Bailing Out the Banks

There's anger in the streets, and there's this feeling that Wall Street was bailed out but Main Street wasn't. What was the attitude about how do we deal with this perception? And ... they weren't dealing with one of the hearts of the issue, which is the problem of housing and the mortgages under water. What is the debate within the halls of the Treasury building and White House?

There was no question it was incredibly frustrating that so shortly after repaying the government that compensation started going up as quickly as it did. I thought that showed poor judgment on the part of the banks. ...

We did not bail out Wall Street and leave Main Street hanging. Everything we did, we did with the purpose of helping Main Street, we did with the purpose of preventing the economy from turning into the second Great Depression. And some of the things that we had to do were terribly unpopular, and our predecessors, terribly unpopular. We knew it was going to be, but it was necessary.

We all had that recent experience with Lehman Brothers, where on the day that event happened, everyone's 401(k), everyone's IRA, businesspeople saw their businesses freeze; home values went tumbling. Every citizen of this country was deeply, negatively impacted by that event.

So if you're going to take steps to prevent that kind of pain for the country, the unfortunate fact is that you have to do certain things which are going to stabilize the financial institutions. If there had been a way to prevent the economic pain and the pain to households and businesses without taking these steps to stabilize those institutions, we would have done it. No one could figure out a way to do that.

Volcker at some point he said that he wished that the crisis had gone on longer because more change could have occurred. ... This question of were there opportunities missed early on to leverage the power that the government had because they were saving the butts, basically, of the banks to make them do some things that in fact politically would have certainly been more helpful down the line and perhaps would have moved the system in ways that would be productive. Was there debate about that?

... In terms of wishing that the crisis had gone on longer, I can't imagine anyone actually really wished the crisis would go on longer, because while the house was on fire, we were losing millions of jobs, and it's all about stopping that as quickly as you can. That's what we were focused on.

This question about were we too easy on the banks is one I find a bit frustrating. ... Of the 15 largest financial institutions in this country before the crisis, only nine exist today as independent entities. The institutions that took the most risk, that got into the most trouble, are basically gone, whether that's Lehman Brothers, Washington Mutual, Bear Stearns.

AIG still exists, but in a very different form. Fannie Mae, Freddie Mac -- there are others. Wachovia, Merrill Lynch. These were big institutions that took big risks. They don't exist in the form that they did before.

So the notion that we saved, bailed out all these institutions I don't think really is right.

So then you have Lehman Brothers coming in the fall. Are you getting any closer to getting any real information on or analysis put forward?

No. ...

Why should you be consulted?

Because we had expertise in resolving financial institutions. And we have resolved institutions with cross-border operations. There were a couple during the crisis that were resolved.

One of the things we always do very early on is we notify the foreign regulator that we have a troubled institution, that it may have to go into an FDIC resolution, that we may have to sell it very quickly. And we find out in advance, what are your regulatory requirements to approve mergers and acquisitions? And we walk them through it and we make sure they're comfortable when we get to that point where the institution actually has to be sold.

How many people worked under you at the FDIC?

About 8,200.

You had procedures and methods in place.

We did.

You drilled these things.

Right.

You do simulations.

We did.

You're sitting there like a firehouse ready to take down a bank and do it in an orderly fashion?

Right. That's exactly what we do.

So the United States gets into a financial crisis with a couple of Wall Street banks that are teetering, with some big commercial banks that are teetering. And you're not consulted?

Not with the investment banks, no, and a very poor consultation with the commercial banks.

As the commercial banks started getting into trouble, we were given a very short timeframes. In one situation with Wachovia, ... were told on Friday by the primary regulator that they were stable. And the next day, we were told that they were going to fail if something didn't happen.

So even with commercial banks we were given very short timeframes, and I think that also limited our ability to pursue different options other than bailouts.

Why are you not consulted?

Because I don't think regulators work as well together as they should. I think a lot of it is turf. I think a lot of it was fear. I think they know our process is a harsh one, and I think there was some desire to protect these big banks and their shareholders and creditors, especially their bondholders. I think that was absolutely part of it. ...

Tell me the mood as you go into that [Monday] meeting [with Hank Paulson].

We had meetings over the weekend. It was at that point we learned that they were going to do these capital investments to these nine big banks. We were not involved with selecting the nine big banks. We were not involved with the dollar amount that they would get.

