Rich Miller

Oct. 1 (Bloomberg) — Federal Deposit Insurance Corp. Chairman Sheila Bair is being thrust into a bigger role in resolving the credit crisis as her better-known counterpart at the Federal Reserve runs into limits on what he can — and wants — to do.

The FDIC this week, for the first time, invoked its authority to avert a breakdown in the financial system by assisting Citigroup Inc.’s purchase of Wachovia Corp.’s troubled banking operations. Bair also asked Congress to temporarily increase the size of individual deposits the FDIC insures to head off bank runs.

Lawmakers who are trying to revive a $700 billion plan to purchase distressed financial assets are exploring other responsibilities the FDIC might assume.

“We’re in a period of stress,” said Dino Kos, a former Fed official who is now managing director at Portales Partners, a New York research firm. “The FDIC will be called on to take extraordinary actions.”

Bair, 54, is being pressed into service as Fed Chairman Ben S. Bernanke and his colleagues try to extricate themselves from the business of using the central bank’s balance sheet to rescue failing companies after some economists criticized them for overstepping their authority.

Majority Stake

Bernanke, with the support of Treasury Secretary Henry Paulson, took advantage of little-used parts of the law that governs the Fed to provide almost $30 billion in backing for JPMorgan Chase & Co.’s takeover of investment bank Bear Stearns Cos. in March and to lend American International Group Inc. $85 billion last month in return for a majority stake in the insurer.

In helping to broker Citigroup’s $2.16 billion takeover of Wachovia, the FDIC abandoned its standard modus operandi of intervening in insolvent institutions at the least cost to its industry-financed deposit-insurance fund.

Instead, it acted preemptively to head off systemic risk and agreed to indemnify Citigroup against some potential losses on Wachovia’s loans in return for a stake in the bank. As part of the deal, Citigroup took responsibility for Wachovia’s debt in a step partly aimed at reassuring creditors of other troubled institutions.

`Prototype’ for Future Steps

Banking experts praised the FDIC’s actions. Unlike the rescues Bernanke, 54, and Paulson, 62, engineered, the Wachovia takeover was clearly carried out within the confines of the FDIC’s authority and had the backing of the Treasury, Fed and President George W. Bush, said Edward Kane, professor of finance at Boston College. “It’s a prototype” for future steps, he said.

Eric Hovde, chief executive officer and portfolio manager of Hovde Capital Advisors in Washington, said the Wachovia sale also helped address a key problem facing the banking industry: insufficient capital. Hovde, whose firm manages about $1 billion in financial-services stocks, said government loss protection on mergers would cost “a lot less” than the $700 billion Paulson is seeking.

Some analysts and lawmakers want the FDIC to go even further and effectively act as a backstop for the financial system by standing behind all bank creditors. Proponents, including University of Texas economics professor James Galbraith, suggest that Bair say this publicly to calm nervous markets.

`National Emergency’

“The FDIC can determine that while this national emergency lasts, it will resolve all bank failures in a manner that protects all general creditors of all banks,” said William Isaac, a former head of the corporation who has been talking with lawmakers on ways to resolve the crisis.

Bair took a step toward broadening the FDIC’s coverage by asking Congress to approve a temporary increase in its deposit- insurance limit from $100,000. The Senate is slated to vote tonight on a measure that would raise the amount to $250,000 as part of its consideration of the financial-rescue plan. Both presidential candidates — Republican Senator John McCain of Arizona and Democratic Senator Barack Obama of Illinois — endorsed the change.

House Republicans have also proposed expanding the FDIC’s authority to handle more troubled institutions. They are exploring plans to revive a 1980s-era program that would let the FDIC issue certificates banks could use as capital and then repay with interest.

Under Fire

There are risks to a bigger role. The FDIC has already come under fire from some investors in Wachovia stock who lost out in the rushed rescue of the bank.

“The credibility of the FDIC and the Treasury is out the window,” said Peter Kovalski, who manages $12 billion at Alpine Woods Capital Investors in Purchase, New York, and owns Citigroup and Wachovia shares. “The FDIC effectively forced Wachovia to mark down to liquidation value.” The all-stock deal was equal to about $1 a share.

The corporation might also run into a financial squeeze if it takes on too big a role. Bair has already said the FDIC will increase this month the premiums it charges banks to finance its insurance program. Its fund contained $45.2 billion at the end of the second quarter.

The FDIC also has the ability to tap a $30 billion credit line with the Treasury and obtain funding if necessary from the Federal Financing Bank.

“If the costs get high enough, they will likely end up in the lap of the taxpayer,” Kos said.

To contact the reporter on this story: Rich Miller in Washington at rmiller28@bloomberg.net
Last Updated: October 1, 2008 10:02 EDT

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