The feds' hypocrisy about J.P. Morgan's takeover of Bear Stearns will make
other banks wary in the next crisis.
In what can only be described as a stunning revelation, the current head of the Federal Deposit Insurance Corp., Martin Gruenberg, said in a speech on Oct. 13, 2013 that "prior to the recent crisis, the major national authorities here and abroad did not envision that these large, systemically important financial institutions (SIFIs) could fail, and thus little thought was devoted to their resolution."
That statement, with its astonishing lack of historical perspective, should be kept in mind when considering the news that emerged over the weekend of a deal in the works for J.P. Morgan Chase to pay a staggering $13 billion penalty to resolve various civil investigations into its conduct over the past several years. A sizeable part of the settlement reportedly would involve penalizing J.P. Morgan Chase for the actions of Bear Stearns—a failing bank that the government persuaded J.P. Morgan to take over in 2008—in the mortgage-backed securities business. Such a penalty would set a terrible precedent and send a dangerous signal to the financial system.
What makes Mr. Gruenberg's statement so surprising?
First, problems with big banks are not new. Six of the top 50 banks in the country in 1980 failed during the banking crisis of the 1980s and early 1990s. At least another 11 of the top 50 banks experienced high-profile problems that eventually led to their sale.
In his 1986 book, "Bailout”, former FDIC Chairman Irvine Sprague identified Continental Bank as "too big to fail," writing that "scores of large and small institutions—perhaps hundreds—would have been in serious jeopardy if Continental could not have met its commitments."
Second, the FDIC has had a long-standing practice of turning to strong, bigger banks to step in when their weaker, smaller sisters failed or hemorrhaged capital. Sprague described the need to find "well-managed" banks "approximately twice as large as the bank to be acquired." As big banks failed, even bigger banks were needed to step in and run the failed bank.
Bank of America, where I once worked, played a significant role in stabilizing the banking system when it acquired two large failed Texas banks in 1988. Over the next seven years, it acquired other banks on the brink of failure. In all cases—and at risk to its own shareholders—Bank of America took immediate action to infuse capital and management into these other ailing institutions.
What Bank of America did in 1988 was no different from what Wells Fargo and J.P. Morgan Chase did 20 years later. At the height of the most recent financial crisis, federal bank supervisors asked them to buy Wachovia, Washington Mutual and Bear Stearns. Largely because of these transactions, by year-end 2008 Wells's assets had grown 127% over the prior year while J.P. Morgan Chase's grew 39%.
The third point to be kept in mind about the FDIC chairman's assertion: Thirty of what were the 50 largest banks in the country in 1980 are now part of Bank of America, Wells Fargo and J.P. Morgan Chase. These three banks are large in part because of their willingness and consistent ability to help bank supervisors calm local and global financial markets—to become part of the solution when the financial system was in danger.
Fourth, and most important: If it is true that J.P. Morgan Chase must pay penalties for mistakes made by Bear Stearns—a firm that Washington encouraged them to take over—then it is likely federal policy makers have actually increased systemic risk to the financial system. In a country that has seen 3,000 banks fail over the past 30 years and more than 12,000 over the past century, it is not difficult to imagine future bank failures.
The FDIC chairman said "little thought was given" to resolving the big-bank crisis, and now equally little thought seems to have been given to the pursuit of J.P. Morgan Chase over Bear Stearns. Once the government proves itself to be an unreliable "partner" in resolving failed institutions, it will find fewer banks willing to step in next time there is systemic risk to the banking system.
Written by Richard J. Parsons
This post originally appeared in the Wall Street Journal on Oct. 20, 2013.