Risky lenders could face ‘clawback’ from their failures

Chairman Sheila Bair does not want a repeat of the cascading bank failures that are soaking up the reserves of the Federal Deposit Insurance Corp. faster than you can say Troubled Asset Relief Program.

Monday, she proposed a system for assessing deposit insurance fees based on the way banks structure their executive compensation packages relative to how much risk they take managing their institutions. The FDIC has assessed institutions based on risk vis-À-vis deposits since 2006. The new approach would refine that system by identifying the ways lending and investment policies might reward management, but increase the risk to the FDIC.

And – no news here – the risk is real. According to the FDIC, reviews of 49 bank failures in 2009 indicated compensation practices were a factor in 17, or more than one-third.

One of those reviews targeted Westsound Bank of Bremerton, which the FDIC and the Washington Department of Financial Institutions closed in May. The failure cost the FDIC insurance fund $100 million. In their examination, FDIC officials determined that 83 percent of loans made by a single, unnamed bank official went sour. But thanks to a compensation system that rewarded loan production with no regard to quality, that individual took home $1.2 million in compensation in the three years from 2005-2007.

One FDIC proposal would allow the agency to “clawback” money from free-lenders like this, even after they have left the bank. Another would award stock at a price equal to the price on the day the stock was granted, and only over several years. If the bank hits hard times, so do executives.

How far down the ladder the program’s provisions might apply is one of the questions the FDIC has put in its proposed rule-making. As the Westsound case makes clear, one person – potentially one loan officer – can do catastrophic damage.

Which brings us to the Financial Crisis Liability Fee proposed Thursday by President Barack Obama.

The president wants our TARP money back, and it’s clear that not every institution that benefited will be writing a check to the U.S. Treasury anytime soon, if ever. The “fee” would recapture the arrears, an estimated $117 billion, over a 10-year period from the 50 largest banks, brokers and insurance companies.

If they do not pay, taxpayers will eat the tab.

Bank executives, some of whom took TARP money against their will, and repaid with interest as quickly as possible, say the fee is unfair. GM and Chrysler, they note, will get a free ride despite receiving $65 billion.

How true, and how beside the point. When an industry awards total bonuses the Wall Street Journal estimates will exceed the gross domestic product of New Zealand, how would its leaders know what is fair?

Some analysts calculation the liability fee will reduce 2010 profits by 5 percent. That sounds fair.

So does a linkage between management compensation plans and FDIC insurance premiums.

Taxpayers, the insurers of last resort, want out of the pool.