What did you think of that idea?

It took my breath away. I was also very surprised that they were going to basically force all of them to take it. The clear message at that meeting when they were all called in was, "You have to take this money." And a lot of them, probably most of them, didn't really need the money. ...

But the idea here was to get lending going again?

That was the stated idea. And we certainly emphasized that in terms of our debt guarantee program. I put this in my speeches and public statements and our guidelines for the program, that this money was to be used to support lending.

So are you on board at that point? Do you think it's a good idea?

No, I never thought any of this was a good idea. I think you do what you need to do.

So you're trying to be a team player even though you're considered not.

I’m trying to be a team player. There was action that was needed to stabilize the system. [If] I was a dictator, would I have done it differently? Yes, but that's really not the point. ... We did what we did and it did, in the short-term, work. It did stabilize the system, and you have to give Hank credit for that.

Longer-term did it meet expectations in terms of these big banks lending? No. Throughout the crisis we consistently saw the smaller banks, who didn't get all this money, were doing a lot better job of lending than the bigger banks. I think it prevented a worse credit contraction, but we still had a credit contraction. ...

It was tense. The weaker banks were happy to take it. The stronger ones, like [Wells Fargo Chair] Dick Kovacevich, didn't want it. I don't think Wells Fargo needed it.

What about Vikram Pandit?

Citi definitely needed it. ...

... The Bloomberg article that came out a few weeks ago, about forget the TARP [Troubled Asset Relief Program], the reality is that there was $7.7 trillion that was lent or opened up to the banks in one way or another, low interest rate loans and everything else. Tell me what the conversation was, what the reaction of the administration was. ...

... Remember the bank bailout stretched out over a very long period of time. Data that's only become available more recently has revealed how deep the problems were.

The first clear symptom was the Bear Stearns bailout in March 2008. A lot of people were very worried after the breaking of the housing bubble. They were aware that banks had exposure. Many economists thought the likelihood that there would be severe consequences was very high.

[Federal Reserve Chairman Ben] Bernanke made a speech: Don't worry, the risks are contained. Those of us who listened to that really got even more worried, because it was clear that they didn't understand or that they were covering up.

The data that has come out since about lending in 2007 and '08 by the Fed shows that it was massive, that the financial system was going through tremors, and they must have known it. The Fed was lending not just to American banks but to banks all over the world, and in amounts that were really astonishing. ...

So as Bear Stearns melts down, what position did you take on what to do about it?

We, being the FDIC and my peers, were not involved.

I got a call on Friday, early in the morning, from one of my staff. He had been notified by somebody at the Fed that [Bear Stearns was] going to go into bankruptcy, and then when I got into the office the narrative had changed. Now there was going to be this government-assisted acquisition by JPMorgan Chase of Bear Stearns.

My reaction when he called me that morning and said they were going into bankruptcy was, "Well, investment banks fail." Because they do. That's the traditional model. Insured banks are supposed to take deposits.

I was surprised that the government had to assist with the acquisition and had taken on risk exposure to assist with the acquisition of an investment bank. It amazed me because the FDIC is the only agency with express legal authority to wind down financial institutions other than Fannie and Freddie. Their regulator has control, and of course ours only extends to insured banks.

So we have ... rules and procedures that we have to go through, and we are really forbidden from doing anything to help shareholders. … Our rules say if the place is going down, they go into receivership, which is just like a bankruptcy, and the shareholders and the unsecured creditors absorb the losses associated with that. ...

So I was very surprised that the New York Fed had found legal authority to go in there and arrange a deal. We auction things too. We never just call up an entity and say, "Will you buy this place?" We might call several entities and say, "Would you be interested," to get an auction going, but we never kind of just arrange marriages. ...

... Did you call up Tim [Geithner] and say, "What's going on?"

Again, it was an investment bank. I did not have any authority over Bear Stearns.

But you knew more than anybody else in the government about what it meant to take down a bank?

We did, and it would have been nice I think if we had been consulted at least on some of these issues.

You were never consulted?

Not outside insured banks, absolutely not. We had nothing to do with Bear Stearns, Lehman Brothers, AIG, none of that. ... We were consulted on Fannie and Freddie, but not the other ones. ...

