcy
process would have been too risky. I'm with Bair in finding this
argument dubious but not clearly incorrect. The Lehman Brothers
bankruptcy was rocky, but it's not clear to me that a similar process
couldn't have worked for other firms. But that aside, retaining the
corporate management (and their salaries and bonuses!) seems a clear
indication to me of the corruption of the system. (Bair, possibly more
to her credit than mine, carefully avoids using that term.)

Bair highlights this as one of the critical reasons why the FDIC
process is legally akin to bankruptcy: these sorts of executives write
themselves sweetheart employment contracts that guarantee huge payouts
even if their company fails. In the FDIC resolution process, those
contracts can be broken. If, as Geithner did, you take heroic measures
to avoid going anywhere near bankruptcy law, breaking those contracts
becomes more legally murky. (Dodd-Frank has a provision, strongly
supported by Bair, to create a legal framework for clawing back
compensation to executives after certain types of financial
misreporting, although it's still far more limited than the FDIC
resolution process.)

A note of caution here: this book is obviously Bair's personal account,
and she's not an unbiased party. She took specific public positions
during the crisis and defends them here, including against analysis in
other books about the crisis. She also describes lots of private
positions, some of which are disputed. (Andrew Ross Sorkin's book is
the subject of some particularly pointed disagreement.) I have read
enough other books about the crisis to believe that Bair's account is
probably essentially correct, particularly given the nature of the
contemporaneous criticism against her. But, that said, the public
position against bailouts had become quite clear by the time she was
writing this book, and there was doubtless some temptation to remember
her previous positions as more in line with later public opinion than
they were. This sort of insider account is always worth a note of
caution and some effort to balance it with other accounts, particularly
given Bair's love of the spotlight (which shines through in a few
places in this book).

Bair is a life-long Republican and a Bush appointee. I suspect she and
I would disagree on most political positions. But her position as head
of the FDIC was that bank failure should come with consequences for
those running the bank, that the priority of the government should be
protection of insured bank depositors first and the deposit insurance
fund second, and that other creditors should bear the brunt of their
bad investment decisions, all of which I agree with wholeheartedly.
This account is an argument for the importance of moral hazard, and an
indictment and diagnosis of regulatory capture from someone who
(refreshingly) is not just using that as a stalking horse to argue for
eliminating regulation. Bair also directly tackles the question of
whether the same moral hazard argument applies to the individual loan
holders and concludes no, but this part of the argument was a bit light
on detail and probably won't convince someone with the opposite
opinion.

It's quite frustrating, reading this in 2018, how many of the reforms
Bair argues for in this book never happened. (A ban on naked credit
default swaps, for example, which Bair argues increase systemic risk by
increasing the consequences of institutional bankruptcy, thus creating
new "too big to fail" analyses like that applied to AIG. Timothy
Geithner was central to defeating an effort to outlaw them.) It's also
a tragic reminder of how blindly partisan our national debates over
economic policies are. You can watch, in Bair's account, the way that
Democrats who were sharply critical of the Bush administration handling
of the financial crisis, including his appointed regulators, swung
behind the exact same regulators and essentially the same policies when
Obama appointed Geithner to head Treasury. Democrats are traditionally
the party favoring stronger regulation, but that's less important than
tribal affiliation. The change is sharp enough that at a few points I
was caught by surprise at the political affiliation of a member of
Congress who was supporting or opposing one of Bair's positions.

As infuriating as this book is in places, it is a strong reminder that
there are conservatives with whom I can find common cause despite being
on the hard left of US economic politics. Those tend to be the people
who believe in the power of institutions, consistent principles, and
repeated and efficient execution of processes developed through
hard-fought political compromise. I think Bair and I would agree that
it's very dangerous to start making up policies on the spot to deal
with the crisis du jour. Corruption can more easily enter the system,
and very bad decisions are made. This is a failure on both the left and
the right. I suspect Bair would turn to a principle of smaller
government far more than I would, but we both believe in better
government and clear, principled regulation, and on that point we could
easily find workable compromises.

You should not read this as your first in-depth look at the US
financial crisis. For that, I still recommend McLean & Nocera's All the
Devils are Here. But this is a good third or fourth book on the topic,
and a deep look at the internal politics around TARP. If that interests
you, recommended.

Rating: 8 out of 10

Reviewed: 2018-05-29

-- 
Russ Allbery (eagle at eyrie.org)              <http://www.eyrie.org/~eagle/>