FDIC’s Bair comes out a winner in new bailout, reform measures

Treasury Secretary Timothy Geithner has had a busy week, introducing the details of his three-pronged bailout plan and outlining his plan for regulatory reform, while also taking more heat for the bonuses at American International Group.

While Geithner has been the front man for the administration’s proposals, there is another official who has made her presence felt this week. Sheila Bair, chairman of the Federal Deposit Insurance Corp. has left her fingerprints all over the measures.

The FDIC plays a major role in both plans, indicating that behind closed doors, Bair lobbied hard and successfully for herself and her agency. Although a holdover from the Bush administration, Bair has enjoyed a high standing among Democrats and Republicans alike for the FDIC’s admirably swift and competent handling of the growing banking crisis.

The agency took over failing mortgage lender Indymac Bank, found a new home for another failed mortgage lender, Countrywide, and resolved the nation’s biggest bankruptcy to date with Washington Mutual – all with barely a ripple in financial markets.

Last fall, Forbes magazine listed Bair as the second most powerful woman in the world, after German chancellor Angela Merkel. Who knows? With the new powers she obtained this week, Bair may even overtake Merkel in the next ranking. In the new version of the bank bailout – the Public-Private Investment Program – the FDIC will be the mainstay of the plan to remove toxic loans from bank balance sheets.

The agency will vet the loans to see if they are appropriate for the 6-to-1 leverage ratio, conduct the auction for the loan pools and then form the Public-Private Investment Fund (PPIF) to purchase them. The equity participation will be provided 50-50 by Treasury and the private investor, but the remaining purchase price will come from debt issued with an FDIC guarantee, collateralized by the purchased loans.

The new role dovetails nicely with the FDIC’s current regulatory role of deciding the capital treatment for these loans by each bank. Banks will probably have to mark down the loans from the price carried on their books before selling them, and the FDIC can help manage this process.

The other half of the program involves securitized assets, with the Federal Reserve acting as Treasury’s partner in providing non-recourse loans to finance private fund purchases of these assets.

The other new role for the FDIC is as the lead agency in the new resolution authority the administration is seeking to be able to seize and unwind non-bank financial institutions, the way the FDIC currently does with banks such as Indymac and WaMu.

The authority would fill a gap revealed by the problems at Lehman Brothers and AIG, where the government faced the choice of letting the institution go bankrupt or propping it up with a slew of ad hoc measures. It would apply, though no one is saying this out loud, to bank holding companies like Citigroup.

The administration submitted draft legislation for this authority on Wednesday and Geithner listed it Thursday as one of the six core measures in his reform program. The others, including designation of a regulator to monitor systemic risk and systemically important financial institutions, will need to be fleshed out in the coming weeks. The only one ripe for legislation is the resolution authority involving the FDIC.

The draft bill leaves blanks in the names of the agencies, but Bair was quick on Wednesday to claim the role of conservator/receiver of these non-bank institutions for her agency. “

Due to the FDIC's extensive experience with resolving failed institutions and the cyclical nature of resolution work, it would make sense on many levels for the FDIC to be given this authority working in close cooperation with the Treasury and the Federal Reserve Board of Governors,” Bair said in a statement.

Treasury confirmed on Thursday that indeed the FDIC would be the conservator agency under the new authority. The Treasury proposal would build on the FDIC's existing authority to seize banks and thrifts, a Treasury spokesman said, but a decision to seize control of a non-bank institution would require involvement of the Treasury secretary and the Federal Reserve and be done in consultation with the president.

Bair explained her thinking to CNBC’s Larry Kudlow in an interview Tuesday: “Clearly, the FDIC has a lot of resources and experience, a good model already. This is cyclical work. You know, you go through cycles where you have to close institutions. So to keep multiple agencies fully staffed to be able to do a receivership function probably doesn't make much sense. So I think it does make sense to give it to the FDIC.”

The FDIC can choose between receivership, conservatorship, or a bridge bank to clean up and re-launch or unwind an institution in a process that’s more controlled than bankruptcy.

In her CNBC interview, Bair described how the new resolution authority would work: “It’s an ability to address the systemic issue through a more controlled, orderly unwinding and enabling the government to come in, repudiate employment contracts, pick and choose who you want to keep, who you want to get rid of, what you want to pay them. Replace the management, get rid of the boards, bring in better management and do an orderly unwinding of the entity. So yes, we think our model is good on the resolution side.”

Sounds appealing compared to the chaotic approach that has been taken with AIG. It’s probably no accident that the administration is hurrying this new authority on its way: It might come in handy in the very near future.