One of the biggest dangers to the banking system is the way the Federal Reserve is designating some banks as “too big to fail” (or systemically important), says Paul Singer.
The FDIC’s new system several factors to judge a bank’s “systemic” (bailout-ability) status that are willy nilly, according to the hedge fund manager of $17 billion Elliot Management.
In a huge interview in the Wall Street Journal this weekend, Singer criticised the way the Fed invites banks to be a member of the “systemically important” club, saying it’s “determined by bureaucratic whim.”
How can you tell if you’re in the club? It’s like poker. If you can’t tell who the sucker at the table is…
“You don’t know how you will be treated,” he says of financial institutions under the new FDIC regime.
“If there are companies that are also counterparties alongside you but they’ve been designated systemically important, that’s a clue. It’s like a game of treasure hunt. It’s a clue that you’re going to get disadvantaged compared to them.”
Sound like high school? Wait until you see how rumours affect the FDIC’s policy.
The speed at which a firm will collapse as word gets around that it might be headed to FDIC resolution could be “amazing,” says Mr. Singer.
And that “speed will drive the size of the losses.”
And how banks could be “in” one day, “out” the next.
The problem, in Mr. Singer’s view, will be the jarring shift from one day being an investor in a member of the “systemically important” club, to the next day being a creditor whose claim is determined by bureaucratic whim.
Obviously, the big banks are the ones that get the special treatment.
“Small and medium-sized financial institutions may be disadvantaged, may be sacrificed in the next crisis to protect these behemoths,” he says.
Making the FDIC’s new system sound as immature as high school is probably to Singer’s advantage. He invests in distressed debt, and he’s not invested in any big bank assets but Lehman’s. So the smaller and mid size banks he says are getting disadvantaged are likely the ones he has a stake in seeing do well.
His suggestions on how to improve the system? Vagueries about “creating reasonable levels of leverage.”
This “atmosphere of unpredictability” is harmful to America’s place in the financial world, he says, and “it doesn’t make the system any safer. . . . This is nuts to be identifying systemically important institutions.“
“[It’s a poor] substitute for creating soundness and reasonable levels of leverage throughout the system.”
The Federal Reserve of course seems to believe that the assurance of a bailout for banks that are systemically important is essential to the continued recovery. So it must find some way to determine which banks are systemically important.