FDIC chair discusses financial malaise
“People talk about the 1930s as the greatest financial crisis, but I think it’s fair to say today that our financial system is a much larger part of our economy and more integrated with the global economy than it was back then,” Gruenberg said.
Gruenberg began by describing the context of the financial crisis, tracing the economic downturn to the mortgage crisis in 2008. Gruenberg explained that mortgage lenders were lending mortgages with low interest rates for the first two years with a sharp adjustment of 4 percent after this initial period. The assumption was that homeowners would refinance their homes at the end of the two-year period, resulting in additional profits for the lenders. However, decreasing housing prices left many homeowners unable to do so, he said.
Had it just been a mortgage crisis, Gruenberg explained, the problem would have been severe enough. Yet it was exacerbated when lenders packed mortgages into securities and sold the securities, their derivatives and the derivatives of derivatives to private institutions in the United States and abroad. Gruenberg called the situation a “house of cards” that resulted not only in homeowners losing their homes, but the failure of some of the largest systematically significant financial institutions in the United States. He cited the failure of Bear Stearns, Lehman Brothers and AIG as the “first dominos to fall.”
Gruenberg said that regulators had been trying to deal with companies on a case-by-case basis, but they realized that they needed a systemic response instead. He also pointed to the segmented responsibilities of regulators such as the U.S. Securities and Exchange Commission, Funding Information Center and FDIC.
“There was no institution entirely responsible for looking at the system across the board to identify systemic risk as opposed to risk existing in individual institutions,” Gruenberg said. The FDIC has since created the Financial Stability Oversight Council to take on such responsibilities.
The FSOC also has the authority to designate any financial corporation as a systemically important financial institution. As such, the institution is subject to full financial regulations of the Federal Reserve. Prior to the crisis, there was no meaningful credential regulation of corporations such as Bear Stearns; the companies were subject to market regulations, but exempt from routine credential examination.
Gruenberg concluded by offering an update on the current state of the FDIC and the economy. The FDIC has established the Office of Complex Financial Institutions to take a larger role in creating resolution plans for the largest systemically significant companies. Furthermore, Gruenberg said, the economy today is “better off than in 2008 or 2009.” The capital of large American institutions is stronger, and bank failures are also down. This time last year, there were 149 bank failures compared with the 90 failed institutions in 2011, he explained. Gruenberg said he expects the total bank failures this year will be under 100 this year, compared to the 157 total failures in 2010.
“The general indicators for the industry are positive,” Gruenberg said.
However, Gruenberg explained, the “big question marks are the developments in Europe.” The European situation is especially complicated because of the overlap between sovereign debt, bank exposure to that debt and the institutional arrangement of the European Union. A financial crisis in Europe would also have significant consequences for the American economy. According to Gruenberg, “This is the big issue going forward.”
Gruenberg was nominated by President Barack Obama as chairman of the FDIC in June 2011, pending Senate confirmation. Prior to his nomination, he served as vice chairman of the FDIC beginning in August 2005.
The lecture, titled “The FDIC’s Response to the Financial Crisis,” was moderated by economics professor Alan Blinder ’67 and was one in a series of talks on economic recovery co-sponsored by the Wilson School and the Julis-Rabinowitz Center for Public Policy and Finance.