After noting that the Fed did not see the crisis coming and that the Fed has actively contributed to the severity of the existing crisis Buiter notes:
The Fed has been actively contributing to the next crisis Here indeed the Fed stands guilty as charged, although it is in good company. The Fed, through its lender of last resort and market maker of last resort actions and through a wide range of quasi-fiscal support operations it has undertaken on behalf of Wall Street and other segments of the US financial establishment (Fannie & Freddie, AIG), has made a major contribution to the creation of the biggest moral hazard machine ever seen in human history. Probably the single most damaging failure of the US Treasury, the US Congress and the US financial regulators was there inability/unwillingness to create a special resolution regime (SRR) with structured early intervention and prompt corrective action for all systemically important financial institutions (those too big, too complex, to interconnected, too international or too politically connected to fail in the ordinary Chapter 11 or Chapter 7 way). An SRR is an `insolvency lite' insolvency regime for banks and ohter systemically important financial institutions. If early interventions fail, a bank that is judged (by a duly appointed administrator of the SRR, e.g. in the FDIC in the case of insured deposit taking banks) to be at risk of becoming conventionally insolvent is instead rushed into a high-speed regulatory insolvency regime, the SRR. There its balance sheet is restructured (typically existing equity is wiped out or diluted and unsecured creditors are turned into new equity holders). The Administrator or Conservator has near-absolute powers to dispose of assets and to restructure liabilities. Existing management, board and shareholders are disenfranchised for the duration of the institutions sojourn in the SRR. The purpose of an SRR is that it wipes out a failing systemically important institution in a legal sense (by abrogating the property rights of shareholders, unsecured debt holders, mangement and board of directors) without wiping it out in the Army Corps of Engineers sense. The bank (or insurance company) as a functioning organisation remains largely intact, and can continue to service existing contracts and commitments (at the discretion of the Adminstrator or Conservator of the SRR) and, most importantly, can engage in new lending, investment and funding activities, possibly with government support, including guarantees, for these new activity flows. When the crisis started, an SRR existed for federally insured deposit-taking banks (administered by the FDIC), although the authorities did not have the nerve to put the largest insolvent institutions (such as Citi Group and Bank of America in it). That SRR also did not apply to banking groups. There was an SRR for Fannie and Freddie, which was used effectively. There was no SRR for investment banks. There was no SRR for insurance companies like AIG. The non-existence of an SRR for any systemically important institution amounts to a major policy failure of the executive and legistative branches of government. The deafening silence of the Fed and the other regulators on the subject is a serious indictment of their competence. After Bear Stearns went belly-up and was pushed into the terminal embrace of JP Morgan, it should have been clear even to the US authorities that either investment banks needed an SRR or that there ought to be no investment banks. Yet we had to wait for the failure of Lehman and the forced acquisition of Merrill Lynch by Bank of America before the last two remaining large independent Wall Street investment banks, Goldman Sachs and Morgan Stanley, were ejected from the investment bank category and became bank holding companies. This was not required to give them access to the Fed's discount window and other facilities. If the Fed declares "unusual and exigent circumstances" to prevail, it can lend, against collateral of the Fed's choosing, to individuals, partnerships and corporations (including non-financial corporations) , should it wish to. It did, however, make it possible for these former investment banks to be put into an SRR. If institutions are too systemically important to fail conventionally and if no SRR is available, they will have to bailed out at public expense should an emergency arise. The regulators knew that. The Treasury knew that. The Congress knew that. The banks knew that and their unsecured creditors knew that. They permitted it to happen nevertheless.
Here indeed the Fed stands guilty as charged, although it is in good company. The Fed, through its lender of last resort and market maker of last resort actions and through a wide range of quasi-fiscal support operations it has undertaken on behalf of Wall Street and other segments of the US financial establishment (Fannie & Freddie, AIG), has made a major contribution to the creation of the biggest moral hazard machine ever seen in human history.
Probably the single most damaging failure of the US Treasury, the US Congress and the US financial regulators was there inability/unwillingness to create a special resolution regime (SRR) with structured early intervention and prompt corrective action for all systemically important financial institutions (those too big, too complex, to interconnected, too international or too politically connected to fail in the ordinary Chapter 11 or Chapter 7 way). An SRR is an `insolvency lite' insolvency regime for banks and ohter systemically important financial institutions. If early interventions fail, a bank that is judged (by a duly appointed administrator of the SRR, e.g. in the FDIC in the case of insured deposit taking banks) to be at risk of becoming conventionally insolvent is instead rushed into a high-speed regulatory insolvency regime, the SRR. There its balance sheet is restructured (typically existing equity is wiped out or diluted and unsecured creditors are turned into new equity holders). The Administrator or Conservator has near-absolute powers to dispose of assets and to restructure liabilities. Existing management, board and shareholders are disenfranchised for the duration of the institutions sojourn in the SRR. The purpose of an SRR is that it wipes out a failing systemically important institution in a legal sense (by abrogating the property rights of shareholders, unsecured debt holders, mangement and board of directors) without wiping it out in the Army Corps of Engineers sense. The bank (or insurance company) as a functioning organisation remains largely intact, and can continue to service existing contracts and commitments (at the discretion of the Adminstrator or Conservator of the SRR) and, most importantly, can engage in new lending, investment and funding activities, possibly with government support, including guarantees, for these new activity flows.
