John Allison

“While the regulators had a legitimate concern, the manner in which they chose to handle WaMu was even more destructive. They decided to take the extra losses created by covering the uninsured depositors from WaMu’s bondholders. The bondholders had expected significant losses on their bonds, but the losses were more than they had expected because the FDIC had taken part of the money that should have been available to pay bondholders and given it to uninsured depositors. This was in complete contradiction to past practice. The bondholders suddenly realized that there is no rule of law when government regulators are involved. In other words, the regulators can make up the law as they go along because of the extreme flexibility of the regulatory structure.”

“The decision to treat WaMu bondholders this way closed the capital markets for banks. BB&T had issued bonds a few weeks before the WaMu decision. It was a choppy market, but we had been able to raise capital funding. However, after the WaMu debtholders were crushed, the capital markets closed for all banks. I believe this was an even more significant event than Lehman Brothers’ failure. I think one of the main reasons that Bernanke and Paulson were so panicky when they went to Congress for $700 billion for the Troubled Asset Relief Program (TARP)—the so-called bank bailout—was that they realized that they had closed the capital markets for banks.”

“Unquestionably, the handling of WaMu forced the failure of Wachovia. Wachovia had been struggling, but its fate had not been completely determined. However, once the bond market saw how WaMu’s creditors had been treated, the market closed for Wachovia. Wachovia did not have a run by individual depositors, but rather a run in the capital markets. Wachovia probably would have ultimately failed, but not necessarily. By the way, Wachovia did fail. Even though it was sold to Wells Fargo (with the shareholders getting a small amount) and the FDIC did not suffer a loss, its sale was mandated by the FDIC and the Fed. If the government forces the sale of a company, that company has failed (fairly or not).”

Excerpt From: John A. Allison. “The Financial Crisis and the Free Market Cure:  Why Pure Capitalism is the World Economy’s Only Hope.” McGraw-Hill, 2013. iBooks.

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