Sheila Bair

(Chuckles.) Well, I think that if the taxpayer has taken an investment interest in a bank, the taxpayer has a right - as part owner - to protect itself. And I think bank regulators have a continuing obligation, if banks are having issues or are in need of government support, to get them to a point where they right their ship and in a position where they can eventually exit these government programs. So, to the extent that it means oversight of adequacy of management and boards, I think that’s absolutely appropriate for regulators to do.

And this is a new environment and we do need bank management and bank boards that know how to work through troubled environments, who know how to do good bread-and-butter basic bank risk management. And so those are the things we’re looking at, and I think that’s quite appropriate.

...

I don’t like to get in the position of telling people to make appointments, but I think in terms of criteria, qualifications, I think those types of standards, we have an obligation to articulate.

In response to a question about whether banks on "government life support" should be able to be in charge of their own governance.

The handling of Bear Stearns kept the institution open, preserved some shareholder value, and protected all other creditors. It also extended the federal safety net by providing discount window liquidity support and an express credit guarantee of $29 billion. In the case of Continental, the shareholders were eventually wiped out and the management was removed.

Should we view the extension as a one-time event or as permanent? In my view, it is almost impossible to go back. As Gary Stern has said, "There is no way to put the genie back in the bottle. Even if we were to announce that we're never going to lend to investment banks again, would that be credible given what we've done?"

I believe that we need a special receivership process for investment banks that is outside the bankruptcy process, just as it is for commercial banks and thrifts. The reason goes back to the public versus private interest.

The bankruptcy process focuses on protecting creditors. When the public interest is at stake, as it would be here, we need a process to protect it. This process must achieve two central goals. First, it should minimize any public loss and impose losses first on shareholders and general creditors. Second, it must allow continuation of any systemically significant operations.

As I've previously suggested, the FDIC's authority to act as receiver and to set up a bridge bank to maintain key functions and sell assets offers a good model. A temporary bridge bank allows the government to prevent a disorderly collapse by preserving systemically significant functions. It enables losses to be imposed on market players who should be at risk, such as shareholders. It also creates the possibility of multiple bidders for the bank and its assets, which can reduce losses.

The authorities that the FDIC has are a good model, but there are still many open issues...

The U.S. government should set up a bank designed to remove toxic assets from private lenders' balance sheets so they could make urgently needed loans, the head of the Federal Deposit Insurance Corp. said Friday.

Establishing an "aggregator bank" with money from the Treasury Department's Troubled Assets Relief Program, or TARP, would return the program to its original goal, FDIC Chairman Sheila Bair told CNBC.

...

"People on (Wall Street) tell me that private-equity investment is holding back now because they don't know what the tail risk is on some of these higher-risk assets," she said. "If we address that problem and perhaps even couple it with a requirement that banks selling into this facility raise some proportion of equity capital, that might be the way to go."

As reported by Dow Jones News

The intense public debate over Basel II seems like a thing of the distant past. And maybe that's understandable with everything else going on in the world. But when we emerge from this crisis, a top priority must be crafting a sound capital framework that helps avoid a repeat of past problems.

So, where do we stand? I still have grave concerns about the advanced approach. The advanced approach assumes banks' internal, quantitative risk estimates are reliable. It also assumes the loss correlations we measured during good times ... which is the backbone of the whole approach ... will hold up in the future.

To say the assumptions turned out to be wrong would be an understatement. They were way wrong in estimating risk. The Basel Committee is changing the rules in a number of areas. These will be improvements. But for most banks, they are unlikely to offset what we see as a capital-lowering bias that is essentially baked into the advanced approach.

A Moody's report in December gives some recent evidence. It looked at Basel II implementation outside the U.S. And it said that almost all the banks using advanced methodologies reported a reduction in risk weighted assets, in many cases material reductions.

So if the advanced approach says banks need less capital at the height of a global banking crisis, imagine the financial leverage it would encourage during good times.

