Tuesday, January 10, 2012

Today's links

1--EURO GOVT-Supply pressure weigh on Italian, Spanish bonds, Reuters

Excerpt: Concerns over euro zone overshadowing U.S. data

* Italian, Spanish bonds under pressure before debt sales

* Austrian benchmark yields rise to highest in over a month

Benchmark Italian 10-year government bond yields rose 3.6 basis points to 7.179 percent --
borrowing levels perceived to be unsustainable over the
long-term. Five-year yields were up 11 bps at 6.335 percent.

The European Central Bank was seen intervening in the market, traders said.

Spanish 10-year government bond yields rose
3.8 bps to 5.72 percent, with the five-year yield surging 12.8
bps to 4.89 percent. Austrian 10-year government bond yields
last stood up 6.6 bps at 3.606 percent.

"We are seeing Spanish, Italian and Austrian spreads
widening rapidly and part of that is obviously due to general
risk-off at the moment: Greece worries, Hungary worries, Spanish
deficit worries, various factors," John Davies, fixed income
strategist at WestLB said.WILL THEY, WON'T THEY?

The market is also nervously waiting for an announcement by
ratings agency Standard & Poor's, which warned early in December
it may downgrade most euro zone countries, including France and

This will almost surely lead to a downgrade of the euro
zone's EFSF bailout fund, which means that the bloc's tools
against the debt crisis will become even weaker and pressure on
the European Central Bank to step up government bond purchases
will increase.

"The market should be prepared for it, but the market does
not need many excuses to sell Italian bonds," Credit Agricole's
Keeble said.

"Confirmation that France is downgraded and than that the
EFSF is downgraded as well could create that movement and then
the ECB will have to buy aggressively."

2--Investors Sour on Subprime Bonds, WSJ

Excerpt: Money Managers Retreat From Market as Prices Decline and Upside Is Limited; 'Buy-and-Hold' Mentality

After flickering to life early in 2011, the market for subprime- and other risky residential-mortgage bonds has returned to its comatose state. And many investors believe a revival could be years away.

Prices on some bonds, which are backed by mortgages that don't meet the standards needed to get backing from government-controlled companies like Fannie Mae and Freddie Mac, plummeted as much as 30% last year. The ABX, an index that tracks the value of subprime bonds, ended the year at 43.44 cents on the dollar, down from 59.90 cents at year-end 2010 and a peak of 62.68 cents in February 2011

While that decline pushed yields up to as much as 17%—bond yields rise as prices fall—many fund managers have pulled out of the market due to worries about further price declines. Moreover, repeated downgrades have left too few investment-grade securities for them to own. Wall Street banks, which traditionally have played a key role in the market matching buyers and sellers, are backing away ahead of new regulations that will make it more expensive to hold riskier assets.

On top of that, European banks and the Federal Reserve still are holding billions of dollars of subprime-mortgage bonds, and investors worry they could flood the market at any time.

Investors are skeptical they can make a profit in the private mortgage market, which are loans not backed by Fannie or Freddie, said Marina Tukhin, head of mortgage and asset-backed trading at broker-dealer Gleacher Descap. This market includes bonds backed by subprime mortgages, which are given to people with poor credit; Alt-A mortgages, which are given to borrowers with decent credit who didn't meet other standard requirements to qualify for a loan backed by Fannie or Freddie; and "jumbo" mortgages, which are too large to get a government guarantee.

Less than 15% of the private mortgage bonds rated by Moody's Investors Service still carry an investment-grade rating, Baa3 or higher, compared with 53% of commercial-mortgage securities.

Without bank participation, confidence wanes, Ms. Tukhin said. "Once that confidence disappears, it doesn't really matter what the fundamentals are, and the fundamentals are not that strong, either."

Some investors had hoped the market was on its way to recovery. After crashing in 2008, as borrowers defaulted on mortgages, the market had risen slowly before rallying strongly in late 2010 and early 2011. By February 2011, the ABX was more than twice the levels of mid-2009. But the renaissance was short-lived.

