Book Review: "Bull by the Horns" by Sheila Bair

Sheila Bair’s book, Bull by the Horns: Fighting to Save Main Street from Wall Street and Wall Street from Itself, recounts her view of the financial crisis from her perspective as chairman of the FDIC during and in the aftermath of the crisis. For those interested in the bureaucratic political and policy disputes, this book provides a trove of information. It should not, though, be read in isolation. There are other books which provide different perspectives, such as former Secretary of the Treasury Henry Paulson’s well written book, On the Brink: Inside the Race to Stop the Collapse of the Global Financial System. 

The most notable aspect of the book is the portrayal of former Treasury Secretary Tim Geithner, which is savage. It is clear that these two do not like each other. Geithner apparently plans to write his own book. We’ll see what he has to say about his disagreements with Bair, if anything.

As way of background, I first met Sheila Bair when she was a commissioner of the Commodity Futures Trading Commission (“CFTC”). I was then an office director in the Domestic Finance section of the Treasury Department. I was impressed with her knowledge of the details of various issues. She eventually became the acting chairman of the CFTC. The meetings we had with her at Treasury on various issues involving the CFTC were always cordial. In particular, on one occasion, I was impressed with her diplomatic skills when discussing futures markets with a new high level Treasury political appointee whose knowledge of the mechanics of futures markets at the time appeared to be limited.

In the George W. Bush Administration, Sheila Bair was appointed Treasury Assistant Secretary for Financial Institutions. I did not report to her but to another Assistant Secretary (Financial Markets). There were some disagreements between my boss and Bair on issues in which I was involved (I forget the details), but, as I recall, they were amicably resolved.

While I was at Treasury, I saw a somewhat different side of her. She could be quite tenacious when she thought she was right.  I am consequently not surprised that, when she was head of the FDIC, others did not view her as a team player. Bair knows that this is how some people perceive her, and on more than one occasion in her book, she makes a statement to the effect that she did something in an effort to be a team player or a good soldier. 

Sheila Bair is a bit of an odd duck for a Republican policy official. She is hardly adverse to financial regulation if she believes it is necessary and is an advocate for strong consumer protection measures. One Republican policy official once remarked to me that discussing policy issues with Sheila Bair was like talking to a liberal Democrat. In fact, on some regulatory issues, she was more pro regulation than some of her Treasury Department predecessors in the Clinton Administration. (This now may not be that surprising to some liberals who make sport of attacking former Secretary of the Treasury Robert Rubin. Readers of this blog know that I think some of the criticisms of Rubin are not based on a full knowledge of the complexity of some issues.)

It was somewhat strange that the George W. Bush nominated her for two significant policy positions – Treasury Assistant Secretary and FDIC Chairman. Her replacement at Treasury was Wayne Abernathy, who had previously worked for Senator Phil Gramm. He was about as anti-regulatory as one could be and still be confirmable by the Senate. His ideology was immediately apparent upon entering his office. He had a sign which read: “Who is John Galt?” (For those who don’t know, this is a reference to Ayn Rand’s Atlas Shrugged.) Given the vast difference between Bair and Abernathy on regulatory issues, it left me wondering why the Bush Administration would nominate two such different people. As is sometimes remarked, personnel choices are policy.

While Sheila Bair obviously is not a good fit with the dominant factions of today’s Republican party, a hint of why she is a Republican can be found at the end of the book where she argues that the current budget deficits are “a source of systemic risk” (p. 353). She provides little in the way of analysis. She does contend that once there are some attractive alternatives to Treasury securities, investors will lose their appetite for Treasuries and interest rates will “skyrocket.”  She treats this as self-evident, though the dangers of the current fiscal situation are highly debatable. There is an argument that the stimulus was too small and withdrawn too soon, and there are prominent economists who disagree with her about the dangers of the current deficits, though some share her concern about the long-term outlook. Be that as it may, her thinking is in line with current Republican orthodoxy on this issue and with the opinions of some Democrats.   

