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Why the Fed Overruled FDIC on Dividends Post-Crisis

“We remain concerned over their ability to withstand stress in an uncertain economic environment. We strongly encourage [that the Fed’ delay any dividends or compensation increases until they can show that their earnings are strong and their assets sound. Given the continued uncertainty in the markets, we do not believe it is the right time to allow transactions that will weaken their capital and liquidity positions.”

-Sheila Bair, Federal Deposit Insurance Corp Chair

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This weekend’s must read article is a long analysis by Jesse Eisinger of the process by which the Fed allowed bailed out banks to restart the process of returning cash to shareholders by dividends: Why the Fed Let Banks Pay Billions to Shareholders.

At the time, the FDIC was very much against it, concerned as they were about the banks weak balance sheets.

Some of the data is pretty devastating:

“From 2006 through 2008, the top 19 banks paid $131 billion in dividends to shareholders, according to SNL Financial. When the financial crisis hit, the banks were weak in large part because they didn’t have those billions. Indeed, in the fall of 2008, the government invested about $160 billion in the top banks.”

Taxpayer funded bank bailouts would not have been necessary if banks had merely retained more of their dividends.

This is quite significant to future reserve requirements. Instead of being prepared and having strong balance sheets, banks have learned the wrong lessons about Captialism and Socialism: They can be as aggressive as they want, and pocket the profits during the good times — and the taxpayers will cover the losses during the bad times. Privatized profits, socialized losses.

This situation arose due to three failures on the part of banks:

1. Bad Economics: It reveals Banks’ collective lack of understanding of economic conditions: Heading into the worst economic storm, bankers had no idea what was in front of them. Given the deterioration of their own mortgage portfolios, this is an inexcusable breach.

2. Poor Preparation: It shows the poor preparation for events dislocations or challenging events; Reserves reduce capital for other uses. It lowers ROI. Thomas Hoenig has suggested banks are more like Utilities, and should be regulated as such.

3. Terrible Risk Management: It reveals banks have terrible risk management approaches. Beyond this blog, numerous credible people has been warning about the oncoming storm. Why did the banks not prep better? My best guess is that profits were so great the risk was willfully ignored.

Since March 2011, the Federal Reserve has allowed the 19 biggest banks to pay out $33 billion in dividends. That is now money unavailabe to cushion banks balance sheets during downturns; in the event of a major crisis (Europe?) that is money that the taxpayer will have to foot.

If banks are healthy enough to be paying out big divvies, why hasn’t the Fed normalized its policies? Why allow loans against garbage paper? Why keep rates so low?

Eisinger notes that “a wide range of current and former Federal Reserve officials, other banking regulators and experts either criticized the decision to allow dividend payments and stock buy-backs then, or consider it a mistake now.” Remember that the next time bankers come hat in hand to DC to beg for taxpayer funding. The better choice remains providing debtor in possession financing during a prepackaged bankruptcy — and not a bailout.

The entire article is a must read . . .

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Source:
Why the Fed Let Banks Pay Billions to Shareholders
Jesse Eisinger
ProPublica, March 4, 2012
http://www.propublica.org/article/fed-shrugged-off-warning-let-banks-pay-shareholders-billions


Read more: The Big Picture