I think that's regrettable, because I think there're some things where our insights and rules could have maybe helped with perhaps making the bailouts not so generous at least. Granted, government had to take some action. ...

It would have been at least nice for there to be some publicly available analysis. ... Why was it necessary for the government? What did the New York Fed see about Bear Stearns failing that convinced it that it was going to be systematic. Who was going to take losses? What would the knock impact of that been?

Throughout the crisis I was very frustrated that I just kept getting these arguments when we started being asked to participate in bailouts. When institutions like Citi got into trouble, I got very frustrated with these categorical statements: "Because they're big. They're systematic. And we've got to bail them out." That wasn't enough for me. Just because you're big doesn't mean you should get showered with government money.

I want more analysis of why. If I'm going to go in there and give exposure for the FDIC, which is a government agency, why am I doing that? Who am I protecting? I don't want to protect this institution. They were badly managed. They should fail. So who am I protecting? ...

... Oct. 13, 2008 was the original meeting at the Treasury where [then-Treasury Secretary Hank] Paulson hands out the billions of dollars to all the different banks. ... Why couldn't they [agree] that a certain percentage of this was going to go to lending? ...

The so-called injection of capital that occurred in October 2008 had many strange things about it that I think could never be justified. They should have put conditions on the money that they were putting in. They could have said: Anybody who receives money can't pay out bonuses, has to use a fraction of this money for lending to small and medium-sized enterprises.

But there were other peculiar things about this. They said that all the banks had to take it whether they wanted it or not. And the reason they said that was they didn't want to signal that any bank was in particularly dire straits relative to others.

Now I thought we had an economic system where we have capital market discipline. Capital markets are supposed to make judgments about ... what's a good bank and what's not.

How do you make a judgment if you don't have information? And if the regulator has information that says you're about to go bankrupt, isn't that relevant to the capital markets? ...

[Former Wells Fargo Chair Richard] Kovacevich's point of view was he didn't want the money and he didn't think he should take the money because his bank didn't need the money. Do you have some sort of sentiment about that philosophy that he was pronouncing at that point?

... Unless you have an administration that's willing to be forceful with the "too big to fail" institutions, you don't have a real market economy. You don't have a level playing field. You don't have anything that resembles a market.

He may have been, in a sense, bluffing, saying: I don't need the money now. But by the way, I know that I'm too big to fail, and in three months' time if the markets turn out bad, I'll come back to you, but on my terms.

If we had an administration that had said: Take the money now, and if you don't take the money now under these terms, if you need to come back to us in six months' time, the terms are going to be very different, ... I suspect he would have taken it.

In the Oct. 13, 2008, when the bankers are all handed this $125 billion in various amounts, what kind of conditions were put on that money?

There were really not much. We had asked for commitments on loan restructurings for residential mortgages. There was a general commitment. There was no specific commitment.

But you had asked for this in your meetings prior when you talked to Paulson.

We had asked for that. ... But in fairness, I think here was the problem: They wanted everybody to take the money, and probably most of the banks around that table didn't need the money, right? ...

So Hank Paulson is worried that they're not going to take the money.

So they had to make it generous. And the reason they needed everybody to buy off was because there were a few institutions like Citi, Merrill Lynch, I think, Morgan and Goldman, they had at least been able to access private capital, but they were having some troubles too. But the rest of them probably didn't need it.

So to use your words just now, they were buying them off?

Well, buying them off in the sense that if they didn't get ... all the major institutions to take it, then the weak ones would have a big target on their forehead. ...

They didn't want the market to differentiate. They wanted to lump everybody in together, but that meant that they had to force the stronger banks who didn't need the money to take it. And that meant that they couldn't put many conditions or restrictions on it or otherwise the strong banks wouldn't take it.

So the federal government, essentially, the Treasury is begging?

Hank's a pretty forceful person. I would say he was pressuring. He was significantly pressuring.

But he had a weak hand in a sense?

He absolutely had a weak hand. ...

[Treasury Secretary Tim] Geithner takes some of the blame from people that think that that is indeed the case, and that the rest of Main Street didn't receive the same benefits as Wall Street did. What was his philosophy? The way it's been defined is a do-no-harm philosophy. And some people say to some extent it was coddling the banks, because the necessity was to save the banks at that point.