Some investors blamed the Federal Reserve for snuffing out the rally. Seeing rising demand for the bonds, the Federal Reserve Bank of New York began shedding some of the $30 billion in mortgage bonds it took on as part of its 2008 bailout of American International Group Inc. But buyers quickly retreated and the Fed stopped selling.

Leading up to the Fed sales, "the market felt like there was price upside, and hedge funds and other active managers participated more frequently," said John Sim, a strategist at J.P. Morgan Chase & Co. "Now, the market is more for buy-and-hold investors who realize that price action to the upside is likely to be very limited."

The price slump has attracted buyers, some of whom anticipate a rally once Europe resolves its sovereign-debt woes. Jeffrey Gundlach, founder of DoubleLine Capital LP; his former employer TCW Group Inc.; Smith Breeden Associates Inc.; and Two Harbors Investment Corp. said they have been buying.

"It's a sector that has been undeniably cheap, but you have to have a longer-term investment horizon because, like any distressed market, it could get cheaper before it outperforms," said Bill Roth, co-chief investment officer at Two Harbors, a real-estate investment trust.

But some investors and analysts worry about an overhang of potential sales. The Fed is holding $20 billion of bonds and European banks own $100 billion, Nomura Securities estimated.

"People think the European debt crisis is going to lead to a tsunami of debt sales, and no one in a mark-to-market position wants to get ahead of that," said Daniel Nigro, founder of Warfield Consultants, a firm focused on mortgage- and other asset-backed securities.

Paul Norris, head of structured products at Dwight Asset Management, with $44 billion under management, has been selling mortgage bonds since March. He is worried that banks have become unwilling to help investors easily get in and out of trades, known as providing liquidity. He sold his subprime debt and recently shed bonds backed by jumbo mortgages that had "any chance" of losing their investment-grade rating

3--Fed Up With the Depressed State of Housing, WSJ

Excerpt: For an institution that jealously guards its independence, the Federal Reserve is wading into treacherous political waters.

With the economic rebound still mediocre at best, the Fed is charging into the housing debate. But in doing so, it runs the risk of politicizing itself, while also sending mixed signals to banks still trying to find their postcrisis feet.

The latest effort was a housing "white paper" sent this week to Congress, along with a series of comments from Fed officials about the importance of housing to the economic recovery. In this, the Fed may be laying the groundwork for further quantitative easing, this time purchasing mortgage securities. But its paper went beyond even the Fed's already unconventional policies. This included ideas that might require more taxpayer funding through Fannie Mae and Freddie Mac.

But having broached the thorny issue of using government entities to boost housing, the Fed didn't touch on questions surrounding a needed long-term revamp of housing finance. This left the Fed implicitly endorsing the housing status quo: a market that is almost completely dependent on the government and, in particular, Fannie and Freddie. Whether the government should be involved in housing, or to what degree, is of course a highly contentious political question for Congress.

The Fed's paper suggested it may be worth pursuing more aggressive actions in terms of loan modifications, mortgage refinancing and sales of foreclosed properties even if they cause greater short-term losses at Fannie and Freddie, and so by extension to taxpayers. And the paper may have led some in markets to believe a new, government housing effort was coming. The Fed's paper said a possible policy option would be for the government to expand existing refinancing efforts "or introduce a new program."

Expectations of such action helped spark a nearly 8% rally in Bank of America shares Thursday, although nothing is reportedly planned. Still, the reaction shows many now see the Fed and White House potentially acting together. That underscores how perceptions of Fed independence have already been eroded.

Beyond Fannie and Freddie, the Fed's paper also took it into other politically charged areas, such as principal forgiveness for underwater mortgage holders. While it didn't specifically endorse such a move, the Fed said that "policy experiments in this area would be useful."

Meanwhile on mortgage modifications, the Fed noted certain types of loan changes "may be socially beneficial, even if not in the best interest of the lender." It went on to acknowledge that this would be "likely to involve additional taxpayer funding, the overriding of private contract rights, or both." While the paper noted this raises difficult public-policy issues, by simply raising the possibility the Fed risks being seen as supporting such an outcome.

