FDIC Chair Rejects 'Too Big to Fail' Notion

Federal Deposit Insurance Corp. Chairwoman Sheila Bair said today that government and the American people need to reject the notion that a bank is simply "too big to fail" -- a 25-year-old idea that she said "ought to be tossed into the dustbin."

Instead -- noting that bankruptcy isn't a viable option either -- Bair called for Congress to give her agency more power to close "systemically important" financial firms, expanding on the FDIC's current ability to close commercial banks.

"The past 25 years have seen vast changes in how credit is provided and in the types of firms which provide financial intermediation," Bair said this afternoon at a luncheon at the Economic Club of New York. "Unfortunately, our laws for dealing with financial crises have not kept pace with these changes."

So far this year, the FDIC has closed down 29 commercial banks. That's more than the 25 closed for all of 2008 and there are still eight months to go this year.

Typically a bank is closed Friday night and is transferred over so that Monday morning it reopens with a new name and under control of the acquiring institution. Bair called the process "unintrusive and seamless."

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But the large banks that play a key part in our economy are very different.

They are involved in complex transactions with numerous other lenders, most not insured by the FDIC. That leaves the government to either bail out the failing institutions or let them file for bankruptcy. When Lehman Brothers filed for bankruptcy in mid-September, it sent the financial world into a freefall.

"The bankruptcy process simply does not work for large, systemically important financial institutions in a way that can preserve stability and avoid disruptions in the financial system," Bair noted. "Bankruptcy is designed to protect the interests of creditors, not to prevent a meltdown of the financial system."

The too-big-to-fail approach doesn't work either, she said, because it "has eroded market discipline for those who invest," created "cynicism about the system" and increased "anger directed at the government and financial market participants."

Let FDIC Break Apart Troubled Banks to Remove Toxic Assets

So Bair is proposing a third solution: give the FDIC power to break apart banks in a way similar to the Resolution Trust Corporation created in the wake of the Savings and Loan crisis of the 1980s.

She said this, along with other government programs, would help to remove the backlog of toxic assets from the bank's balance sheets and allow the economy to start growing again.

Under these proposed powers, the government would take the bad assets off the banks' books, find a way to sell them off and then let the banks grow.

"Taxpayers should not be called on to foot the bill to support non-viable institutions because there is no orderly process for resolving them," she said.

Bair, a self-described life-long Republican and market advocate, said the government faces a difficult balancing act between letting the market correct itself and stopping it from utter collapse.

"The government is going into places where we don't want to be," she said. "We're doing things we'd rather not be doing, but had little choice not to undertake them -- and they have worked so far."

Bair started off her speech today with a little humor. Noting that she was speaking to a group normally addressed by presidents, prime ministers, five star-generals, Federal Reserve chairmen and corporate CEOs she said, "That's a lot of gravitas and intellectual capital to follow. So I'm feeling, dare I say, that this is my own personal 'stress test'."