I think Tim's kind of policy framework and views on this have not been well understood. It was never his view that we should bail out the banks to save Wall Street. His view was that it's very hard for Main Street to be successful if Wall Street is shut down.

There are credit flows from financial markets on Wall Street and across the globe to the smallest business on Main Street. The idea was always about those kinds of interconnections, that if the credit system is shut down, there's going to be some small, tiny manufacturer there off of Main Street who won't be able to roll over a loan and restock their inventory.

And I think that that fairly simple connection was never made such that it looked like all we wanted to do was to help these banks become profitable again. But the Wall Street/Main Street credit connection was always at the heart of our thinking.

... Overall, how do you rate the decisions by the administration, by Geithner's Treasury Department and Bernanke's Fed?

If you judge the bailout by the fact that the banking system has survived, most of it, and that it's back paying bonuses, then you'd say it was a success.

If you judge the bailout on the criteria of has the banking system returned to lending, has the American economy been returned to health, has the problem of "too big to fail" banks been resolved, has the problem of non-transparency been resolved, you have to say we failed.

If you ask the question is the problem of moral hazard worse, you have to say we failed even more. Has the problem of the undermining of our democratic processes [been rescued]? You have to say we failed. ...

Was the AIG bailout necessary in your view?

I still to this day question why they paid off all of those counterparties in full at par with government money. ...

Did you ask Geithner?

No. Again, we were not involved in that at all. ...

We have rules in terms of derivatives. We have the power to accept or repudiate derivatives contracts. And typically if they have enough collateral or more collateral than necessary, the counterparty, to protect their position, then we'll ask for continued performance.

But if they're under-collateralized, we tell them, "Fine, take your collateral and go and take your haircut and go." That's kind of the rule we follow, and they could have done that. ... They could have used that same kind of approach I think.

Because not only was it the right thing to do, but the optics of this, I think the insensitivity of how people on Main Street would view of all this was always troubling to me. ...

The argument would be that there was no time for that. At this point the world's financial markets were going to melt down on Monday morning if Lehman Brothers or if Bear Stearns failed.

That was the argument. But even if you had to make a decision in a nanosecond, require them to take a 10 percent haircut. Just tell them, "We're going to pay you off at 90 percent. If you don't like it, too bad."

But the government had no legal obligation to put money into AIG to bail it out. If the government hadn't intervened, those counterparties would have taken huge losses, so there was some leverage there. But at least tell them, "You're going to take 10 percent." That would have helped.

But there was just willingness to kind of throw lots of money at the problem. I think we threw more money at the problem than we needed to, absolutely. ...

You're watching all [the Troubled Asset Relief Program negotiations] from the sidelines?

Pretty much. We were not really involved in their first attempt to get TARP passed. We got brought in later because they couldn't get the votes, and so one of the things they decided to do to get the votes was to increase the deposit insurance limit to $250,000. ...

So you had to agree to that?

Right. We had to buy in. They needed us to get the votes, so we got brought in at that point.

And that was throwing something out to Main Street?

That was the Main Street benefit. ...

I was summoned to a meeting. ... It was at Hank Paulson's office. I kept asking him what it was about. Nobody would tell me what it was about. I thought it was about TARP and how to spend the TARP money. ...

I go into the room, and there's Hank sitting there, Ben [Bernanke] sitting there, and Tim Geithner's on the phone. And they basically hand me a piece of paper that would have the FDIC announcing that they're going to guarantee pretty much all of the liabilities in the financial sector. So all the debt we're going to guarantee for banks and bank holding companies.

That was quite a thing, and I didn't want to do that. ... So I told them that I would have to think about that.

On the one hand, it's hard for the chairman of the FDIC to go in a meeting and be pointedly asked by the secretary of the Treasury and the chairman of the Fed to do something and to say no. But I bought for time. I played for time. ...

Was that a tense meeting?

I don't know if it was tense. I was so flabbergasted. At that point I didn't even have the wherewithal to fight back. I just played for time. I said, "I have to go talk to my board about it." ...

So anyway, I went back, talked to the board, my internal directors. They had the same reaction I did. They were incredulous.

What is that they're asking you to do?

