NEW YORK, June 30 (Reuters) - When it comes to taxpayers’ money, the chutzpah of banks knows no bounds. Take Guaranty Financial Group, a Texas savings and loan, which said in a filing last month that there was “substantial doubt” that it can continue as a going concern. Now it is calling for an unusual government lifeline.
Guaranty said in an SEC filing on Monday that it has approached the Federal Deposit Insurance Corporation over “open bank assistance,” a method by which FDIC subsidizes “too-big-to-fail” banks in order to avoid absorbing their toxic assets.
If GFG’s primary bank subsidiary, Guaranty Bank, collapses, it would be the largest bank failure so far this year. With $14.4 billion of assets and $11.7 billion of deposits, it would be a very big fish to swallow at a time when FDIC is already choking on illiquid assets received from other failed banks.
FDIC prefers to resolve failed banks via purchase and assumption transactions, whereby a healthy bank buys part of a failed bank’s balance sheet while FDIC takes the remaining assets into receivership.
Typically this is least disruptive for bank customers and it has the attendant benefit of wiping out shareholders and some creditors. What’s left of the failed bank’s franchise value accrues first to depositors and secondly to the Deposit Insurance Fund, which is ultimately backed by taxpayers. Between 1980 and 1994, 73 percent of bank failures were handled this way.
Deposit payoff transactions are a second option and made up 18 percent of bank resolutions between 1980 and 1994. Here the bank’s assets are essentially liquidated. From a market discipline perspective, this is the superior solution. Shareholders, creditors and uninsured deposits are wiped out. No moral hazard here.
A third, if rarely used option, is open-bank assistance. It is intended for larger banks whose failure poses a systemic risk or that FDIC is badly equipped to resolve. FDIC prefers to avoid this method — only 8 percent of 1980-94 resolutions were handled with OBA — because of the obvious moral hazard implications. Shareholders are largely wiped out, but uninsured depositors and general creditors are made whole.
With its SEC filing, Guaranty management now acknowledges it can’t survive its portfolio of toxic mortgage-backed securities and loans, not without OBA, an FDIC bailout as it were. Without it, the bank will no longer be able to maintain the accounting fiction that it has the “ability to hold” toxic assets to maturity, forcing it to increase estimated losses for 2008 from $444 million ($8.84 per share) to $2.2 billion ($39.92 per share).
Fortunately for taxpayers, Sheila Bair isn’t keen on bailouts (if you exclude the subsidized debt offered to banks and “nonbanks” like GE Capital, General Electric’s financial services business, through the Temporary Liquidity Guarantee Program.) She turned down BankUnited’s request for OBA last month.
Indeed, her agency is typically the last refuge of market discipline for the banking sector. Every Friday evening the FDIC forces more failed banks to meet their maker (45 seizures so far this year). This is the proper way to resolve failed financials: recapitalization whereby shareholders are wiped out and creditors are forced to absorb their share of losses. In the case of Guaranty, she needs to stick to her guns.
If only the government would impose similar recaps on the biggest busted banks — Citigroup and Bank of America for starters — we might finally achieve a solid financial foundation for sustainable economic growth.