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Sheila Bair on Why the “Vampire Squid” is NOT Too Big To Fail

Lauren Lyster
Daily Ticker

Goldman Sachs (GS) is the latest big bank to report earnings, and the firm beat analyst expectations today. Goldman reported gains in the bank’s debt and equity underwriting for the last quarter.

Now, nowhere did Goldman tell investors that they are benefiting from an “implicit bailout guarantee.” But when it comes to the nation’s biggest banks, the notion that this guarantee exists may be one of the assumptions investors continue to make. More than five years after the financial crisis, the belief seems to persist that firms like Goldman remain “too big to fail”.

This may no longer be the case though, according to Sheila Bair, former chair of the FDIC and now senior advisor of The Pew Charitable Trusts. Bair recently penned a piece explaining that 'too big to fail' might be over, and she sat down with The Daily Ticker to talk about why.

Related: Suddenly, Things Are Going “Terribly Wrong” for the Big Banks

“There’s an explicit ban on future taxpayer bailouts in Dodd-Frank,” Bair explains. Not only that. She adds that in Dodd-Frank, “there’s a new resolution process - a government-controlled bankruptcy process - to be used to deal with these large so-called systemic institutions if they get into trouble, in a way that imposes the losses on their shareholders and creditors and protects the rest of us.”

To describe the process, Bair invokes author Matt Taibi’s description of Goldman Sachs as the Vampire Squid (maybe not the blood sucking part, but the part where it has all of these tentacles that are business offshoots). The head of the creature is the life-blood source at the top. That’s a big bank’s “holding company,” and in its new resolution plan, the FDIC can take control of it.

Some critics of ‘too big to fail’ are skeptical that this FDIC resolution would happen in reality or that it would work as it's supposed to, especially given Wall Street’s influence in Washington through lobbying and campaign contributions.

Related: ‘Too Big to Fail’: Conservatives and Liberals See Eye to Eye

But Bair isn’t moved.

She considers her message a "warning to investors and bondholders that I do think ‘too big to fail' is over."

"And if another one of these big institutions gets in trouble," she says, "I think [investors] are going to be taking losses."

As for the government's will to resolve a big bank, she says, "I believe in it, I believe in my former agency, and even if you don’t agree with me completely…I still think if you’re an investor you should understand you’re at risk.”

Related: Banks Are Not As Bad As You Think: Pettis

For non-investors, does having the framework to wind down a failing “systemically important” bank reduce the risk its failure poses to the system? Bair says yes. Here’s what would need to happen.

“Once the market becomes convinced that ‘too bit to fail’ is over, the funding costs for these very large complex institutions are going to go up,” she contends. “Some people question - including me - whether they really are economically viable if you can tease out this notion that they’re going to be bailed out, that they have this big put on the government.”

Without the belief in that government “put,” Bair figures with the market charging more money for the higher risk proposition, it’s going to create more market pressure for these big banks to downsize.

It's one reason she's spreading the message.