... I didn't bring the text with me, but it basically said the FDIC would guarantee all the creditors of banks and bank holding companies, including the investment banks.

So they want your budget?

They want my budget. They wanted my legal authority ... to guarantee debt, guarantee bondholders. It's all about the bondholders.

Where was that money going to come from?

... That what was one of my questions.

One of the criticisms I got during the crisis was that all I cared about was the FDIC, and I didn't care about broader financial stability.

Well the FDIC was holding things together. … If people had lost confidence in the FDIC and started pulling their money out of banks, we would have been back in the Stone Ages. It would have been cataclysmic. I don't even want to think about what would have happened.

So this idea that by caring about the FDIC I wasn't caring about system stability I thought was ludicrous. I was very concerned about the credibility of the FDIC doing what it was supposed to do, which was insure deposits.

Now if I go out and insure all the debt and $13 trillion financial system, what kind of credibility was I going to have? Insured depositors are going to be saying, "They can't do all that."

So I told them that, and that was one of the many arguments I used subsequently to tell them we weren't going to do that. ...

So you're insuring, at the FDIC, Main Street?

Right.

But you're being asked by these three guys to insure Wall Street?

Pretty much. To insure the bondholders, and these are big Wall Street firms, pension funds, big bondholders, mutual funds.

Which props up Wall Street, but this is not your mandate?

... It's not anywhere close to our mandate. It was a real stretch in terms of legal authority, and it was a huge stretch in terms of our financial capability to make good on this. ...

So did you say no?

... We entered into a negotiation. Throughout the crisis ... another criticism was that I wasn't a team player, I was always difficult. I tried very hard to meet these folks halfway, even though I didn't agree with a lot of what was going on. ...

The markets were freezing up. Nobody wanted to lend to anybody after the Lehman failure, and I agreed there was a problem with the ability of financial institutions to roll expiring debt. ...

So ... we said we'll guarantee new debt. We will not guarantee the existing debt. That's there for loss absorption if these institutions go down. And then we're also going to charge money for it."

You wanted some moral hazard?

Yeah. Actually our original proposal was we'd only guarantee 90 percent of it. We wanted them to take 10 percent, and that was just a non-starter with both the Fed and the Treasury. They said that wouldn't work. They just refused. ...

So you signed?

We did. I think at the peak of the program it was about $330 billion worth of debt. Have not taken any losses on it so far. I don't think we will. And we did make money off of it.

I don't think that justifies that. There's so much of this, "Oh, we made money off of the bailout." I'm not sure overall we did make money off the bailouts because you have to look at Fannie and Freddie and AIG and GM and some of the other places where the government's still in pretty deep.

We also printed a lot of money, which could come back to bite us.

That’s true. This could have tremendous inflationary pressures down the road. ...

I think in the last quarter of 2008, [Citi] lost between $30 and $40 billion.

It was a very large number. They also had very unstable funding, so they used foreign deposits to fund a lot of their bad loans and other toxic assets that they had. ... But they were losing foreign deposits, and so they funded short-term too. They didn't have a lot of long-term debt that would have been stable, and their capital was low as well. They were in very bad shape at that point.

Just a few weeks later, Citi continues to be a problem. ... You have another crisis.

... They needed another bailout. ...

Another weekend.

... Got the call on Friday. We were playing catch up, but we had started paying a lot more attention to these large institutions, so we had a little bit of better sense.

But again, we weren't notified until Friday that the Fed and the Treasury wanted to do another bailout. They felt another bailout was necessary, and it had to be done that weekend.

Again, not much [time] to plan or look at alternatives, and so they got another very generous bailout, another $20 billion in capital. And the government agreed to guarantee losses above a certain point and about $306 billion of toxic assets that they had.

You commented that basically you had no real feel for whether or not Citi's failure at that point would have been systemic.

I think Hank and Tim Geithner have said that. ... What I did say was, can we at least explore putting the insured banks, the Citigroup structure, the bulk of the assets -- I think it was around 67, 65 percent of the assets -- can we explore running that through a receivership, creating a good bank, bad bank structure?

So you keep the bad assets back in what we call the bad bank. The current shareholders and unsecured debtors have to take whatever losses are associated with that. The good stuff, the good part of the franchise, you spin off. You sell or you recapitalize.