Whatever you may think {nationalization} means, I don't see the U.S. government operating a large institution for an extended period.

In fact, based on where we stand today, I would be surprised if the FDIC had to step in as conservator or receiver of a large, systemically important institution. The regulators' Joint Statement last week restated our commitment to preserve the viability of systemically important financial institutions. This will be done through capital injections, if needed, and the supervisory process.

If more direct intervention to take over a large financial group is needed, that will present significant challenges. The main hurdle is that there's no clear process for resolving a large financial holding company with multiple affiliates. We have a process for dealing with large banks, but not financial conglomerates.

Many have pointed to the FDIC's model of resolving failed banks as a possible solution. I believe the FDIC model is tried and true...But clearly, there would be practical problems if we had to use our resolution process for a large, internationally active institution. First, we do not have authority to resolve financial holding companies. Our powers extend only to federally insured banks.

Second, there is a very real question of whether our current funding mechanism is adequate to deal with the failure of a very large institution...

Another major problem, which has received less attention, is the difficulty in handing a cross-border failure. The key question is: What you do when more than one country is regulating a piece of the institution?

To be sure, a new resolution regime is not panacea. We also need better and smarter regulation. Many of the institutions that got into trouble were already heavily regulated. We didn't do enough to constrain leverage, regulate derivatives, and most important, protect the consumer. We forgot that there is a difference between "free markets", and "free for all markets".

{Chuckles}  Well, I think that if the taxpayer has taken an investment interest in a bank, the taxpayer has a right - as part owner - to protect itself. And I think bank regulators have a continuing obligation, if banks are having issues or are in need of government support, to get them to a point where they right their ship and in a position where they can eventually exit these government programs. So, to the extent that it means oversight of adequacy of management and boards, I think that’s absolutely appropriate for regulators to do.

And this is a new environment and we do need bank management and bank boards that know how to work through troubled environments, who know how to do good bread-and-butter basic bank risk management. And so those are the things we’re looking at, and I think that’s quite appropriate.
...

I don’t like to get in the position of telling people to make appointments, but I think in terms of criteria, qualifications, I think those types of standards, we have an obligation to articulate.

In response to a question about whether banks on "government life support" can remain in charge of their own governance.

The Administration's proposal addresses the need for broader-based identification of systemic risks across the economy and improved interagency cooperation through the establishment of a new Financial Services Oversight Council. The Oversight Council described in the Administration's proposal currently lacks sufficient authority to effectively address systemic risks.

In designing the role of the Council, it will be important to preserve the longstanding principle that bank regulation and supervision are best conducted by independent agencies. Careful attention should be given to the establishment of appropriate safeguards to preserve the independence of financial regulation from political influence.

See further comments on an oversight council:
Mary Schapiro's Testimony ; Daniel Turullo's Testimony

In some cases, marking banking assets to market prices doesn't make sense. When a bank is holding a deposit, a loan or a similar banking asset for the long-term, it shouldn't have to mark them to market values that may vary widely over time. Extending MTM accounting to all banking assets takes a good approach for market-based assets, like securities, but extends it to areas where it doesn't accurately reflect the business of banking.

We don't need to deepen crises by inaccurately reporting so-called market values for loans and other banking assets. This introduces a level of pro-cyclicality that can have dire consequences when the accounting is divorced from reality. During good times, such an approach could inflate the true value of bank assets and capital strength. And during periods of market stress, losses could be exaggerated.

Moreover, given the idiosyncratic nature of the credit characteristics of individual loans, trying to determine a "market price" for many of them would be more art than science ... and of questionable utility to investors compared to cost accounting. In fact, the apparent "transparency" may be illusory because fair valuing assets and liabilities without any clear "market" prices may simply increase valuation discretion.

I would note that in a recent letter to the President, the oversight body for the International Accounting Standards Board recognizes that cost-based accounting is appropriate for certain financial instruments and that the IASB is not proposing that the loan book of banks be held at fair value.