The paper also signaled that the Fed, ostensibly the most important bank regulator, will try to involve banks more directly in housing-revival approaches, even as it imposes new, more stringent regulatory constraints. One area involves efforts to turn foreclosed homes into rental properties. While this primarily pertains to Fannie and Freddie, the Fed noted that commercial banks as of last September had $10 billion in foreclosed homes on their books.

Banking regulations typically direct banks to sell foreclosed homes quickly, although the rules do recognize this isn't always practical and so these properties can be held up to five years. The Fed said it is now "contemplating issuing guidance" to banks and regulators that would possibly allow banks to turn some of these foreclosed homes into rental properties.

The hope is this may help stanch the flow of foreclosed properties into markets, although the effect may not be that great. Goldman Sachs economists noted Thursday that a rental effort may add 0.5% to home-price appreciation in the first year and 1% the second, although the impact "would likely be smaller." For banks, a move into the rental business would potentially clog parts of their balance sheets, while requiring them to essentially bet on house prices rebounding.

Housing is indeed important to the economy. But the Fed has to recognize there is only so much it can, or should, do

4--Unlimited Firepower, Bloomberg

Excerpt: If the economy keeps deteriorating even after the rate cuts and more liquidity is needed, the ECB may end up following the Fed and Bank of England by buying assets in bulk and not offsetting the purchases, said Owen at Jefferies. Such an initiative may come as soon as March and initially involve promising to buy as much as 500 billion euros of bonds across the region over three months, he said.

The ECB has so far refused to use its unlimited firepower to defeat the fiscal crisis. Officials warn that doing so would amount to a bailout of governments and lessen pressure on them to restore fiscal order. While it has bought the bonds of some stressed countries, Draghi says the program is aimed at stabilizing markets and is temporary and limited.

The result has been ECB asset purchases totaling about 3 percent of GDP, compared with more than 15 percent by the Fed and Bank of England, according to Berenberg’s Schmieding.

Bundesbank Opposition

Bundesbank President Jens Weidmann, who opposed buying Italian and Spanish bonds, said Jan. 3 it would be “profoundly wrong” to step up the purchases to contain the fiscal crisis. The influence of Germany’s central bank at the ECB shouldn’t be underestimated and means it would back quantitative easing only if its price-stability mandate is jeopardized, said Stephen Jen, managing partner at SLJ Macro Partners LLP in London...


The ECB has used its non-standard measures - bond purchases and liquidity operations - to help to fight the debt crisis and the provision of 3-year funds to banks has been seen in some quarters as a form of "quantitative easing" via the back door.

French President Nicolas Sarkozy said last month the funds provision meant governments in countries like Italy and Spain could look to their countries' banks to buy their bonds.

However, the record deposits at the ECB indicate this is not happening on a significant scale, even if ECB policymaker Christian Noyer has said European sovereign debt sales have been going better since the ECB started extending the long loans.

"I don't think (Draghi) will tell banks what to do with the money," said Schulz. "We think there may be a small help to governments ... but larger banks will continue to deleverage and stay away from government assets as far as they can."

Lorenzo Bini Smaghi, a former Executive Board member who left the bank at the end of the year together with Stark, opened the door to a possible ECB policy shift by saying last month the bank should launch a U.S.-style asset purchase program if economic conditions required it.

If employed, such a policy could mark a venture into the realm of quantitative easing - essentially printing money to buy assets like bonds - a path pursued by the U.S. Federal Reserve and the Bank of England but one the ECB has fiercely resisted.

5--Investors pay to lend to Germany, want more from France, Reuters

Excerpt: Investors paid to lend Germany a combined 3.9 billion euros for six months on Monday, accepting a loss in a renewed flight to safety from the euro zone debt crisis.

France, by contrast, had to pay more to borrow short-term funds, albeit that demand for its bills was strong. Investors are increasingly focusing on a handful of euro zone economies, notably Germany and The Netherlands, to park their money.

While yields on the bonds of peripheral euro zone countries have hit record highs in recent months on concerns about the debt crisis, Germany's yields have fallen to record lows.

On Monday they went negative for the first time at a regular auction, sliding to -0.0122 percent compared with a positive return of 0.001 percent at a similar auction in December.

