FDIC’s Bair: ‘Playbook’ Needed for Failure of Investment Banks

The Federal Deposit Insurance Corp.’s Sheila Bair seems likely to have ruffled at least a few feathers on Wall Street Wednesday, by suggesting that financial regulators need to develop a “playbook” for handling investment bank failures akin to the systematic approach used by the FDIC. She also argued for a single regulator over investment banks, without go so far as to overtly suggest that the FDIC should have regulatory responsibility for the Wall Street behemoths.

“It makes sense to extend some form of greater prudential regulation to investment banks as well as a process or protocol for dealing with a systemically significant investment bank approaching failure,” Bair said in remarks to the the Exchequer Club in Washington.

“The government cannot be put in the position of having to simply write a blank check when these institutions get into trouble.”

While she stressed that her remarks weren’t meant as a criticism of the Federal Reserve, Bair’s remarks clearly zeroed in on the Fed’s bailout of Bear Stearns & Cos., which saw the U.S. government take on illiquid Bear Stearns assets valued at $30 billion.

“At a minimum, there should be greater parity between commercial banks and investment banks over how they manage risk, liquidity and capital. There should be a Prompt Corrective Action-like mechanism with mandatory triggers for supervisory intervention and, if necessary, closure if capital is not restored,” she said.

The Bear Stearns failure underscored Bair’s belief that the belief of “too big to fail” in the investment banking sector has evolved. While she has stressed that the failure of a large scale financial institution — commercial or investment bank — is unlikely, the FDIC chairman is no longer seeing such possible failure as unthinkable.

“The FDIC plans and prepares for the possibility of such a failure–however remote–seriously,” she said. “We need to do the same for major investment banks, since they can pose systemic risks at least as severe.”

“There is a playbook for the failure of a commercial bank, even a systemically important one, but there isn’t any for the failure of an investment bank. The Fed had to invent one on the fly [in addressing Bear Stearns].”