Bair Details Inside Story of Regulatory Clash Over Basel III

WASHINGTON — Sheila Bair, former chairman of the Federal Deposit Insurance Corp., nearly succeeded in forcing the largest banks to hold at least 10% common equity capital as part of Basel III rules, but was stymied by Treasury Secretary Tim Geithner.

In her book released Tuesday, "Bull by the Horns," Bair offers new behind-the-scenes details of her aggressive push for higher capital requirements, including allegations that Geithner attempted to water down the international deal.

Following the financial crisis, there was a "strong consensus" by members of the Basel Committee on Banking Supervision that banks should hold higher capital, Bair said. But international and domestic regulators were divided about what the right level should be.

While the panel attempted to hash out an agreement, Bair said Geithner unexpectedly inserted himself into the discussions, calling a meeting in spring of 2010 to discuss the U.S. position even though Treasury was not part of the Basel Committee.

During that and further meetings, which included Federal Reserve Board Chairman Ben Bernanke and central bank Gov. Daniel Tarullo, Bair said all three regulators were "uncomfortable" with Geithner's interference

"It wasn't clear whether Tim was trying to build consensus among the U.S. regulators or trying to stir the pot," writes Bair, who had a strained relationship with the Treasury Secretary. "At each meeting, he would try to elicit our views on what the new standards should be, but he was very cagey when it came to expressing his own views."

But Geithner's presence in the talks was just one factor in a long drawn out battle over capital requirements — a fight that involved not just the FDIC, Fed and Office of the Comptroller of the Currency, but overseas supervisors.

The War Over 10%
Regulators at the time were still wrestling with exactly how much capital to require. According to its own analysis, the Basel Committee projected that a bank's common equity capital ratio should range between 7% to 11%. Fed research, meanwhile, said the ratio needed to be between 8% to 10%.

Bair — "never bashful" — pushed for 10%, including a capital conservation buffer. She pointed to FDIC analysis that showed the two weakest big banks — Citigroup and Bank of America — would be able to achieve a 10% tangible common equity ratio given enough time.

But she also supported a Fed plan that would institute an 8% requirement of all banks, but only if the Basel Committee agreed to an additional surcharge on systemically important financial institutions, or SIFIs.

Still, U.S. regulators had trouble convincing French and German officials to go along with the idea.

In part, this was due to weak leadership from the Fed, Bair said, criticizing Pat Parkinson, the central bank's lead negotiator, for not speaking up more.

"The Fed representative was supposed to be the head of the U.S. delegation, but Pat hardly ever spoke up," Bair writes. "He talked a good game when he met with us, but when it came to engaging the French and Germans during the Basel Committee discussions, he was reticent."

Similarly, Bernanke appeared reluctant to weigh in at the meetings of the Group of Governors and Heads of Supervision, a collection of the principals of international regulators, in part because of his status.

"As the head of the world's largest central bank, he didn't want to get down into the fray, which I understood," Bair writes.

Dudley and Tarullo, meanwhile, also "spoke with frustrating rarity."

"I didn't know if they were just intimated by mixing it up with the French and Germans or whether I was being gamed and they didn't really want reform," writes Bair.

But Bair found an unlikely ally in Mervyn King, the head of the Bank of England, and Adair Turner, who headed financial services regulation at the bank.

"Together they were quite a 'dynamic duo' in advocating for higher capital requirements," she said.

They were also joined by Philipp Hildebrand, a career banker who headed the Swiss National Bank.

"Between the U.K. and Swiss delegations, most of the arguments that needed to be said were said. I just wish more of them had come from the U.S. delegation," Bair writes.

In part to prompt Tarullo to speak out more, Bair said she decided to play "a little game" with the governor and former academic. Saying he was known to have a "bit of an ego" and that he "didn't like hearing me take an active role in some of the discussions," Bair said she would gesture to hit a small button on the microphone to signal she wanted to talk any time the French or Germans made an "outrageous argument."

Tarullo, she said, would "catch me out of the corner of his eye and almost always jump first."

Geithner Power Play
Although the financial industry was opposed to the 8% threshold, U.S. regulators entered the September 2010 meeting committed to the idea, although they were willing to fall back to 7% if a capital surcharge would win support from other international regulators, including the Germans.