For a press account of what motivates her, Bair points readers to a New Yorker article by Ryan Lizza, “The Contrarian: Sheila Bair and the White House Financial Debate.”  She writes: “I felt that Lizza ‘got me’…” (p. 306). The article, which I highly recommend to those curious about Sheila Bair, indicates that she aligns herself with the “trust-busting” Republican president, Teddy Roosevelt. Left unmentioned is that there was a schism in the Republican Party after his presidency, and Roosevelt, along with others, created the Progressive or “Bull Moose” party. Many former adherents of this party eventually became part of Franklin Roosevelt’s New Deal Democratic coalition.

One of the issues which Sheila Bair discusses but needs to think about more is the problem of regulatory capture. To be fair, this is an incredibly difficult issue, and no one really has any good answers. She is, though, somewhat inconsistent in her discussion of the proper regulatory structure to deal with this.

On the one hand, she argues that a single financial regulator for all banks would in effect be just a larger Office of the Comptroller of the Currency (“OCC”) and would be captured in the same way as she contends the OCC has been. This is the reason she says she opposed Senator Dodd’s proposal for a single bank regulator during the legislative process that led to the enactment of the Dodd-Frank legislation. 

On the other hand, at the end of the book, Bair proposes that the OCC be abolished and bank regulation be consolidated in the FDIC and that bank holding company regulation be the responsibility of the Fed. If this were to happen, which is unlikely, it would significantly transform the FDIC.  Existing staff of the OCC, including those current OCC staff that previously worked for the now-defunct Office of Thrift Supervision, would end up working for the FDIC. The FDIC would then be the primary federal agency responsible for the supervision of all the banks in the U.S. including the largest. This would radically change the agency’s focus on a day-to-day basis. The banks with their lobbyists would then try to capture the new agency intellectually. It is not clear why Bair is in favor of this but was against Dodd’s proposal. After all, putting the name FDIC on what effectively would be a new agency does not by itself guard against regulatory capture.

Moreover, Bair does not discuss the pros and cons of merging the current mission of the FDIC of insuring bank deposits and resolving failed institutions with greatly enhanced supervisory responsibilities. One could argue, as she does in other places, that the FDIC’s focus on insurance made it more conservative about banks taking on leverage and risk than the other regulators, and, without the FDIC at the table, things might have been worse.

There is, in fact, a good case that the current U.S. financial regulatory structure should be simplified. It is the result of historical events and not a rational design. On one particular regulatory structure issue, the nonsensical division of responsibilities for various derivative markets between the SEC and the CFTC, many agree, as do I, with Bair. At a minimum, the two agencies should be merged, though this is unlikely any time soon for political reasons.

As for the banking regulators, along with the regulators for government-sponsored enterprises, I would argue that there are way too many of them. Many people agree with Bair that the OCC is too sympathetic to the concerns of big banks, and, if it can, acts as an advocate for them. That does not mean, though, that a single regulator would be captured and weak, as Bair argues in dismissing Senator Dodd’s proposal. In fact, one could make the opposite argument that competition between the Federal Reserve and the OCC for banks leads to a certain laxness in regulation. In the case of the OCC, there is an obvious additional conflict that it relies on fee income for its budget, not appropriated funds. If it loses a bank to another regulator, it has less money to spend.

There are, however, other factors at play. The U.K. consolidated its multiple regulators into the Financial Services Authority (“FSA”).  The performance of the FSA leading up to the financial crisis was not better than that of U.S. regulators. Many observers did not see this, though. In fact, prior to the financial crisis hitting in full force, Secretary Paulson was trying to import its “light-touch,” “principles-based” regulation to the U.S., because he felt that stricter regulation was hurting New York in favor of London. Once the financial crisis hit, that idea of course had to be dropped.

