Remarks by
Sheila C. Bair, Chairman,
Federal Deposit Insurance Corporation
at the
Exchequer Club
Washington, DC
March 21, 2007
Good afternoon everyone. Thank you, Ron, for that very kind introduction. As a former
member of the Exchequer Club, I am very pleased to be back with you today. As I look
around the room, I am struck by how many old "Washington hands" I see. Indeed, the
Club's membership includes many veterans of the major public policy wars in financial
services, both past and present.
It is with your collective public policy experience and expertise in mind, that I want to
talk to you about an issue that the FDIC has been working on for a number of years
now. It primarily involves the largest banks in the system, but it has important
consequences for the competitive balance between the largest banks and community
banks. The actions public policymakers take or don't take in this area will have
important implications for the stability of the financial system, not just in the U.S., but
around the globe. It is fair to say that the FDIC's approach to this issue tends to reflect
our unique perspective as deposit insurer. Therefore, it is also fair to say that our view
on the subject is not necessarily well-understood or even welcomed by the largest
banks.
For those of you who thought I was going to talk about Basel II, you can breathe a sigh
of relief. I hope by now my views on Basel are well known and clear. Instead, I want to
talk about what the FDIC is doing to be prepared for the possibility, however remote, of
the failure of a large bank.
Looking Back at the Crisis Years
To understand where we are today and why we think this sort of planning and
preparation is absolutely essential, it is important to review how we got here. In the past
twenty-five years, the FDIC has handled more than 1,600 bank failures. The vast
majority of these happened during the late 1980s and early 1990s. The crisis period
began with the sharp spike in interest rates necessary to rein in double-digit inflation. It
became characterized by a series of rolling regional recessions – booms and busts in
several key sectors – farmland, energy, and commercial real estate.
The resulting savings and loan failures cost the industry and taxpayers approximately
$150 billion. Failures among FDIC-insured banks were also significant and led to
sharply higher deposit insurance assessments paid by the industry during the crisis to
restore the bank insurance fund.
Sheila C. Bair, Chairman,
Federal Deposit Insurance Corporation
at the
Exchequer Club
Washington, DC
March 21, 2007
Good afternoon everyone. Thank you, Ron, for that very kind introduction. As a former
member of the Exchequer Club, I am very pleased to be back with you today. As I look
around the room, I am struck by how many old "Washington hands" I see. Indeed, the
Club's membership includes many veterans of the major public policy wars in financial
services, both past and present.
It is with your collective public policy experience and expertise in mind, that I want to
talk to you about an issue that the FDIC has been working on for a number of years
now. It primarily involves the largest banks in the system, but it has important
consequences for the competitive balance between the largest banks and community
banks. The actions public policymakers take or don't take in this area will have
important implications for the stability of the financial system, not just in the U.S., but
around the globe. It is fair to say that the FDIC's approach to this issue tends to reflect
our unique perspective as deposit insurer. Therefore, it is also fair to say that our view
on the subject is not necessarily well-understood or even welcomed by the largest
banks.
For those of you who thought I was going to talk about Basel II, you can breathe a sigh
of relief. I hope by now my views on Basel are well known and clear. Instead, I want to
talk about what the FDIC is doing to be prepared for the possibility, however remote, of
the failure of a large bank.
Looking Back at the Crisis Years
To understand where we are today and why we think this sort of planning and
preparation is absolutely essential, it is important to review how we got here. In the past
twenty-five years, the FDIC has handled more than 1,600 bank failures. The vast
majority of these happened during the late 1980s and early 1990s. The crisis period
began with the sharp spike in interest rates necessary to rein in double-digit inflation. It
became characterized by a series of rolling regional recessions – booms and busts in
several key sectors – farmland, energy, and commercial real estate.
The resulting savings and loan failures cost the industry and taxpayers approximately
$150 billion. Failures among FDIC-insured banks were also significant and led to
sharply higher deposit insurance assessments paid by the industry during the crisis to
restore the bank insurance fund.
While the difficult economic environment placed great stress on the banking system,
most observers would agree that the problems and costs were compounded by
regulatory responses and policy choices, such as inadequate capital standards, lax
accounting, and the practice of extending safety net protection beyond insured deposits.
The last of these, the extension of the government safety net, is one of the most
challenging issues faced by regulators and policymakers not just in the U.S. but
throughout the world. Indeed, the appropriate size and conditions of safety net
protections have been the subject of much academic work and policy debate. When a
bank fails, there is a tradeoff between minimizing spillover consequences in the short
run and increasing moral hazard concerns in the long run.
