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Read the Fine Print: Who May Save a TBTF Bank From Death Row?

Once upon a time, our financial system faced oblivion. Every bank, including Goldman Sachs, was heading the way of the allosaurus and Vanilla Ice. Then, Uncle Sam started printing mass quantities of money, and lending it to the TBTF (Too Big To Fail) banks at next to zero interest. Instead of lending the money to credit-starved folks, the banks clung to it, like Linus to his security blanket. Many of these banks are hoarding this money because there will be a day of reckoning (wishful thinking?) when they have to purge their toxic assets from their books. Multifamily default rates exceed all other asset classes, including retail.

To make it easier for banks to appear solvent, the FASB, a seemingly independent agency gutted mark to market accounting rules for banks in June, 2009. Critics said that the FASB succumbed to pressure from lobbyists and politicians. If many multifamily purchasers bought buildings at 75-80 LTV, and their properties have dropped 30-40% in value since the time of purchase, the banks are holding notes that are worth much less than their face value.  They can either “extend and pretend,” hoping that the market returns, or a wave of defaulters ultimately brings down the lending institution. See Bank, Corus.

Even with the system getting gamed for the benefit of TBTF banks’ survival, many more banks indeed will go to allosaurus-land. Legislation was supposed to be forthcoming, but now that TBTF banks no longer appear to be in jeopardy, the urgency seems to have gone.

The American Bankers Association is filling the void. It is offering its own resolution plan: the administration would have the ultimate authority to decide when a systemic firm should be resolved, acting on the recommendations of several government bodies. Critics want the FDIC to wield the scalpel under a clearly defined set of circumstances. Senator Bob Corker of Tennessee said that if a bank is insolvent or can’t function, it should be closed, specifically by the FDIC.

Due to a turf battle between the Treasury Department and the FDIC, Treasury wants to decide when a bank gets puts down like a mangy dog. Only then would it appoint the FDIC as receiver. The problem with this approach, and the ABA approach, is that it creates too many bureaucratic hurdles and opportunities to save a zombie bank.

If the FDIC is not given definitive power to put down a moribund financial institution based on an objective set of criteria, the credit and CRE crises will drag like the last half of  Tom Cruise’s War of the Worlds.

P.S. Let’s hope that in the unlikely event the FDIC gets such power, it does not fall asleep at the switch again. The FDIC failed to enforce its own guidelines to rein in excessive commercial real estate lending by at least 20 banks that later collapsed, according to its inspector general. The FDIC had specifically failed to prevent banks from letting commercial real estate holdings exceed 300% of capital. See Bank, Corus. Again.

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