Foreclosure Prevention

The newspaper articles were devastating. They claimed that the initials FDIC stood for “Fear, Deception, Intimidation, and Chaos.” In 1994 Scripps-Howard News Service published a highly critical series of articles on the FDIC's loan collection practices under the heading, “Protector Turned Predator.” Needless to say, it was not a flattering portrait. We were referred to, among other things, as Fiscal Robocops.

Some dissatisfied borrowers expressed their feelings more directly. The writer of one letter told us, “The whole damn lot of you at the FDIC ought to be taken out on the steps of Capitol Hill and be given a public whipping.” After colorfully discussing his complaints, he still felt obligated to conclude with the salutation, “You obviously do not have my good will or best wishes.”

That writer would have been pleased to know that the public whippings actually did occur. The only difference was that they took place inside congressional hearing rooms rather than on the steps of Capitol Hill. Congress was as critical of the FDIC as were the letters and newspaper articles.

The brewing controversy over the FDIC's loan collections was turning into a major storm. I was about to find myself in the center of that storm. In November 1992, the FDIC's acting chairman, Andrew “Skip” Hove, had named me as the director of the Division of Liquidation. This was the division that was responsible for closing insolvent banks, paying insured depositors their money, and then managing the rest of the affairs of the failed bank. If you were a borrower who owed money to a bank that had just been closed, you now owed that money to the FDIC. That money was used to reimburse the deposit insurance fund for some of what it paid out to insured depositors and also to return money to the failed bank's uninsured depositors and other creditors.

This was an important responsibility. With hundreds of failed banks, there was a lot at stake for the financial system, the general public, and the people who had been customers of failed banks.

Some parts of the job were easier than others. There was little controversy about paying money back to insured depositors. That is a very rewarding activity. You are returning money owed to the failed bank's insured depositors within a couple of days. Those depositors generally are appreciative that everything works so quickly. There is a great sense of satisfaction for the government employees who are responsible for making that happen.

But collecting the money owed to a failed bank is a thankless task. Each borrower's situation is no different than it was before the bank was closed. They still owe the same amount of money as before, and they are still expected to pay it back to the best of their ability. But once the federal government becomes involved, there could be a change in expectations about paying off one's loans.

The volume of loans, real estate, and other assets under the FDIC's control had grown quite rapidly during the previous few years. Questions and complaints about how the FDIC was managing those assets were growing. Many of those complaints were coming out of New England.

After the January 1991 closing of three large banks owned by the Bank of New England, three FDIC-owned bridge banks were temporarily created to maintain banking services in the region and to preserve the banks' remaining value while they were being sold. In April, the bridge banks were sold to another large New England bank, Fleet Bank, which entered into a partnership with Kohlberg, Kravis Roberts & Company (KKR), Merrill Lynch, and Salomon Brothers in order to raise enough new capital to complete the transaction. KKR's participation in this transaction marked the first time since the Great Depression that a “nonbank” investor had participated in the acquisition of a failed bank. Given the depletion in overall bank capital that had occurred over the past decade from nearly 2,000 bank closings, then-FDIC Chairman Bill Seidman noted, “We are delighted to see this new money coming into the banking system.”

Fleet Bank, which later would become part of Bank of America, assumed ownership of the higher-quality loans that had been created by the Bank of New England. The FDIC retained ownership and responsibility for managing more than 17,000 of the lower-quality loans. The FDIC hired Fleet Bank to manage these poorly performing loans, and in June 1991 Fleet Bank created a separate company for that purpose, named RECOLL, which was short for “Recovery and Collections.”

In effect, the Bank of New England's three failed banks were broken up into one “good bank,” which was sold to Fleet, and another “bad bank,” which became RECOLL. The dividing line for distinguishing the good loans from the bad loans was based on standard criteria used by bank examiners for making such distinctions. All of the loans that had been “classified” as bad loans were placed into RECOLL.

The small business owners who were responsible for paying back the loans transferred to RECOLL were in a difficult position. The regional economy was weak, their businesses were suffering, and the amounts they owed as a group exceeded $5 billion.

Many of these borrowers had been loyal customers of the Bank of New England for years. Often, their loan terms required only that they make monthly interest payments. No principal payments were required until a balloon payment of the entire loan balance became due on the final maturity date. Some of these struggling business owners could make their interest payments, but many of them had no real prospect of being able to pay off the entire remaining principal balance once it became due.

In the past, the Bank of New England often extended the amount of time during which only interest payments were required. In the aftermath of the 2008 financial crisis such loan extensions often were referred to as “extend and pretend” loans, given that for many borrowers it was simply postponing the final day of reckoning. In the early 1990s, such loans were called “performing nonperforming loans.” They were “nonperforming” in that the final maturity date had already passed without any final payment being made, or it was about to pass without any real prospect of there ever being a final payment. Nevertheless, many borrowers felt that they were “performing” on their loans since they were able to continue to make their interest payments and in better times had always been able to get interest-only loan extensions.