From Continental to FDICIA
The crisis period was marked by two key events that essentially serve as bookends for
the way the U.S. has approached this tradeoff in modern times: the failure of
Continental Illinois and the passage of the FDIC Improvement Act of 1991, or FDICIA.
When Continental Illinois failed in 1984, the FDIC had fairly broad discretion to
determine whether to extend protection beyond insured depositors. The FDIC exercised
this discretion to protect all creditors – even the subordinated debt holders of the bank's
holding company. In the aftermath of Continental Illinois – which highlighted the notion
of "too-big-to-fail" – it would have been difficult to justify a policy that protected creditors
of large banks but allowed the creditors of small banks to take losses.
Thus, over the next eight years, as the bank and thrift crisis was building, the FDIC
typically resolved banks, large or small, in ways that protected most, if not all, creditors
and, in some cases, even shareholders. In terms of the public policy tradeoff at the time,
the scales were tipped in favor of minimizing short-term disruption.
With the passage of the FDIC Improvement Act in 1991, known as FDICIA, Congress
sent a clear signal that tipped the scale the other way. The least-cost provision of
FDICIA sharply curtailed the FDIC's discretion to extend protection beyond insured
deposits. FDICIA makes it the norm, not the exception, that uninsured depositors and
creditors of a bank will suffer losses.
The systemic risk provisions of FDICIA also significantly raised the bar for policymakers
inclined to favor short-term stability. According to FDICIA, safety net protections can be
extended beyond insured depositors only if it can be determined that not doing so would
"have serious adverse effects on economic conditions and financial stability." To invoke
the systemic risk exception, FDICIA requires a two-thirds majority of both the Boards of
the FDIC and the Federal Reserve, as well as the approval of the Secretary of the
Treasury, who must first consult with the President. In addition, the banking industry
must pay for the additional cost associated with a resolution pursuant to a systemic risk
finding through a special assessment. Because the special assessment is to be
most observers would agree that the problems and costs were compounded by
regulatory responses and policy choices, such as inadequate capital standards, lax
accounting, and the practice of extending safety net protection beyond insured deposits.
The last of these, the extension of the government safety net, is one of the most
challenging issues faced by regulators and policymakers not just in the U.S. but
throughout the world. Indeed, the appropriate size and conditions of safety net
protections have been the subject of much academic work and policy debate. When a
bank fails, there is a tradeoff between minimizing spillover consequences in the short
run and increasing moral hazard concerns in the long run.
From Continental to FDICIA
The crisis period was marked by two key events that essentially serve as bookends for
the way the U.S. has approached this tradeoff in modern times: the failure of
Continental Illinois and the passage of the FDIC Improvement Act of 1991, or FDICIA.
When Continental Illinois failed in 1984, the FDIC had fairly broad discretion to
determine whether to extend protection beyond insured depositors. The FDIC exercised
this discretion to protect all creditors – even the subordinated debt holders of the bank's
holding company. In the aftermath of Continental Illinois – which highlighted the notion
of "too-big-to-fail" – it would have been difficult to justify a policy that protected creditors
of large banks but allowed the creditors of small banks to take losses.
Thus, over the next eight years, as the bank and thrift crisis was building, the FDIC
typically resolved banks, large or small, in ways that protected most, if not all, creditors
and, in some cases, even shareholders. In terms of the public policy tradeoff at the time,
the scales were tipped in favor of minimizing short-term disruption.
With the passage of the FDIC Improvement Act in 1991, known as FDICIA, Congress
sent a clear signal that tipped the scale the other way. The least-cost provision of
FDICIA sharply curtailed the FDIC's discretion to extend protection beyond insured
deposits. FDICIA makes it the norm, not the exception, that uninsured depositors and
creditors of a bank will suffer losses.
The systemic risk provisions of FDICIA also significantly raised the bar for policymakers
inclined to favor short-term stability. According to FDICIA, safety net protections can be
extended beyond insured depositors only if it can be determined that not doing so would
"have serious adverse effects on economic conditions and financial stability." To invoke
the systemic risk exception, FDICIA requires a two-thirds majority of both the Boards of
the FDIC and the Federal Reserve, as well as the approval of the Secretary of the
Treasury, who must first consult with the President. In addition, the banking industry
must pay for the additional cost associated with a resolution pursuant to a systemic risk
finding through a special assessment. Because the special assessment is to be