Zombie Banks by Yalman Onaran & Sheila Bair

Author:Yalman Onaran & Sheila Bair
Language: eng
Format: epub
Publisher: Wiley
Published: 2011-10-17T16:00:00+00:00

Chapter 7

U.S. Zombies on IV Drip

At the time Ireland’s leaders were deciding to offer a blanket guarantee for their banks’ liabilities, U.S. officials were also discussing measures to stem the panic in financial markets following the collapse of Lehman Brothers. The idea of a blanket guarantee was first brought up by Timothy Geithner, head of the New York Federal Reserve at the time, during the summer of 2008 but was dismissed as too radical by others. However, a few months later and after Lehman’s fall in September, it was back on the table and its proponents had grown in number. This time Treasury Secretary Henry Paulson and Fed Chairman Ben Bernanke were also leaning toward supporting it, hoping that it would help reverse the erosion of trust in the banking system.

Two days after Iceland’s parliament passed its emergency act to seize its banks, a memo from Paulson’s office proposed a public statement that would announce the U.S. authorities’ full support to “protect depositors, protect unsecured claims, guarantee liabilities and adopt other measures to support the banking system.” Not everybody liked the idea. Sheila Bair, chairman of the Federal Deposit Insurance Corporation (FDIC), didn’t think the guarantee was warranted. She wrote a long response to Paulson and Bernanke—starting with “Dear Hank and Ben”—explaining why it wasn’t. Bair told her colleagues that the guarantee would encourage banks to borrow more rather than raise capital and insolvent banks to attempt growing out of their problems. She suggested instead that the Treasury use Troubled Asset Relief Program (TARP) funds authorized by Congress to inject capital into banks, that the government offer guarantees on new bank debt to be issued for a temporary period and insure some banks’ certain group of assets against further losses.1

Though it came close, Bair’s arguments won the day, and the United States ended up not going Ireland’s way. A blanket guarantee for all bank liabilities would have potentially caused the U.S. government debt to swell by $5.6 trillion, or about 40 percent of national output. The measures taken, some of which were suggested by Bair, cost about $1 trillion, most of which has since been recovered.2 But even though the United States didn’t repeat Ireland’s big mistake, it didn’t follow in Iceland’s footsteps either. The biggest troubled banks that were on the verge of death at the peak of the crisis weren’t seized and liquidated. Instead, they were patched up with capital infusions, temporary debt, and asset guarantees, and allowed to live as zombies like Germany’s were. Despite Bair’s warning in October 2008, they have been allowed to try growing out of their troubles.

The Fed’s zero percent interest rates maintained years after the crisis and its efforts to prop up the housing market have been like IV drips that slowly are nursing the banks back to health, along with regulatory forbearance that overlooks their unrecognized losses. Even though there was some discussion of nationalizing the largest troubled banks, Bair’s opinion wasn’t sought on that. Three years later, on her way

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