Somehow This Doesn’t Surprise Me

Oh noes! Somebody (William Black) went on Bill Moyers and said that Obama is breaking the law by not nationalizing stricken banks!

Um, except that he isn’t:

Again, let me repeat.  This is a lie.

And quite a lie it is.  It is a lie on at least two levels.

First, the Prompt Corrective Action (“PCA”) law does not give the FDIC (or OCC or Federal Reserve) the ability to take over any Bank Holding Company (“BHC”).  BHC’s are regulated and governed by the Federal Reserve, pursuant to The Bank Holding Act of 1956. The PCA applies to insured depository institutions, i.e. the retail bank operation as opposed to the investment bank and bond trading desk.

Amongst the financial institutions that are thus not subject to the PCA are:

JP Morgan Chase

Citigroup

Bank of America

Wells Fargo

HSBC

Goldman Sachs

Morgan Stanley

And, of course, the PCA also does not apply to AIG, which is an insurance company and not involved in banking at all.  So, pretty much all of the really big players don’t fall under the PCA in the first place.  Their commercial banking subsidiaries very well may, but your local Bank of America branch is not at the root of this crisis.  We can seize the banking units that aren’t the problem, but we can’t seize the banking units that are the problem.  (See the UPDATE regarding the horror show that could result from plucking a retail bank out of a conglomerate like Citi).  And we won’t even get into the whole problem of international banks like Citi, CSFB, or UBS.

Second, the diary is a blatantly inaccurate because it states an impossibility.  What?  It claims that Obama is breaking the law by not nationalizing a bunch of banks, when the language of the statute explicitly gives the government considerable discretion in deciding whether to do . The PCA does not mandate that the FDIC take over any bank .

And Sheila Bair has more (h/t white widow):

While the depository institution could be resolved under existing authorities, the resolution would cause the holding company to fail and its activities would be unwound through the normal corporate bankruptcy process. Without a system that provides for the orderly resolution of activities outside of the depository institution, the failure of a systemically important holding company or non-bank financial entity will create additional instability as claims outside the depository institution become completely illiquid under the current system.

In the case of a bank holding company, the FDIC has the authority to take control of only the failing banking subsidiary, protecting the insured depositors. However, many of the essential services in other portions of the holding company are left outside of the FDIC’s control, making it difficult to operate the bank and impossible to continue funding the organization’s activities that are outside the bank. In such a situation, where the holding company structure includes many bank and non-bank subsidiaries, taking control of just the bank is not a practical solution.

If a bank holding company or non-bank financial holding company is forced into or chooses to enter bankruptcy for any reason, the following is likely to occur. In a Chapter 11 bankruptcy, there is an automatic stay on most creditor claims, with the exception of specified financial contracts (futures and options contracts and certain types of derivatives) that are subject to termination and netting provisions, creating illiquidity for the affected creditors. The consequences of a large financial firm filing for bankruptcy protection are aptly demonstrated by the Lehman Brothers experience. As a result, neither taking control of the banking subsidiary or a bankruptcy filing of the parent organization is currently a viable means of resolving a large, systemically important financial institution, such as a bank holding company. This has forced the government to improvise actions to address individual situations, making it difficult to address systemic problems in a coordinated manner and raising serious issues of fairness.

UPDATE: Geekesque has updated his diary:

UPDATE: Big Tent Democrat misapprehends, or perhaps I have failed to explain, a crucial point.

Let’s step back and take Bank of America as an example.  A great deal of its toxic garbage is concentrated not in its retail and consumer banking divisions, but in its investment banking and securities trading divisions, especially after the acquisition of Merrill Lynch.  In other words, its chartered depository bank is doing just fine and is no danger of missing capitalization requirements.  However, its other divisions are struggling under the weight of the toxic assets and could fail.  But, no one can touch those.

Or, let’s take Citi as an example.  Per Time’s excellent Justin Fox.

The first striking thing there that Citi’s U.S. banking operation just isn’t all that big: J.P. Morgan Chase has $722 billion in U.S. deposits (and $287 billion outside the country). Washington Mutual, which was not deemed by regulators to be too big too fail, had $182 billion in deposits, in the same territory as Citi’s U.S. bank.

The second is that if Citibank’s overall business breaks down along domestic/foreign lines pretty much as deposits do (which probably isn’t quite the case, but close enough), that gets you to $392 billion in assets and $365 billion in liabilities. That’s the part of Citigroup that the FDIC has the authority to take over. I bet the FDIC could handle it, at least if it gets the new $500 billion credit line it wants from Congress. But this would leave an entity (or entities) with about $1.5 trillion in assets and $1.4 trillion in liabilities to be taken over by foreign governments or fail in pretty much the same unruly manner that Lehman Brothers did.

To repeat: Citigroup has liabilities of $1.797 trillion. The deposits that the FDIC has some responsibility for (up to $250,000 per depositor) add up to $241 billion. So we have this reasonably sensible system for winding down troubled banks, but when it comes to the most troubled big banking company in the country, said system only covers a fraction of the overall operation. Which leads to a couple of conclusions:

1. I get why the administration is so reluctant to take over Citi completely.

1. I don’t get why we all (I’m including myself in this) thought it was okay to allow the creation and growth of gigantic financial companies for which we had absolutely no plan for winding down in case of trouble.

This is all getting lost in the shrieking, I’m afraid.