Dutch bill yields also went negative last month, meaning that investors are actually losing money by buying the supposedly safe assets. Based on Reuters estimates, Berlin will earn 242,000 euros on the money it borrowed on Monday.

"In such uncertain times, return of money beats return on money," said Unicredit analyst Kornelius Purps.

6--Exclusive: Borrowers turn lenders as banks tap firms for cash, Reuters

Excerpt: Europe's banks are struggling to secure the cash to fund their day-to-day business and have largely stopped lending to each other for fear Europe's sovereign debt crisis could land any of their peers in trouble.

As a result a group of well-known, cash-rich companies with solid cash flows has stepped in the repo market, which provides a form of lending so far almost exclusively in use between banks, and between banks and central banks.

One market participant said in one key area of lending companies now accounted for 25 percent of these deals.

Repos provide the new financiers with the strict guarantees they need before parting with their cash, answering worries that the crisis has weakened Europe's banks to the extent that they might not be able to pay the money back.

"Companies in the past were ... happy to deposit cash on an unsecured basis to a bank for an interest payment," said Frank Reiss, who oversees some of the repo business at Euroclear, the Brussels-based settlement house owned by a group of banks.

"Now following the crisis, we have seen that companies are engaging in repos secured with collateral against the cash they are lending," said Reiss. Euroclear is the largest administrator of repo trades in Europe

7--Freddie Mac to grant breaks on mortgage payments for up to a year, Chicago Tribune

Excerpt: Freddie Mac announced Friday that it was giving mortgage servicers the authority to offer up to 1 year of mortgage forbearance to unemployed homeowners who have Freddie Mac-backed mortgages.

The change, with takes effect Feb. 1, means loan servicers can offer six months of forbearance to jobless borrowers without Freddie's approval and another six months with approval. Currently, servicers can grant up to three months of no mortgage payments without prior agency approval, or six months of reduced payments with approval .

Fannie Mae is expected next week to announce guidelines that will align with the new ones at Freddie Mac. The expansions are the result of a directive from the Federal Housing Finance Agency, which oversees Fannie Mae and Freddie Mac.

According to the most recent report from the Office of the Comptroller of the Currency, the percentage of Fannie Mae- and Freddie Mac-based loans that were seriously delinquent increased to 2.5 percent at the end of September, from 2.3 percent in June

8-- Will foreclosure activity increase in 2012?, CalculatedRisk

Excerpt: There are several significant policy changes in the works: 1) a possible Mortgage Settlement, 2) HARP refinance (the automated program starts in March), and 3) a REO to rental program. (See: Housing Policy Changes). It appears the overall goal of these policy changes is to reduce the large backlog of seriously delinquent loans while, at the same time, not flood the housing market with distressed homes.

Note: Diana Olick at CNBC has an update on the REO to rental program today: Government Set to Sell Foreclosures in Bulk

The Obama administration, in conjunction with federal regulators and led by the overseer of Fannie Mae and Freddie Mac, is very close to announcing a pilot program to sell government-owned foreclosures in bulk to investors as rentals, according to administration officials...

The REO inventory for the "Fs" increased sharply in 2010, but may have peaked in Q4 2010. However there may be a new peak when the foreclosure dam breaks (after the settlement) - however I expect quite a few modifications as part of the settlement too, and also a bulk REO selling program from Fannie and Freddie.

The Fannie, Freddie, FHA, PLS, FDIC REO decreased to about 455,000 in Q3 from just under 500,000 in Q2....

There are 4 million seriously delinquent loans (90 day and in-foreclosure). This is about 3 million more properties than normal. Probably when the mortgage settlement is announced, some of these loans will cure as part of the settlement with loan modifications that include principal reduction, but many of these properties will become REOs fairly quickly.

So even though REO inventory is declining, there are still many more to come - and this doesn't include all the homeowners with negative equity who may default in the future (although the refinance programs are aimed at keeping many of these borrowers from defaulting).

My guess is the policy changes will all be announced in the next few months, and that foreclosure activity will increase significantly. Some portion of these REO will be sold in bulk to investors and rented, so it is difficult to tell how many REOs will come on the market.

