"Why Sheila Bair Must Resign"

John Hempton is still unhappy with Sheila Bair:

Why Sheila Bair must resign, Bronte Capital: Sheila Bair is doing a fine job at one thing – modifying mortgage terms in the mortgages she has taken over – particularly those at Indy Mac. As a liberal I would be expected to applaud – but I am profoundly glad that Obama did not do as Robert Kuttner suggested and nominate Sheila Bair for the Treasury Secretary post.

Sheila Bair is simply wrong when she implies that the problem started with mortgages and therefore it will end with mortgages. The problem with mortgages is no more than a trillion dollars (say 20 percent of the mortgages in the US defaulting with a 50% loss). Indeed it is much less than a trillion. If the financial crisis were about mortgages it would be over now – what with 500 billion of capital raising, a few hundred billion chipped in elsewhere (either by the Government into AIG or Maiden Lane or by Lehman and Washington Mutual bond holders and all the Fannie and Freddie losses that will be picked up by the Feds). The financial crisis is not about mortgages – it is about trust.

The people who provide finance to financial institutions (inter-bank and otherwise) no longer believe they will get their money back – and so are no longer willing to provide finance. The unwillingness to lend to financial institutions dooms them regardless of their solvency. The crisis is about trust.

It is alarming enough that the head of the FDIC in so self serving a manner misdiagnoses the nature of the financial crisis – self serving because her institution is building up enviable expertise in modifying mortgage terms. ... But if misdiagnosis of the crisis were the end of it then there would be no pressing need for Sheila Bair to resign. It is not the end of it. Sheila Bair is an obstacle – indeed one of the principal obstacles in the way of reinstalling trust to American financial institutions.

It comes about as follows: if you accept that the problem is that people will no longer lend to financial institutions then the core thing that is required is the perception that the US Government will not arbitrarily confiscate your rights if you lend to financial institutions. On Friday I suggested that Sheila Bair might confiscate Citigroup wiping out in excess of 100 billion dollars in parent company debt. I am just a humble blogger in Australia – and my suggestion would be outrageous except that Sheila Bair through her actions on Washington Mutual and Wachovia made my suggestion plausible. She has form. She has done it before. ... Her judgment is unsound (proven) and her willingness to use powers to wipe out or compromise people who lend to financial institutions make her unsound judgment dangerous.

She just might confiscate Citigroup – because that sort of rash action is up her ally. She shoots from the hip – and Wachovia proves her aim is not true.

Anyway – this crisis will be over when people are willing to lend to American financial institutions unsecured again. And they will not lend to financial institutions when Sheila Bair is around. Her presence makes it dangerous.

A policy statement saying she will not do it again would be nice – but is implausible. Debt holders make a small amount of money when they are right – and lose a large amount when they are wrong. Sheila Bair – even if she promised not to be so rash again would not be believed.

There remains a small chance that she will again exercise her unsound judgment to compromise debt holders – and that alone is enough reason not to lend to American financial institutions.

I do not know what a complete solution to the financial crisis (other than full nationalization as per the Citigroup post) would look like – but if full nationalization is not on the agenda (and as far as I can tell it is not) then any solution to the financial crisis involves removing Sheila Bair. She is an obstacle to trust.

It is simple Sheila. Resign now. You owe it to your country.

I don't agree with his diagnosis of the fundamental problem, but the real intent here is probably policy advice - a statement of what not to do this time - as much as anything else (or can be taken in that light). [Update: Follow-up from John Hempton.]

Felix Salmon says bondholders shouldn't worry:

Who Will Take Over Citi?: ...Possibly more likely is the idea that Citigroup will be nationalized this weekend, with shareholders being wiped out. John Hempton today sketches out what might happen if bondholders got wiped out at the same time; I'm reasonably confident that in the wake of the Lehman debacle there's no way that Hank Paulson would let that happen.

In any case, with Citi shares trading at less than $4 apiece, something needs to be done. ... The market is essentially forcing the board's hand here -- not to mention that of policymakers. Citi's managed to muddle through this week. But my guess is that there will be some kind of major announcement over the weekend.

Robert Reich wonders why we are thinking of bailing out Citigroup at all given that we are, apparently, letting General Motors go under:

Why CitiGroup is About to Be Bailed Out and Not General Motors, by Robert Reich: Citigroup was once the biggest U.S. bank. General Motors was once the biggest automaker in the world. Now, both are on the brink. Yet Citigroup is likely to be rescued within days. General Motors may not be rescued at all.

Why the difference? Viewed from Wall Street, Citi is too big and important to be allowed to fail while GM is simply a big, clunky old manufacturing company that can go into chapter 11 and reorganize itself. The newly conventional wisdom on the Street is that the failure of the Treasury and the Fed to save Lehman Brothers was a grave mistake because Lehman's demise caused creditors and investors to panic, which turned the sub-prime loan mess into a financial catastrophe -- a mistake that must not occur again. But GM? GM is only jobs and communities. Citi is money....

Citigroup had a market value of $274 billion at the end of 2006. Now its value is about $21 billion. That's awful news for Citi, its executives and traders, and its investors and creditors. But it's not necessarily awful news for the economy as a whole. Even if Citigroup were to go belly up, the real economy would not be seriously harmed. The mutual funds, pension funds, and deposits overseen by Citi would be safe; fund managers would find their way to other banks.

In other words, Citigroup is not much different from General Motors. It's a company that once made lots of money but, through a series of management blunders, is now losing money hand over fist. Just like the shareholders and creditors of GM, Citi's shareholders and creditors are taking a beating.

So why save Citi and not GM? It's not clear. In fact, there may be more reason to do the reverse. GM has a far greater impact on jobs and communities. Add parts suppliers and their employees, and the number of middle-class and blue-collar jobs dependent on GM is many multiples that of Citi. And the potential social costs of GM's demise, or even major shrinkage, is much larger than Citi's -- including everything from unemployment insurance to lost tax revenues to families suddenly without health insurance to entire communities whose infrastructure and housing may become nearly worthless. I'm not arguing that GM should be bailed out; as I've noted elsewhere, GM's creditors, shareholders, executives, and workers should have to make substantial sacrifices before taxpayers should be expected to sacrifice as well.

Nonetheless, Citi is about to be bailed out while GM is allowed to languish. That's because Wall Street's self-serving view of the unique role of financial institutions is mirrored in the two agencies that run the American economy -- the Treasury and the Fed. Their job, as they see it, is to keep the financial economy "sound,"...

Because the public doesn't understand the intricacies of finance, it's easily persuaded that this is the same thing as keeping credit flowing to Main Street. That's why the public and its representatives have committed $700 billion of taxpayer money to Wall Street and another $500 to $600 billion of subsidized loans to the Street from the Fed -- bailing out the investors and creditors of every major bank, including , momentarily, Citi -- only to discover, at the end of this frantic and unbelievably expensive exercise, that American jobs and communities are more endangered than they were at the start.