FDIC Chair says financial reform ‘will make bailouts impossible’

Mike Riggs Contributor

A House staffer sends along this American Banker interview with FDIC chair Sheila Bair, in which she denies Sen. Mitch McConnell’s claim that the new financial regulatory bill would perpetuate bailouts:

Would this bill perpetuate bailouts?

SHEILA BAIR: The status quo is bailouts. That’s what we have now. If you don’t do anything, you are going to keep having bailouts. Bankruptcy doesn’t work — we saw that with Lehman Brothers.

But does this bill stop them from happening?

BAIR: It makes them impossible and it should. We worked really hard to squeeze bailout language out of this bill. The construct is you can’t bail out an individual institution — you just can’t do it.

In a true liquidity crisis, the FDIC and the Fed can provide systemwide support in terms of liquidity support — lending and debt guarantees — but even then, a default would trigger resolution or bankruptcy.

Critics say the bill would let the FDIC pick and choose creditors to pay back in a resolution. Is that a form of a bailout?

BAIR: We’ve always had that. You close a bank, you set up a bridge bank, and you have IT service providers, property upkeep — they are general creditors. You want to keep paying them to keep the services going.

That’s just an example. You need to keep that kind of thing going to maintain the franchise value. You have the power to do that in bankruptcy too.

The FDIC will provide detailed disclosure of any creditor that receives more than others of the same class. Let’s be clear, this is limited only to those essential to maintain critical functions and preserve value of assets to benefit all creditors. It will not include bondholders or shareholders.

Do you see any way left for the government to bail out a financial institution?

BAIR: No, and that’s the whole idea. It was too easy for institutions to come and ask for help. They aren’t going to do that. This gives us a response: “Fine, we will take all these essential services and put them in a bridge bank. We will keep them running while your shareholders and debtors take all your losses. And oh, by the way, we are getting rid of your board and you, too.”

The whole idea is to get market discipline back.

That’s what ending “too big to fail means.” It means debtors and shareholders understanding their money is at risk and especially the debtholders starting to look at the balance sheet of these big institutions and asking their own hard questions instead of relying on government support.