9--Bank of America severing some small-business credit lines, LA Times

Excerpt: Bank of America is demanding that some small-business customers pay off their credit line balances all at once instead of making monthly payments.

Bank of America Corp., under pressure to raise capital and cut risks, is severing lines of credit to some small-business owners who have used them to stay afloat.

The Charlotte, N.C., bank is demanding that these customers pay off their credit line balances all at once instead of making monthly payments. If they can't pay in full, they are being offered new repayment plans for as long as five years, but with far higher interest rates than their original credit lines had.

Business owners complain that BofA's credit squeeze is abrupt and could strain their small companies and even put them out of business. The credit cutoff is coming at a time when the California economy can't seem to catch a break, and bucks what the financial industry says is a new trend of easing standards on business loans.

10--Stock Funds in U.S. See Largest Redemptions Since ’08 as Volatility Surges, Bloomberg

Excerpt: U.S. stock mutual funds that invest in domestic equities had their second-biggest redemptions last year as record market swings sent investors to the perceived safety of bond funds.

Investors pulled an estimated $132 billion from mutual funds that invest in U.S. stocks, the fifth straight year of withdrawals for domestic funds, according to preliminary data from the Investment Company Institute, a Washington-based trade group whose numbers go back to 1984. Withdrawals reached $147 billion in 2008 when the Standard & Poor’s 500 Index fell 37 percent, including dividends.

Withdrawals accelerated in May and June amid concern that weaker European economies would not be able to repay their debts. They peaked in July as Congress debated whether to lift the nation’s debt ceiling. Those events, as well as lingering memories of the 2008 selloff and a subpar U.S. economic recovery, may all have contributed to investor discontent, said Russel Kinnel, director of mutual fund research at Chicago-based Morningstar Inc. interview.

“A lot of people remember they got burned so they are more sensitive to bad news than they were before,” Kinnel said in a telephone interview....

“Investors just can’t bear the pain, which sets the stages for an unwillingness to take risk,” said Christopher Blum, chief investment officer for behavioral finance at JPMorgan Asset Management in New York....

Leaving Active Funds

Funds that invest in international stocks attracted about $6 billion last year, ICI data show, down from $58 billion in 2010. Taxable bond funds saw an estimated $141 billion in deposits, below the $230 billion they attracted the previous year. Municipal bond funds suffered withdrawals of about $12 billion. In 2010 they had $11 billion in deposits.

The ICI has released monthly flow data through November and weekly numbers through Dec. 28, which may be revised. Final numbers for December will be published at the end of January, according to the ICI.

Domestic equity funds captivated the American public in the 1990s, thanks to a stock market that rose at an annual pace of 18 percent a year and the well-publicized success of stock pickers such as Peter Lynch of Fidelity Investments. Lynch guided Fidelity’s Magellan Fund to gains of 29 percent a year from 1977 to 1990 compared with 15 percent annual returns for the S&P 500 index.

11--Germans increase office efficiency with 'cloud ceiling', The Register

Excerpt: Worker output boosted by illusion of open sky overhead

So you thought you had deployed every form of office technology that could possibly increase the productivity of your company's cripplingly expensive salaried employees? You were wrong. Remorseless German boffins have discovered a way to make office workers still more efficient using - quite literally in this case - cloud technology. (Take a look at photos)

According to the top researchers of the Fraunhofer-Institut für Arbeitswirtschaft und Organisation (IAO) in Stuttgart, the human mind is set up to work at its best under the open sky, with changing illumination caused by clouds passing overhead. The unvarying glare of office lighting is sub-optimal, therefore, and in order to wring the last ounce of efficiency from German workers whose productivity has already been pushed to unprecedented heights they have decided to rectify this.

Their answer is the installation of luminous LED-equipped ceiling tiles which project a low-resolution moving image suggesting clouds rolling across the sky above office workers.