Both the U.S. fractionated financial regulatory structure and the U.K.’s unified regulator failed in the years leading up to the financial crisis. The David Cameron government has been restructuring financial regulation in the U.K., and the FSA is in the process of being abolished.

In the U.S., unfortunately, barring another financial crisis, nothing is likely to happen legislatively anytime soon to restructure the U.S. regulatory system. Dodd-Frank was a missed opportunity. The financial regulators will have to work together to make the current unwieldy system work.

More thought needs to be given to the problem of regulatory capture. Regulatory capture not only involves the implicit promise of jobs in the private sector; it can also be intellectual and social. Regulators by necessity have to rely on information about business and market practices and developments from the institutions they regulate but have to be discerning enough to know when information is provided in a self-serving and selective fashion. This is not easy. There are outside groups who do research on regulatory issues and lobby on them from a pro-regulatory perspective. While I am sympathetic with the motivations of such groups, their knowledge about the details of the financial industry is of course inferior to that of the participants, and it is also sometimes presented in a selective and biased way.

As for Sheila Bair, she obviously was a very capable leader of the FDIC and led it through an incredibly difficult and challenging period. She has been a dedicated public servant, and we are all the better for it. Her main criticism of Tim Geithner is that he was too inclined to favor large financial institutions is not unique to her, and it is a legitimate point. Her ideas on forcing the restructuring the largest financial institutions into a manageable number of distinct subsidiaries should be considered by current government officials, senior bank officials, and others.    

Now that she is out of government, perhaps she will have the time to give more thought to regulatory structure and ways to mitigate the problem of regulatory capture.  After all, the regulatory failure that contributed to the financial crisis was not primarily the result of a lack of regulatory authority but the failure of regulatory agencies – and with respect to mortgage lending practices, the refusal of the Federal Reserve – to use existing authority. In the case of derivatives, while Bair contends that the regulatory problem was that the Commodity Futures Modernization Act of 2000 prohibited the CFTC and the SEC to regulate over the counter contracts such as credit default swaps (“CDS”), the financial regulatory agencies did have authority over many of the financial institutions who made markets in these instruments and could have taken action.  For example, does anyone think that some of the activities of financial institutions with respect to CDS and synthetic collateralized debt obligations were safe and sound banking practices?  And why did the banking regulators not notice the buildup of risk at AIG, since it was in effect acting as an insurance company for commercial and investment banks they regulated or supervised?

Bull by the Horns is worth reading for those interested in financial regulatory issues. It gives the perspective of one major participant in developing the government’s response to the financial crisis. While there are somewhat more passages that are sharply critical of her colleagues than I would have expected, I should warn though that this does not make the book a page-turner. The book does not assume that readers have a lot of knowledge about the subjects covered, but it will probably be primarily of interest mainly to those who have studied and thought about these issues.

A Brief Remark about the State of the Union Address

This is a small point, but one thing I noticed about the State of the Union address  which has not seemed to have received much, if any comment, is President Obama's statement: “Together, we have cleared away the rubble of crisis, and can say with renewed confidence that the state of our union is stronger." Usually, presidents say that the state of the union is strong.

I am sure that President Obama and his speechwriters and advisors chose this phrasing deliberately. There is a difference between saying that the state of the union is strong and saying that it is stronger than it was.

The most pessimistic assessment of the state of the union by a president that I can recall is in President Ford's 1975 State of the Union address. He said then:

“Today, that freshman Member from Michigan stands where Mr. Truman stood, and I must say to you that the state of the Union is not good: Millions of Americans are out of work. Recession and inflation are eroding the money of millions more. Prices are too high, and sales are too slow. This year's Federal deficit will be about $30 billion; next year's probably $45 billion. The national debt will rise to over $500 billion. Our plant capacity and productivity are not increasing fast enough. We depend on others for essential energy. Some people question their Government's ability to make hard decisions and stick with them; they expect Washington politics as usual.”

He was being honest.