When the crisis started, an SRR existed for federally insured deposit-taking banks (administered by the FDIC), although the authorities did not have the nerve to put the largest insolvent institutions (such as Citi Group and Bank of America in it). That SRR also did not apply to banking groups. There was an SRR for Fannie and Freddie, which was used effectively. There was no SRR for investment banks. There was no SRR for insurance companies like AIG.
The non-existence of an SRR for any systemically important institution amounts to a major policy failure of the executive and legistative branches of government. The deafening silence of the Fed and the other regulators on the subject is a serious indictment of their competence. After Bear Stearns went belly-up and was pushed into the terminal embrace of JP Morgan, it should have been clear even to the US authorities that either investment banks needed an SRR or that there ought to be no investment banks. Yet we had to wait for the failure of Lehman and the forced acquisition of Merrill Lynch by Bank of America before the last two remaining large independent Wall Street investment banks, Goldman Sachs and Morgan Stanley, were ejected from the investment bank category and became bank holding companies. This was not required to give them access to the Fed's discount window and other facilities. If the Fed declares "unusual and exigent circumstances" to prevail, it can lend, against collateral of the Fed's choosing, to individuals, partnerships and corporations (including non-financial corporations) , should it wish to. It did, however, make it possible for these former investment banks to be put into an SRR.
If institutions are too systemically important to fail conventionally and if no SRR is available, they will have to bailed out at public expense should an emergency arise. The regulators knew that. The Treasury knew that. The Congress knew that. The banks knew that and their unsecured creditors knew that. They permitted it to happen nevertheless.
So this is the candidate put forward by the Obama Administration as the "Systemic Risk Regulator." They would be better off recommending Tommy. At least he played a mean pin ball. As the Dutch said while fighting the Spanish: "It is not necessary to have hope in order to persevere."
These links contain useful information for the customers and vendors of these closed banks. Temecula Valley Bank, Temecula, CA Vineyard Bank, Rancho Cucamonga, CA BankFirst, Sioux Falls, SD First Piedmont Bank, Winder, GA [...] VIII. Priority of Claims In accordance with Federal law, allowed claims will be paid, after administrative expenses, in the following order of priority: Depositors General Unsecured Creditors Subordinated Debt Stockholders
Temecula Valley Bank, Temecula, CA Vineyard Bank, Rancho Cucamonga, CA BankFirst, Sioux Falls, SD First Piedmont Bank, Winder, GA
[...]
VIII. Priority of Claims In accordance with Federal law, allowed claims will be paid, after administrative expenses, in the following order of priority:
Precisely, the reverse priority of settlement provided IB/brokerages by TARP guarantees.
Depositors' Protection | Bloomberg | 18 July 2009
Zions Bancorporation's California Bank & Trust unit acquired the deposits of Vineyard Bank, one of four lenders seized yesterday by regulators. The failures will cost the Federal Deposit Insurance Corp. a total of $1.09 billion. California Bank & Trust in San Diego said it assumed $1.5 billion in deposits and $1.4 billion in loans from Rancho Cucamonga, California-based Vineyard, which lost more than $100 million last year as builders defaulted on construction loans. Vineyard was closed by the Office of the Comptroller of the Currency [OCC] and the FDIC was named receiver, the FDIC said in a statement. The FDIC entered a loss-sharing transaction with California Bank & Trust on the acquired assets. The regulator will also share losses on $1.3 billion of assets related to the seizure yesterday of Temecula Valley Bank in Temecula, California, which was shuttered by the state's regulator.... The failures of Vineyard and Temecula Valley bring to eight the number of banks closed in California this year. Zions, a Salt Lake City, Utah-based lender with bank operations in 10 Western states, purchased four failed banks in the past year in California and Nevada. ...
California Bank & Trust in San Diego said it assumed $1.5 billion in deposits and $1.4 billion in loans from Rancho Cucamonga, California-based Vineyard, which lost more than $100 million last year as builders defaulted on construction loans. Vineyard was closed by the Office of the Comptroller of the Currency [OCC] and the FDIC was named receiver, the FDIC said in a statement. The FDIC entered a loss-sharing transaction with California Bank & Trust on the acquired assets. The regulator will also share losses on $1.3 billion of assets related to the seizure yesterday of Temecula Valley Bank in Temecula, California, which was shuttered by the state's regulator....
The failures of Vineyard and Temecula Valley bring to eight the number of banks closed in California this year. Zions, a Salt Lake City, Utah-based lender with bank operations in 10 Western states, purchased four failed banks in the past year in California and Nevada. ...