12--From the archive; Sheila Bair’s Bank Shot, NY Times

Excerpt: Alone among the regulators, though, the F.D.I.C. began to home in on subprime lending. By 2006, the subprime industry was running amok, making loans — many of them fraudulent, with hidden fees and abusive terms — to just about anyone with a pulse. Most subprime loans had adjustable interest rates, which started low but then jumped significantly after a few years, making the monthly payments unaffordable for many homeowners. The lenders didn’t care because they sold the loans to Wall Street, which bundled them into mortgage-backed bonds and resold them to investors.

Curbing subprime-lending abuses should have been the job of the Federal Reserve, which has a consumer division. But the Fed chairman, Alan Greenspan, with his profound distaste for regulation, could not have been less interested. The other bank regulators, the Office of the Comptroller of the Currency, which oversees national banks, and the Office of Thrift Supervision, which regulates the savings-and-loan industry, should have cared, too. But their responses to the growing problem were at best tepid and at worst hostile. (The O.C.C. actually used its federal powers to block efforts by states to curb subprime abuses.) By the time Bair got to Washington, the O.C.C. had spent a year devising “voluntary subprime guidance” for the banks it regulated, but it had not yet gotten around to issuing that guidance.

The F.D.I.C. jumped into the breach. Bair knew the issue well, because during her time at Treasury, when the industry was much smaller, she tried, unsuccessfully, to get the subprime lenders to agree to halt their worst practices. Now she was hearing that things had become much worse. Bair instructed the F.D.I.C. to buy an expensive database that listed all the subprime loans in the mortgage-backed bonds that Wall Street was selling to investors. She was shocked by what she saw. “All the practices that we looked at back in 2001 and 2002, which we thought were predatory — things like steep payment resets and abusive prepayment penalties — had gone mainstream,” she said....

The European banks, lacking adequate capital, were crushed by the financial crisis. Big banks in places like Ireland and Iceland collapsed. Germany doled out hundreds of billions of dollars to shore up its banks. Even today, banks in Europe are in far worse shape than they are in the U.S. American banks didn’t have enough capital, either, but they had a lot more than their European counterparts, and for all their ongoing problems, they are much healthier institutions today....

Too often, she felt, their requests were excessive, putting taxpayers at risk while bailing out undeserving debt holders. For instance, during the peak of the crisis, with credit markets largely frozen, banks found themselves unable to roll over their short-term debt. This made it virtually impossible for them to function. Geithner wanted the F.D.I.C. to guarantee literally all debt issued by the big bank-holding companies — an eye-popping request.

Bair said no. Besides the risk it would have entailed, it would have also meant a windfall for bondholders, because much of the existing debt was trading at a steep discount. “It was unnecessary,” she said. Instead, Bair and Paulson worked out a deal in which the F.D.I.C. guaranteed only new debt issued by the bank-holding companies. It was still a huge risk for the F.D.I.C. to take; Paulson says today that it was one of the most important, if underrated, actions taken by the federal government during the crisis. “It was an extraordinary thing for us to do,” Bair acknowledged.

Citigroup was another example. No bank needed more federal assistance than Citi — it required three separate bailouts. And yet, in Bair’s view, no bank was treated as solicitously, especially by the New York Fed. She felt pressured by the Fed to allow Citi to buy a failing Wachovia — which she suspected was a kind of backdoor way to strengthen Citi by giving it access to Wachovia’s stable deposit base. To make the deal work, the F.D.I.C. agreed to absorb some of Wachovia’s losses. When the F.D.I.C. accepted the Citi offer, Geithner felt that a deal had been made. But before Citi could close the deal, Wells Fargo, a much stronger bank, made a better offer — one that didn’t require government assistance. Bair leapt at it. Geithner was furious, complaining that Bair’s action was sending the wrong signal at the wrong time: that the federal government couldn’t be trusted to stick to its word. Bair didn’t care; she clearly got the right outcome for taxpayers and bank depositors, even if it didn’t help Citigroup.

As she thinks back on it, Bair views her disagreements with her fellow regulators as a kind of high-stakes philosophical debate about the role of bondholders. Her perspective is that bondholders should take losses when an institution fails. When the F.D.I.C. shuts down a failing bank, the unsecured bondholders always absorb some of the losses. That is the essence of market discipline: if shareholders and bondholders know they are on the hook, they are far more likely to keep a close watch on management’s risk-taking.

