- The Washington Times - Wednesday, August 26, 2009

Big banks and Wall Street firms appear to be taking big risks again, possibly putting taxpayers in jeopardy, thanks to generous government programs that guarantee they will get bailed out no matter how badly they bungle, Federal Deposit Insurance Corp. Chairman Sheila C. Bair said in an interview Tuesday with The Washington Times.

Ms. Bair, who was among the first to call for a crackdown on the mortgage abuses that led to the global financial crisis, said large institutions that currently enjoy extensive government backing must also be subject to a “harsh” new regimen that ensures they are no longer “too big to fail” and will be shut down like smaller banks if their recklessness gets them into trouble again.

“I do worry that we’ve kind of institutionalized ‘too big to fail’ now. Institutions will be attracting investment dollars and continuing because of government support and the perception that government will always step in,” she said, noting that “several” large banks would have failed by now without the backing of the government. “That’s problematic - not a healthy situation.”

“If you have an institution that is sick because it’s been poorly managed or has taken imprudent risks, I don’t think they should be bailed out just because they’re big. They should be wound down,” said the top bank regulator, who so far this year has shut down 81 small banks that succumbed to mounting losses on loans.

“You need a tough process. You need a harsh process” to close insolvent giants like American International Group, which nearly a year ago the Federal Reserve and Treasury deemed to be too big to fail and rescued with a record-breaking government bailout worth $170 billion.

AIG’s bailout followed the uncontrolled and devastating bankruptcy of Lehman Brothers in September, which so roiled markets around the world that regulators cite it as their reason for rushing to AIG’s assistance.

What followed was a succession of lavish government assistance to other banking giants, including Bank of America and Citigroup, which came on top of near zero-interest loans from the Fed and the FDIC’s own guarantees of bank debt offerings.

Ms. Bair stresses that she’s not second-guessing decisions that were made “in the fog of war” in the midst of the global financial crisis, but said: “We have got to get market discipline back into the system, because regulation is only going to accomplish so much.”

She said most congressional proposals she has seen dealing with the big bank problem do not go far enough and appear to mostly authorize “organized bailouts” rather than provide a process to close failing giants that would be a disincentive for bailouts in the future.

“What I don’t think is acceptable is to say, ‘These institutions are big. Live with it. We’re just going to regulate them all. We’re just going to impose higher capital requirements.’ ”

She said the shareholders and creditors of big banks must be forced to take losses, as is the case currently with small banks - but it’s too late to go back to the separation of government-insured banks from securities firms, which in earlier eras did not enjoy government backing because of the greater risks they took.

Ms. Bair said the impression that big banks could count on a government bailout no matter what they did was particularly fed by the stress tests bank regulators conducted on the 19 largest banks in March to determine whether they needed additional capital to weather the financial crisis. The Treasury said if banks could not raise the capital they needed on their own - which most of them did - it would step in and provide cash in exchange for ownership shares.

Comforted by the results of the stress tests, worries about banks that had haunted the stock and credit markets for months mostly disappeared, and the stock market staged one of its strongest rallies in history, with major indexes posting nearly 50 percent gains. Even downtrodden stocks such as AIG, Fannie Mae, Freddie Mac, Citigroup and Bank of America have rebounded strongly as investors bet their troubles are over, despite mounting losses on loans of all kinds.

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