WaPo Shreds Fed’s Pre-Crisis Performance as Regulator

An intriguing piece is up at the Washington Post, “Fed’s approach to regulation left banks exposed to crisis,” not simply because it does a good job of finding and analyzing some case studies of the Federal Reserve’s failures at a bank regulator, but also because in the critical opening paragraphs, it launches a full bore attack on Bernanke. It focuses on a speech he gave at the Federal Reserve Bank of Chicago in May 2007:

“Importantly, we see no serious broad spillover to banks or thrift institutions from the problems in the subprime market,” Bernanke said. “The troubled lenders, for the most part, have not been institutions with federally insured deposits.”

He was wrong. Five of the 10 largest subprime lenders during the previous year were banks regulated by the Fed. Even as Bernanke spoke, the spillover from subprime lending was driving the banking industry into a historic crisis that some firms would not survive. And the upheaval would shove the economy into recession.

Just as the Fed had failed to protect borrowers from the consequences of subprime lending, so too had it failed to protect banks.

For those of you who are not crisis mavens, the subprime market, which had been bumpy since the end of 2006, officially went terminal in July 2007 with the failure of two Bear Stearns hedge funds, a mere two months after Bernanke’s remarks. But he had given evidence earlier of being wildly out of touch. In a March speech, he had estimates subprime losses at $50 to $100 billion. I recall gasping out loud when I read that, for by then no private sector analyst pegged the damage as anything less than $150 billion.

But the bigger point is that a piece openly critical of the Fed’s performance, and one that puts Bernanke in the spotlight, is running while his confirmation is still in play. This appears to be further confirmation of the observation made by Politico last week, that the enthusiasm for him is waning. That does not mean he will not be confirmed in the end (as much as we think it would be salutary; as one reader pointed out, any replacement would be sorely aware of the fact that the Fed was being called to conceive of its constituency more broadly than it has of late). But it does signal that his confirmation is not a done deal.

The article focuses on how:

The Fed let Citigroup make vast investments without setting aside enough money to cover its eventual losses. The company would need more than $45 billion in federal aid.

The Fed watched as National City made billions of dollars in subprime loans that were never repaid. Regulators would arrange its sale to a rival, PNC.

And the Fed approved Wachovia’s purchase of a California mortgage lender shortly before California mortgage lenders led the nation into recession. Wachovia, on the verge of collapse, was bought by Wells Fargo with government help.

The piece accessible to laypeople while still presenting key financial and regulatory details. And it has some wonderfully revealing tidbits, to wit:

In fall 2006, the Fed conducted a broad review of the nation’s largest banks. The result was a picture of an industry in good health.

The report, called “Large Financial Institutions’ Perspectives on Risk,” found “no substantial issues of supervisory concern for these large financial institutions” and that “asset quality . . . remains strong,” according to a summary by the Government Accountability Office. The Fed declined to release the internal report.

The full article is here.

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  1. NYT

    I bet this story in the Wapo is Bair’s revenge for the Fed placing this story in the WSJ on Friday. Apparently she has a difficult management style and is not a team player.

    “WASHINGTON — In the darkest days of the financial crisis a year ago, Sheila Bair was hailed for having predicted the housing bust. Today, the chief of the Federal Deposit Insurance Corp. is fighting for her agency’s future.”

    1. alex

      “Apparently she has a difficult management style”

      That can either mean she’s an asshole, or that she’s demanding. I’d say the latter judging from the article: “Ms. Bair blasted a group of employees for handing her two staff-written economic reports with conflicting data”.

      “and is not a team player”

      Given the economic team in Washington, that can only be a good thing.

      Seriously, while I don’t discount your revenge theory, the WSJ article made me think more highly of her.

    2. Doug Terpstra

      Bair’s struggle with Bernanke and Geithner is an eerie replay of CFTC chair Brooksley Born’s warning to Greenspan, Rubin, and Summers in the mid-90’s about the imminent unraveling of over-leveraged credit default swaps. Born was rudely snubbed and sidelined by those jowled old banksters (fools), and we know how well that turned out.

      See Frontline’s “The Warning”: http://www.pbs.org/wgbh/pages/frontline/warning/interviews/born.html

      I hope Bair prevails. It’s interesting that she’s one of the more hopeful regulators we have—ironically a Bush holdover. With Elizabeth Warren and Christine Romer, lets have a team of women steer our economic ship, and drop the old guys off on the nearest iceburg.

