In an appearance before the Financial Crisis Inquiry Commission on Thursday, Federal Reserve Board Chairman Ben Bernanke said Wachovia Corp. in September 2008 told regulators the bank wasn’t going to be able to open up in a “day or two” in the face of a serious deposit run.
Bernanke’s answer came after a commission member wondered why an acquisition appeared to be the only solution considered for an ailing Wachovia, the Charlotte bank now owned by Wells Fargo & Co. The Fed’s discount window – a funding source of last resort for banks – is considered a tool to stem bank runs, noted commission member Peter Wallison.
“They thought that the liquidity drains were such that they could not meet them even with the discount window,” Bernanke said. The Federal Reserve Bank of Richmond later confirmed this diagnosis, he added.
The questioning came on a second day of hearings about how the government handled “too big to fail” banks such as Wachovia and Lehman Brothers Holdings Inc. at the peak of the financial crisis. The commission is charged with examining the causes of the meltdown and must issue a report on its findings by Dec. 15.
Over the weekend of Sept. 27-28, 2008, regulators initially arranged a government-assisted sale of most of Wachovia to Citigroup. Days later, Wells Fargo prevailed with an offer to buy Wachovia without government aid.
Under questioning, Bernanke said the run on Wachovia’s deposits was initiated by the failure a day earlier of Seattle-based mortgage lender Washington Mutual Inc. Federal Desposit Insurance Corp. Chairman Sheila Bair, however, later disputed that characterization in defending the FDIC’s handling of WaMu’s collapse.
“I think there was a culmination of events that led to Wachovia’s liquidity problems,” Bair said. “And if there was a connection between WaMu and Wachovia, it was not how the resolution of WaMu was handled. It was the fact that WaMu had failed for reasons related to a very large option-ARM portfolio on the West Coast, which Wachovia also had, because of its Golden West acquisition.”
The FDIC shuttered WaMu on the evening of Thursday, Sept. 25, 2008. The move was highly unusual and spooked the markets: Financial institutions are almost always closed on Fridays, but Bair said that “circumstances” forced regulators to close WaMu a day earlier than planned.
The next day, Wachovia was pummeled: Investors sent the stock plunging 27 percent. By the end of the day, Wachovia was in talks with Citi and Wells Fargo.
In testimony Wednesday, an FDIC official, John Corston, said Wachovia lost $5.7 billion in deposits on that Friday. But he also said a deposit drain had begun weeks earlier. In the week after Lehman’s bankruptcy filing on Sept. 15, Wachovia lost $8.3 billion in deposits, he said.
Wachovia was losing uninsured deposits. They were losing transaction accounts. They were losing derivatives counterparties,” Bair said. “It was part of a larger, escalating – I won’t use the word panic, but it was a near panic situation from a whole series of events – Lehman, AIG, the uncertainty of the TARP legislation.”
Under questioning from Wallison, Bair said Wachovia was technically solvent at the time, but it was an “open question” as to whether it could stay that way.
“There were certainly a lot of credit quality issues with Wachovia,” Bair said. “I don’t think anyone can suggest that it was a perfectly healthy institution that just fell victim to broader market events. Clearly, the market was reacting to some very bad decisions the management had made.”
Wachovia shareholders have complained bitterly about the losses they suffered when the bank was sold, but they fared better than WaMu shareholders, who were wiped out because the FDIC placed WaMu into recievership.
Regulators had thought that it might be cheaper to shutter Wachovia as well, rather than help another bank buy it, but they agreed to let Wachovia try to sell itself because they deemed the bank “systemically important” – a designation that WaMu didn’t qualify for.
Commmissioner Keith Hennessey asked Bair to elaborate on how the distinction was made. “Can you explain where you draw the line?” he asked.
Bair noted that Wachovia was more deeply intertwined with other financial firms and foreign depositors, so its failure would have hurt a number of other parties. Wachovia was also bigger, with $782 billion in assets to WaMu’s $307 billion. And the FDIC had more time to figure out all the options for WaMu, because it had known for months that WaMu was in trouble. With Wachovia, the FDIC didn’t know until the weekend of Sept. 26 how dire the situation was. “The short timeframe for developing a resolution strategy and soliciting acquirer bids sharply limits the FDIC’s options in the case of Wachovia,” Bair testified.
Commissioner Peter Wallison asked why the FDIC agreed to let a bank like Citigroup, which was racking up billions in subprime-related writedowns and other losses, buy Wachovia.
Bair replied that “we had to do something.” From a liquidity standpoint, she said, Wachovia “was clearly failing.”
Both Citigroup and Wells Fargo submitted bids to buy Wachovia on Sunday, Sept. 28, 2008. Both bids would have required the government to assume some of Wachovia’s potential losses. However, the FDIC believed that the Citi proposal would end up generating no costs for the FDIC.
“Based on the information we had, we thought Citi was a stronger institution,” Bair said, “and obviously later they ran into their own problems.”
Wells Fargo’s ultimate winning bid did not require the government to share in Wachovia’s losses.
Less than two months after Wells bought Wachovia, regulators announced that Citigroup needed a second, $20 billion bailout loan from
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