The chairman of the Federal Deposit Insurance Corporation, Sheila Bair, delivered the Alfred Landon lecture today at Kansas State University, and the text is worth deconstructing.
Ms. Bair: "WAMU became the largest insured depository institution to fail, though thanks to the FDIC's resolution powers, it was sold in a seamless transaction that required no support from the government and fully protected all depositors."
FutureOfCapitalism.com: The depositors of WaMu may have been protected, but the shareholders and senior debt holders suffered quite a bit, as detailed here. The events weren't exactly seamless for them.
Ms. Bair calls the American government actions to prop up and bail out or take over financial institutions "mostly necessary." The natural follow-up question is which ones were necessary and which ones were not, but Ms. Bair doesn't say.
She goes on to say, "Government intervention has in too many cases protected stockholders, bondholders and managers from the consequences of their mistakes." The natural follow-up question is which stockholders, bondholders, and managers does Ms. Bair think should have suffered more, and what, if anything, will she do as a powerful regulator to try to make that happen? Again, she doesn't specify.
Ms. Bair also offers some thoughts on how to regulate derivatives:
The collateral calls generated by derivatives counterparty credit risk management mimic the depositor runs of the past.
One way to reduce these risks while retaining market discipline is to make derivative counterparties keep some "skin in the game" throughout the cycle. Under this approach, the receiver for a failed institution could impose losses of up to 20 percent of the secured claim. This would ensure that market participants always have an interest in monitoring the financial health of their counterparties. It also would limit the sudden demand for more collateral because the protection could be capped.
This is a variation on the proposal she made in Istanbul that we wrote about at the time. It's not clear that giving that sort of discretion to receivers would increase the stability of the financial system; instead, such penalties might spread the instability more rapidly to other institutions.
