Statement of
Sheila C. Bair, Chairman,
Federal Deposit Insurance Corporation
on
Systemically Important Institutions and the
Issue of "Too Big to Fail"
before the
Financial Crisis Inquiry Commission;
Room 538, Dirksen Senate Office Building
September 2, 2010
Chairman Angelides, Vice Chairman Thomas, and Commissioners, I appreciate the
opportunity to testify on behalf of the Federal Deposit Insurance Corporation (FDIC) on
how systemic risks can be managed and mitigated in the wake of the financial crisis
using the new tools provided by the Dodd-Frank Wall Street Reform and Consumer
Protection Act (Dodd-Frank Act).1
The market turmoil of late 2008 is now largely behind us, but the consequences for the
U.S. financial system and economy continue. The fall of 2008 was marked by
unprecedented levels of mortgage defaults, extreme risk aversion in financial markets
and, finally, generalized illiquidity in global money markets. This chain of events
ultimately led to the problems of a number of large, complex banks, bank holding
companies, and non-bank financial companies, some of which were subject to
prudential supervision and the FDIC's resolution authority and some that were not.
Taken together, these financial disruptions had a rapid and highly adverse effect on real
economic activity here and around the world. The events led to unprecedented
government intervention to restore order to the financial markets, including the bailouts
of a number of large financial institutions both here and abroad.
While the financial system and the U.S. economy are now recovering from the
immediate effects of the crisis, it has caused widespread damage to communities
across the nation. Millions of families have experienced job loss, home foreclosure, and
reduced savings and retirement funds. Businesses—small ones in particular—have
suffered from declining consumer demand and tight credit. State and local governments
have faced substantial budgetary shortfalls. Hundreds of community banks have failed
and many more remain troubled. Clearly, the impact of the financial crisis will be felt for
some time to come.
As the recovery slowly moves forward, it is important to apply the lessons learned in the
crisis and implement strong, sensible reforms that will prevent a costly recurrence. The
facts surrounding the collapse of two large banks—Washington Mutual Bank (WaMu)
and Wachovia Bank—illustrate many of the challenges faced by the FDIC in resolving
large, complex financial institutions under the rules in place at that time. In addition,
because holding companies of large banks and non-bank financial companies were
subject to the Bankruptcy Code when they ran into trouble, their failures were much
more difficult to resolve without either bailing-out stakeholders or causing systemic risk
Sheila C. Bair, Chairman,
Federal Deposit Insurance Corporation
on
Systemically Important Institutions and the
Issue of "Too Big to Fail"
before the
Financial Crisis Inquiry Commission;
Room 538, Dirksen Senate Office Building
September 2, 2010
Chairman Angelides, Vice Chairman Thomas, and Commissioners, I appreciate the
opportunity to testify on behalf of the Federal Deposit Insurance Corporation (FDIC) on
how systemic risks can be managed and mitigated in the wake of the financial crisis
using the new tools provided by the Dodd-Frank Wall Street Reform and Consumer
Protection Act (Dodd-Frank Act).1
The market turmoil of late 2008 is now largely behind us, but the consequences for the
U.S. financial system and economy continue. The fall of 2008 was marked by
unprecedented levels of mortgage defaults, extreme risk aversion in financial markets
and, finally, generalized illiquidity in global money markets. This chain of events
ultimately led to the problems of a number of large, complex banks, bank holding
companies, and non-bank financial companies, some of which were subject to
prudential supervision and the FDIC's resolution authority and some that were not.
Taken together, these financial disruptions had a rapid and highly adverse effect on real
economic activity here and around the world. The events led to unprecedented
government intervention to restore order to the financial markets, including the bailouts
of a number of large financial institutions both here and abroad.
While the financial system and the U.S. economy are now recovering from the
immediate effects of the crisis, it has caused widespread damage to communities
across the nation. Millions of families have experienced job loss, home foreclosure, and
reduced savings and retirement funds. Businesses—small ones in particular—have
suffered from declining consumer demand and tight credit. State and local governments
have faced substantial budgetary shortfalls. Hundreds of community banks have failed
and many more remain troubled. Clearly, the impact of the financial crisis will be felt for
some time to come.
As the recovery slowly moves forward, it is important to apply the lessons learned in the
crisis and implement strong, sensible reforms that will prevent a costly recurrence. The
facts surrounding the collapse of two large banks—Washington Mutual Bank (WaMu)
and Wachovia Bank—illustrate many of the challenges faced by the FDIC in resolving
large, complex financial institutions under the rules in place at that time. In addition,
because holding companies of large banks and non-bank financial companies were
subject to the Bankruptcy Code when they ran into trouble, their failures were much
more difficult to resolve without either bailing-out stakeholders or causing systemic risk
to the financial system. Failing non-bank financial companies also could only be
resolved under the Bankruptcy Code, further exacerbating the financial crisis.