I wanted to explore doing that. I didn't want to do just another kind of one-off bailout. ... Obviously we needed to take action. We needed to do something to Citi, but I still think that would have been a better model to use. ...

You said again to the inspector general looking into this, "I don't think that additional assistance is going to fix Citi." So this was a patch-up job in your opinion?

It was a patch-up job. ...

I had a very tense conversation with [Former Comptroller of the Currency] John Dugan, their primary regulator. I said: "What is your supervisory plan? How are you going to fix this institution, because it's still sick? What are you going to do?"

He had no answers for me whatsoever. And the CAMEL rating, ... they had capped at a CAMEL 3.

CAMEL?

That's a supervisory rating. So 1, you're a very healthy bank; 5, you're a failing bank; 3, you're kind of an in-the-middle bank.

And Citi was?

Citi had failed twice and it required two government bailouts. It should have been a 5, right? If it had been a little bank. But they still had it as a 3.

When I asked him on that, his rationale was well, because it was getting all this government bailout money, it was a 3. So here we go. Now we're going to be rating the health of institutions based on how much government money they get.

After the fact.

So the fact that they were big and connected and can get a lot of government money, then we're going to give them a nice supervisory rating.

Like I would be less insolvent if you gave me a few million dollars.

It amazed me. And there was no plan and no sense of developing a plan to right the ship. ...

The criticism of the inspector general in looking at these deals was that these were ad-hoc assessments, sort of seat-of-the-pants, instinctual kinds of things.

They were. ... There is no question. ...

When all of it starts to cascade, what were you thinking when you were watching it go? Did you have a sense of how vulnerable everything was over Labor Day weekend in 2008? Were you personally concerned?

Extremely, yes. It was a very, very scary time. I think up until that Labor Day weekend, we were in just another financial crisis. Those aren't pleasant occurrences, but they repeat, and they have patterns that one can recognize, and over the course of a 20-year career, you learn to recognize them. Up until that point, I think we were in one of those situations.

At that point, we were in totally new territory. The notion that a Lehman Brothers could be filing for bankruptcy and AIG could be at risk of the same fate -- and it was very uncertain what would happen to the rest of the broker/dealer community that week -- was absolutely unprecedented. And thinking through the implications of that for the health of not just the U.S. economy but the world, it wasn't really conceivable to do that. I couldn't get my mind around it. I know others couldn't.

The extraordinary actions that were subsequently taken by governments to intervene were absolutely necessary, because the consequences of an interconnected failure by all of those institutions simultaneously would have been unimaginably terrible in terms of impact not on the shareholders of those corporations who suffered terribly anyway, but on the man on the street.

We know that credit conditions are tight today; they would be nonexistent had those events unfolded. Absolutely nonexistent. The Great Depression would have looked like a small event by comparison to what I think would have happened had that process continued unrestricted.

And one of the great tragedies of understanding, or misunderstanding, it through all of this is the notion that somehow banks and/or Wall Street were bailed out at the expense of the taxpayer. What has been lost in translation is that it is for the sake of the man on the street that the financial system needed to be stabilized, and it was unambiguously in the interests of the taxpayer that that system be stabilized.

And let us not forget that the shareholders and many, many employees of these financial institutions that did make major mistakes have paid dearly in terms of their own personal net worth and the value of their companies. The bailing out aspect was keeping them afloat through the presence of government backstops and capital so that credit markets could go through a process of un-seizing themselves without abject panic. And that was what we were looking at then.

This wasn't about credit derivatives, this was a much more complex situation. It had at its core credit conditions that were easy and had been that way for many years; it had the low savings rate in the United States, the high savings rates in the emerging economies, particularly China and India, the growth in the emerging markets.

All of these things had conspired to create an environment that essentially became a bubble. The consuming habits of United States citizens driven, in part, by the housing bubble led to a lot of this buoyancy and lack of fear of risk in financial markets. And there was a significant deployment of leverage, leverage in the form of balance sheets that were running with very little capital against large volumes of assets which all looked fine, except when the music stopped in a correlated fashion, they deteriorated.

That, at its essence, was the root cause of this financial crisis. The derivatives, in a sense, are a manifestation of people's risk appetite. How they used derivatives reflected their lack of fear of the consequences of market behavior, lending in particular in mortgage markets. …