Friday, February 19, 2010

President, Congress, Treasury and Fed Fail to Learn Lessons of Crisis

John Hussman has a great piece (dated 1/25/2010) which he titles "A Blueprint for Financial Reform". The first item on the agenda is as follows:

"1) Immediately vest the FDIC (or other regulator that has a strict consumer-protection mandate) with the authority to take receivership / conservatorship of distressed bank and non-bank financial institutions, including bank holding companies, in the event of insolvency.

It is essential for the public and policymakers to understand that the "failure" of a financial institution does not generally imply losses to customers or counterparties, but only to its stock and bondholders. The FDIC efficiently handles scores of bank "failures" annually by taking receivership or conservatorship of the whole bank, typically selling its assets and non-bondholder liabilities as a single going concern (which can then be recapitalized), wiping out stockholder equity, and providing partial recovery to bondholders with any residual. This receivership process works.

Bank failure through the receivership process - even involving major banks - does not create economic harm or even loss to depositors. Witness the seamless and almost forgettable receivership of Washington Mutual two years ago, which was the largest bank "failure" in history. We should not be devoting public funds to bail out such failures, outside of the receivership process. What should, and must be avoided are disorganized Lehman-style failures requiring piecemeal liquidation of going entities. This distinction is crucial. The disruption created by Lehman's disorganized failure need not have occurred if the FDIC had been vested with authority to take the going concern into receivership and to provide partial recovery to bondholders with the proceeds of Lehman's intact transfer."

The original failure happened after Bear Stearns. Paulson, Geithner and Bernanke knew that a disorganized failure would cause major disruptions, yet they did not push for such resolution authority in Congress - then Lehman hit and exposed even further the need for such authority. Now congress and president are aware of the issue and have been since the Lehman failure, yet there has not been any progress on this most important front. Both parties are likely to blame the other, but at the end of the day both parties are derelict in their duty to the American people by not coming together on a narrow piece of legislation that everyone agrees is needed.

I encourage you to read the remainder of Hussman's blueprint.

Scott Dauenhauer CFP, MSFP, AIF