My remarks today will primarily focus on the provisions to enhance financial company
regulation and resolution procedures recently enacted in the Dodd-Frank Act. If properly
implemented, these provisions will not only reduce the likelihood of future financial
crises but will also provide effective tools to address large financial company failures
when they do occur without resorting to taxpayer-supported bailouts or damaging the
financial system.
Dilemmas Faced in Resolving Large Bank Failures During the Crisis
In my January 2010 testimony before the FCIC, I discussed a number of interrelated
factors that contributed to the buildup of risks in our financial system and led to the
crisis. Many of those causal factors stemmed from a set of misaligned incentives among
all of the parties to the securitization process—including borrowers, loan originators,
credit rating agencies, loan securitizers, and investors. Differences in the regulation of
capital, leverage, and consumer protection between institutions in the shadow banking
system and the traditional banking sector, and the almost complete lack of regulation of
over-the-counter derivatives, allowed regulatory arbitrage to proliferate. Even within the
regulatory system, existing authorities were not always used and consumers were not
adequately protected. Moreover, the lack of an effective resolution process for large,
complex financial institutions limited regulators' ability to manage the crisis as it
unfolded.
Liquidity Crisis. Starting in mid 2007, global financial markets began to experience
serious liquidity challenges related mainly to rising concerns about U.S. mortgage credit
quality. As U.S. home prices fell, recently-originated subprime and non-traditional
mortgage loans began to default at record rates. These developments led to growing
concerns about the value of financial positions in mortgage-backed securities and
related derivative instruments held by major financial institutions in the U.S. and around
the world. The difficulty in determining the value of mortgage-related assets and,
therefore, the balance-sheet strength of large banks and non-bank financial institutions
ultimately led these institutions to become wary of lending to one another, even on a
short-term basis.
Disruptions in the interbank lending market and declines in the value of mortgage-
related security holdings directly affected the stability of bank funding and the liquidity of
bank asset portfolios. During late 2007 and early 2008, the FDIC began to see failures
of some smaller depository institutions that occurred not because the institution had
become critically undercapitalized, but because of a rapidly deteriorating liquidity
position. The FDIC was in several cases forced by events to move more quickly to
resolve these institutions than would normally be the case for failures arising from
capital deficiency.
In early 2008, the liquidity crisis began to have serious consequences for larger banks,
thrifts, and non-bank financial companies with heavy exposures to mortgage-related
resolved under the Bankruptcy Code, further exacerbating the financial crisis.
My remarks today will primarily focus on the provisions to enhance financial company
regulation and resolution procedures recently enacted in the Dodd-Frank Act. If properly
implemented, these provisions will not only reduce the likelihood of future financial
crises but will also provide effective tools to address large financial company failures
when they do occur without resorting to taxpayer-supported bailouts or damaging the
financial system.
Dilemmas Faced in Resolving Large Bank Failures During the Crisis
In my January 2010 testimony before the FCIC, I discussed a number of interrelated
factors that contributed to the buildup of risks in our financial system and led to the
crisis. Many of those causal factors stemmed from a set of misaligned incentives among
all of the parties to the securitization process—including borrowers, loan originators,
credit rating agencies, loan securitizers, and investors. Differences in the regulation of
capital, leverage, and consumer protection between institutions in the shadow banking
system and the traditional banking sector, and the almost complete lack of regulation of
over-the-counter derivatives, allowed regulatory arbitrage to proliferate. Even within the
regulatory system, existing authorities were not always used and consumers were not
adequately protected. Moreover, the lack of an effective resolution process for large,
complex financial institutions limited regulators' ability to manage the crisis as it
unfolded.
Liquidity Crisis. Starting in mid 2007, global financial markets began to experience
serious liquidity challenges related mainly to rising concerns about U.S. mortgage credit
quality. As U.S. home prices fell, recently-originated subprime and non-traditional
mortgage loans began to default at record rates. These developments led to growing
concerns about the value of financial positions in mortgage-backed securities and
related derivative instruments held by major financial institutions in the U.S. and around
the world. The difficulty in determining the value of mortgage-related assets and,
therefore, the balance-sheet strength of large banks and non-bank financial institutions
ultimately led these institutions to become wary of lending to one another, even on a
short-term basis.
Disruptions in the interbank lending market and declines in the value of mortgage-
related security holdings directly affected the stability of bank funding and the liquidity of
bank asset portfolios. During late 2007 and early 2008, the FDIC began to see failures
of some smaller depository institutions that occurred not because the institution had
become critically undercapitalized, but because of a rapidly deteriorating liquidity
position. The FDIC was in several cases forced by events to move more quickly to
resolve these institutions than would normally be the case for failures arising from
capital deficiency.
In early 2008, the liquidity crisis began to have serious consequences for larger banks,
thrifts, and non-bank financial companies with heavy exposures to mortgage-related