WaPo Shreds Fed’s Pre-Crisis Performance as Regulator

WaPo Shreds Fed’s Pre-Crisis Performance as Regulator

Posted: 20 Dec 2009 11:18 PM PST

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.

http://www.washingtonpost.com/wp-dyn/content/article/2009/12/20/AR2009122002580.html?hpid=topnews

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