So, What is Plan B?

Now that the Paulson Plan has failed to pass the House (at least this time around) the question everyone seems to be asking is: Where do we go from here?While it is likely that a modified version of the Paulson Plan (suitably changed to entice the needed votes – from the left or the right remains to be seen) will come up again for a vote, as with before, other plans are bubbling to the surface. Rich Lowry over at the National Review Online’s The Corner blog notes that there is a lot of “chatter” about using the FDIC as an alternative. He points to this piece in the Wall Street Journal calling for the FDIC to be plan B (whether Paulson passed or not):

There is a better — and more transparent — way to put public capital into the banks while protecting taxpayers: through the Federal Deposit Insurance Corp. The FDIC has long had the power to handle failed banks. But in 1991, Congress passed the Federal Deposit Insurance Corporation Improvement Act (FDICIA) that limited the FDIC’s ability to provide assistance to struggling but still solvent banks.

The exception is when there is a risk to the entire financial system. In that case, the President, Treasury Secretary and two-thirds of the Fed board can authorize such open-bank aid. The current moment would seem to qualify. Yet the White House has so far refused to trigger this exception and let the FDIC work with the likes of Wachovia, Morgan Stanley, and others before they crash and burn.

Whether or not the Paulson plan passes, President Bush should sign the FDICIA waiver. This would allow Treasury and the FDIC to inject new capital into banks early enough to prevent failures; in return, the feds could impose some discipline in the form of management dismissals and preferred stock or warrants that would protect taxpayers when the banks recover. This also beats the Congressional idea of attaching taxpayer warrants to the Paulson plan, which will be much harder to administer to hundreds of banks as opposed to one at a time through the FDIC.

On the surface, this suggestion would seem to have a lot of merrit. It already exists as a tool of the federal government. We would not need to create new powers for the Treasury to complete Paulson’s plan. So, why hasn’t President Bush, Secretary Paulson and the Fed board ordered the FDIC to start up the open bank aid?

The FDIC’s own website offers some clues. They have published a Resolution Handbook that was put together to relay the important lessons that the organization learned from the Savings and Loan crisis of the 1980s and 1990s. There is an entire chapter devoted to the open bank assistance transactions(pdf). You can go read the whole thing, but the summary provides enough evidence to give one pause when considering this plan:

Those “Other Considerations” would seem to provide plenty of reason for hesitancy on the part of the FDIC to engage in open bank assistance. If something leaves the “toxic” assets (the mortgage backed securites) in the hands of the banks, I’m not really all that sure that it will solve the problem of freeing up the credit markets. It would however allow for an orderly sale of the bank, but that is not the goal of the government (at least not primarily) in this current situation.

While it may be necessary to include this option in the tool box for the government to deal with this crisis (to deal with the banks that will fail anyway), it should not be seen as Plan B.