During the crisis, however, Treasury and the Fed were adamant about protecting debt holders, fearing that if they had to absorb losses, the markets would be destabilized and a bad situation would get even worse. “What was it James Carville used to say?” Bair said. “ ‘When I die I want to come back as the bond market.’ ”

“Why did we do the bailouts?” she went on. “It was all about the bondholders,” she said. “They did not want to impose losses on bondholders, and we did. We kept saying: ‘There is no insurance premium on bondholders,’ you know? For the little guy on Main Street who has bank deposits, we charge the banks a premium for that, and it gets passed on to the customer. We don’t have the same thing for bondholders. They’re supposed to take losses.” (Treasury’s response is that spooking the bond markets would have made the crisis much worse and that ultimately taxpayers have made out extremely well as a consequence of the government’s actions during the crisis.)....

Grudgingly, Bair acknowledged that some of the bailouts were necessary. There was no way, under prevailing law, to wind down the systemically important bank-holding companies that were at risk of failing. The same was true of a nonbank like A.I.G., which the government wound up bailing out just two days after allowing Lehman Brothers to fail. An A.I.G. bankruptcy would have been disastrous, damaging money-market funds, rendering giant banks insolvent and wreaking panic and chaos. Its credit-default swaps could have brought down much of the Western banking system.

“Yes, that was necessary,” Bair said. “But they certainly could have been less generous. I’ve always wondered why none of A.I.G.’s counterparties didn’t have to take any haircuts. There’s no reason in the world why those swap counterparties couldn’t have taken a 10 percent haircut. There could have at least been a little pain for them.” (All of A.I.G.’s counterparties received 100 cents on the dollar after the government pumped billions into A.I.G. There was a huge outcry when it was revealed that Goldman Sachs received more than $12 billion as a counterparty to A.I.G. swaps.)

Bair continued: “They didn’t even engage in conversation about that. You know, Wall Street barely missed a beat with their bonuses.”

“Isn’t that ridiculous?” she said. ....

Getting the banks to make large-scale mortgage modifications is no different today than it was in 2007 — next to impossible. The servicers still lack the economic incentives to modify mortgages; it’s easier in most cases for them to foreclose, which also generates fees, while modifications don’t. As Bair herself discovered during the IndyMac experience, changing that attitude requires dogged effort. “I ended up having calls with our servicers every Friday, to get a status report on what they’d done that week on loan modifications, just to keep the pressure on,” Bair said....

In the early wrangling over what became the Dodd-Frank bill, “resolution authority” was not a prominent part of the agenda. Then in March 2009, A.I.G. filed documents showing that it had set aside $165 million in bonuses for its traders. The public anger over these bonuses was enormous. One day in the middle of the furor, the president summoned Bair to the White House. When she arrived at the Oval Office, Geithner and Lawrence Summers, Obama’s top economic adviser, were sitting on the couch — and the seat next to the president was empty. That was where she was supposed to sit.
As the president vented his frustration over the A.I.G. bonuses, Bair saw her opportunity. “This doesn’t happen with our process,” she told the president. “We have a resolution process that we’ve used for decades, and when we put a bank into receivership, we have the right to break all contracts, we can fire people, we can take away bonuses and we don’t get into this kind of problem.” The president quickly signed on to the idea of having Dodd-Frank include the ability to resolve giant bank-holding companies and other systemically important financial institutions like A.I.G.

That was the easy part. Dealing with the Treasury Department was, as usual, the hard part. The original white paper the administration produced that outlined the financial reforms it wanted from Congress included a section calling for the government to be able to legally “resolve” the big banks. It had the F.D.I.C. running the process, which clearly made the most sense; the agency had been doing it for so long, it had the process down to a science. That’s why bank depositors scarcely notice when the F.D.I.C. shuts down their bank on a Friday and reopens it under new management on a Monday morning.