"I told the Fed I could live with the 7% only if there were a firm, public, written commitment from the GHOS that we would also develop and impose a higher surcharge on the SIFIs," wrote Bair.

Although the Fed was in agreement, Geithner had other plans. He wanted the U.S. delegation to hold out for an 8% threshold, even if it meant failing to reach an agreement with foreign counterparts. Geithner personally called Bair and Bernanke to convince them.

Bair was surprised by Geithner's position, as it appeared to conflict with his earlier push for a lower capital ratio. "I was perplexed and not sure what Tim's true agenda was," writes Bair. "In late July, he had seemed to be moving toward weaker standards."

Only a month prior to the international meeting, Geithner had been shooting for a 6% capital ratio and putting pressure on Bair to concede.

He had "lobbied me intensely on lower numbers for the Basel III calibration, knowing full well that our healthy banks will be just fine with a high numbers, but of course Citi and BofA will get killed," Bair wrote in a memo after an Aug. 6 meeting with Geithner, which is cited in the book. "Why do we keep making banking policy to accommodate weak institutions? Keep hoping our relationship will improve, but this was a new low."

Ultimately, Bair sees the entire episode as a power play by Geithner. She argues he was trying to blow up the meeting between international regulators so that the issue would be kicked higher to the Group of 20 finance ministers who were set to meet in November. If the G-20 took over negotiations, Geithner would be leading the U.S., not Bernanke. The FDIC would have little say in the final number.

If so, the plan didn't work. Regulators ultimately agreed to the 7% ratio, although international regulators were "squishy" on the size of the surcharge that would be applied to SIFIs. Bair and the Fed issued their own statement "strongly committing" to even higher capital standards for the largest institutions, even though the OCC's John Walsh, now the acting comptroller, was concerned about the size of the surcharge.

"For once, Tarullo, Dudley, and I were all on the same page with a clear statement on higher capital requirements for SIFIs, while Walsh kept trying to soften it," said Bair.

The SIFI Surcharge
The battle wasn't over just yet. Knowing she would be stepping down in June 2011, Bair wanted to see the surcharge finalized before she left. Yet the decision over the issue had been handed to the Financial Stability Board — a group Bair viewed as an "unwieldy bureaucracy."

Bair called Stefan Walter, who led the Basel Committee's technical staff, in the hopes of moving the decision back to that panel.

"I openly confessed to him that once I was gone, I did not know how resolute the U.S. delegation would be on a surcharge," writes Bair.

She had "growing confidence" in Tarullo, who had proven himself to be a "capital hawk," but she wasn't as sure about Dudley and some of the Fed staff. She also suspected that Geithner might be "working behind the scenes to water down the surcharge."

Although the Basel Committee reclaimed the negotiations over the issue, Bair's suspicions were borne out when Walsh announced unexpectedly he would support a SIFI surcharge with a maximum of 1% — far away from the 3% surcharge that was needed to get to the 10% the FDIC was pushing for. Walsh even took it upon himself to send a letter to the Basel Committee endorsing the 1%.

"The Fed went ballistic, as did we. He was purposefully trying to undermine our negotiating position," wrote Bair.

She suspected that — once again — Geithner was behind it all.

"It didn't make sense that Walsh would go so far out on a limb without some encouragement from Tim, his patron," she writes.

Tarullo would later confirm that Treasury's position had been to support a maximum of 1.5%. It was yet another example of Bair not being privy to certain discussions. It was now her turn to go "ballistic."

"Why weren't we in the loop?" she asked Tarullo at the time. "There should have been a principal levels discussion. We insure these banks. I'm sick and tired of being kept out of key decisions after everything that we have been through."

At the June 2011 meeting, it was Walsh and the Germans against 26 other countries. Bair whispered to Walsh that the "Germans were using him to block any agreement."

Walsh finally bent, comparing the situation, as Bair writes, to "Custer's last stand… It was time to surrender." The OCC could live with a 2.5% capital surcharge.

While the U.S. hadn't succeeded in winning the 10% it had hoped for, it was close. The largest and riskiest banks would face a capital requirement of 9.5%.

"We had won," wrote Bair, "And that 9.5% percent capital requirement was a good going-away present."