  2. fresno dan

    I read that article this morning (I got the Sunday paper as I spent Sunday digging out, and thought discretion was the better part of valor as far as going out. I decided I might as well get the Monday paper as well, and I’m glad I did.)
    What I got out of the article is the number of people who gave very clear warnings about the impending crisis:
    “In January 2005, National City’s chief economist had delivered a prescient warning to the Fed’s board of governors: An increasingly overvalued housing market posed a threat tot he broader economy, not to mention his won bank and others deeply involved in writing mortgages.”

    I don’t expect Federal officials to be able to predict the future – but I do expect them to understand that if you jump off a 50 story building, that eventually you will go splat. It seems that Bernanke has a knack for ignoring those who analyse things correctly, and agreeing with those who don’t.

  3. LeeAnne

    Yes, this collapse of finance rule of law, fraud, and corruption is different from every other collapse, but for a better perspective on the matter it was really worthwhile to listen to Carmen Reinhart at a book signing who co-authored with Kenneth Rogoff the well-titled “This Time Is Different: Eight Centuries of Financial Folly” at C-SPAN here

    At least it makes me feel a little better about things political. The book as outlined by Reinhart is straight history without being sappy or prognosticating -just the facts.

    It really helps to see recent events as an interruption of our rights, freedoms and financial future rather than the end. If this generation can’t rise up to revive our Constitution, and it will be great if it can be done without mayhem, another will given that we have the foundation for peaceful revolution.

  4. john newman

    I have been surprised that Martin Taylor’s FT piece about bankerly innumeracy has received so little attention. In the absence of cash flow accounting the entire financial industry has become a bestial miscegenation of pump and dump and Ponzi schemes.

    Perhaps the Post is beginning to recognize that its source based journalism has made it an accomplice to looting and lawlessness. But I doubt it.

  5. Doug Terpstra

    Woe and despair, it turns out that the banks are mere hapless helpless victims not just of CRA deadbeats in the hood who won’t (or can’t) pay their mortgages and 33% credit cards but even of the negligent nanny Fed, force-feeding cheap credit and hyper-leveraged casino derivatives. For the banks chests are heaving and tears are welling to the mournful wail of violins.

    Greenspan and Bernanke are confidence men of the highest order. Bernanke must be confirmed in order to maintain the coverup and keep the hot air balloon inflated (as long as possible).

  6. Blurtman

    Perhaps readers will recall Timmy Geithner’s Congressional testimony earlier this year when he stated that he did not view his role at the FRBNY to be that of a regulator. Odd because the FRBNY website describes their regulatory responsibilites quite clearly.

  7. Francois T

    Can someone help me understand something?

    Here it goes: There is ample evidence that the Fed failed abysmally as a regulator during the last decade.

    So, why does the political leadership wants the Fed Chief to e confirmed for a second mandate? Do they fear the complete collapse of the world markets and a plunge into Financial Armageddon? Or are they making sure they’ll have the perfect bitch at their service for another number of years?

    I mean…wtf?

    1. joebhed

      Yeah, like why would our elected leaders, who are completely ignorant of their own power to turn things around, fearful of a global financial collapse from not appointing the guy who threatened to bring the whole thing down if we dared take a publicly-spirited peek behind the bankers’ curtain?
      So,my answer is political ignorance and successful intellectual engineering in economics.

  8. Hugh

    What makes this interesting is that the WaPo is a Villager rag filled with what passes for the capital’s conventional wisdom (CW). Occasionally, the WaPo still commits the random act of journalism, but coming on the heels of Republican criticisms of him during his confirmation hearings, this looks like a hit piece, albeit a well deserved one. Like Mark Twain said about history, our elites are not monolithic but they do rhyme. Bernanke has been a soldier of the corporacy. But he has never embraced winger rhetoric and ideology. Nor does he have a natural political constituency. This makes him both conveniently blamable and expendable. While generally anathema, the WaPo will still use facts and solid writing when it serves a higher purpose, like sticking a shiv in someone who was never quite a Villager. This is likely what we are seeing here.

  9. NYT

    I don’t think the piece indicates that Bernanke is expendable. The WSJ piece shows that Bair is losing the turf war, in spite of, or because of her agency’s relative success .
    Now Geithner wants to give away most of her responsibilities to Bernanke so she is fighting back.
    I don’t think Bair is likely to win this one.

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