Weeks passed. About an hour before the president was set to announce the reform package, F.D.I.C. officials, including Bair, were shown the latest copy of the white paper. According to Bair, “The resolution authority had completely changed.” While the F.D.I.C. still had an important role, its authority had been seriously diluted — now the Treasury and the Federal Reserve would also have to sign off before a bank could be wound down. From Treasury’s point of view, this was completely reasonable. After all, any wind-down would require short-term lending from the Treasury, so it wanted some say in the process. But Bair felt strongly that this was yet another example of her — and her agency — being undercut by other regulators.

So she fought back; and in typical Bair fashion, she did so publicly. When called to testify before the House Financial Services Committee about the new resolution authority, she bluntly told Barney Frank, then the committee chairman, that, as she put it to me: “It still doesn’t resolve the large bank-holding companies. We would like the authority to do that.” In the final Dodd-Frank bill, Treasury’s oversight role was diminished — and the F.D.I.C. had the authority to manage a failing too-big-to-fail bank.

Even so, there are many people who remain convinced that the government will never have the nerve to let an important institution actually fail. Indeed, the big banks currently have a much lower cost of capital than their smaller brethren precisely because the bond market doesn’t believe they will ever be allowed to fail.

Bair has spent much of the last year trying to convince the country — and Wall Street — that the F.D.I.C. is up to the task. Most people remain unconvinced. But she insists, thanks to the new resolution authority, “I think we are in a lot better shape than we were.” The truth, of course, is that nobody can possibly know what the government will do. The only way to find out is to have an institution fail — not exactly a prospect to relish. But that will be a problem for someone else, not for Sheila Bair. She has done her part....

Which brings me back to where we began, with Bear Stearns. As I’ve thought about it in the weeks since our interviews, I’ve come to the view that she was absolutely right. “I think that the Bear deal set up an expectation for government intervention that was not really helpful,” she told me. Letting Bear Stearns fail would most likely have sent the right message to the rest of Wall Street, while there was still time, and without creating the kind of chain reaction that the Lehman failure caused. “I’ve always thought,” she said, “that it was really important for everybody to have to play by the same set of rules.”

That didn’t happen in 2008. Fighting the good fight, Bair has tried to make sure that it will happen the next time there’s a crisis.

13--From the archives: Greater Power Over Wall Street, Left Unexamined, NY Times

Excerpt: the most powerful banking regulator in the world, one that became even more powerful after financial reform was passed, is also the least examined. Mr. Bernanke’s opening remarks were about monetary policy and the economy. When he answered questions, he repeatedly referred to the Fed’s “dual mandate” — to keep inflation low and stable and to maintain full employment for the economy.

But that’s not the Federal Reserve’s true dual mandate. The Fed is indeed the steward of the economy, but it also has to regulate the financial system, making sure banks are safe and sound.

In the years before the financial crisis, the Fed was a miserable failure in that role, a creature of the banks, not a watchdog. The news conference was an opportunity for Mr. Bernanke to demonstrate what the Fed had learned from the crisis about banking oversight. After all, a collapsed financial system does spectacular damage to an economy.

There’s more to discuss about this now than ever. Under the giant Dodd-Frank package, the Fed was given an expanded regulatory role. The new consumer financial products regulator is housed within the central bank. The Fed also now officially oversees investment banks, which it had to rescue during the crisis. Congress broadened the Fed’s remit to cover nonfinancial institutions deemed “systemically important.” Congress created a new role, the “vice chairman of supervision,” to raise the prominence and importance of its responsibility. (It remains unfilled.) Perhaps most important, the Federal Reserve is supposed to play a major role in taking over big banks that fail...

Either expressly or implicitly, the Fed permeates every part of the Dodd-Frank reform,” says Dennis Kelleher, the chairman of Better Markets, a new Washington advocacy group that aims to be a Wall Street watchdog. “Yet there is no indication that the leadership of Fed understands or is undertaking its new role as systemic risk regulator. It’s not on the mind of the Fed chairman.”...

“Regulation needs accountability and transparency, and the Fed is just not set up to be accountable or transparent,” says Mike Konczal, a fellow at the Roosevelt Institute, a liberal think tank focused on financial matters.

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