But as the Bank of New England Corporation's problems had grown worse, so too had its tactics. The banks' collection officers often would threaten to initiate foreclosure proceedings just to get the borrower's attention. They began to pursue a parallel collection process of continuing to pursue their regular loan collection efforts while at the same time initiating foreclosure proceedings. Foreclosure was a lengthy process in most northeastern states and the banks decided to get a head start on that process in case they were unable to collect on their loans. The strategy was designed to keep as much pressure as possible on their less financially secure borrowers. Once the Bank of New England's banks were closed many of these collection officers were hired by RECOLL, where they continued to engage in the same type of highly aggressive loan collection behavior.

The small business owners facing foreclosure had limited options for refinancing their loans. The largest lender in the region had just been shut down. Many other banks were being closed. The remaining banks now were much more conservative in their lending practices. The credit crunch was at its peak. To the extent that another bank might be interested in taking over a loan from RECOLL they worried about how their own bank examiners would treat that loan, since other bank examiners already had classified it as a poorly performing loan in order for it to end up in RECOLL in the first place.

These small business owners felt stigmatized. Their loans were held in RECOLL, the “bad bank,” rather than in Fleet, the “good bank.” They began to complain about RECOLL's aggressive behavior. Foreclosure actions were piling up. The complaints drew a lot of attention in Congress and elsewhere since each new foreclosure meant fewer remaining jobs and more economic stress within the region.

At that time, Mitchell Glassman was the senior FDIC official responsible for overseeing the agency's asset management contractors. This meant that RECOLL's performance, as well as its behavior, now fell under his watch. Mitchell joined the FDIC in 1975 after a brief stint as a banker, starting his FDIC career as a field liquidator, helping manage bank closings in Illinois and Wisconsin. A native of Kansas City, Missouri, Mitchell was in the Midwest during the mid-1980s boom-to-bust cycle that resulted in the closing of 200 agricultural banks. He had experienced firsthand the difficulties creditworthy farmers had finding new sources of credit once their lender went out of business. Mitchell saw the impact this had on their lives and as a result he was very sensitive to the difficulties small communities and their citizens faced when their local bank had to be shut down.

As the regional recession had moved across the country during the 1980s, Mitchell and his family had moved along with it. By the early 1990s, they already had moved eight times. Now Mitchell was based in Dallas, and from there already he could hear the complaints coming out of New England. He was about to feel the full brunt of that anger.

Barney Frank (D-MA) was one of the congressmen who heard from the small business owners in his Massachusetts district about the problems they were having finding new sources of credit and in dealing with RECOLL. He wanted Mitchell to come to his office to discuss the situation. Eric Spitler, from the FDIC's Office of Congressional Affairs, accompanied Mitchell to the meeting. Once the meeting started, Barney Frank proceeded to tear into Mitchell about what RECOLL and the FDIC were doing to small business owners and the broader communities in New England. He told Mitchell in no uncertain terms that there was such a thing as good governance regardless of what the law said and regardless of what the FDIC viewed its mandate to be, and that the FDIC wasn't practicing good governance.

Mitchell respected Barney Frank and knew going into the meeting that the congressman was a strong advocate for his constituents. He also knew that there were real problems at RECOLL that had to be fixed. Nevertheless, the pounding Mitchell already had been taking over RECOLL's behavior, culminating in this severe tongue-lashing, jolted him.

Glassman sent Bill Ostermiller and a small team of FDIC employees to Boston to provide local oversight over RECOLL, and in October, Mitchell met with Ostermiller; Jay Sarles, a senior Fleet official; and Tom Lucie, the Fleet executive who was put in charge of RECOLL. Like the FDIC, Fleet Bank was feeling the heat from all of the criticism and was anxious to find a solution. The four of them went out to dinner, where a concept developed.

The discussion revolved around getting some of the borderline loans out of RECOLL by having Fleet Bank purchase them from the FDIC. Under a deal reached in January 1992, Fleet agreed to purchase about 1,000 business loans with an aggregate outstanding loan balance of about $500 million and extend the loan terms for these borderline borrowers. In order to complete the deal, the FDIC agreed to give Fleet the right to return any of these loans if the borrowers ultimately were unable to meet their loan commitments. The FDIC effectively guaranteed Fleet Bank that it would not lose any money on the transaction. The FDIC also agreed that Fleet could lend these borrowers an additional 10 percent if necessary and the FDIC would accept any losses from this additional lending as well.

These small business owners now had a new source of credit and a second chance. The FDIC also put a temporary halt on all of the RECOLL's foreclosure activity while it further reviewed the company's loan collection practices.

But even these steps did not quiet the complaints. Congress held hearings to focus on the FDIC's alleged mismanagement of the loans under its possession and its alleged mistreatment of those borrowers. In early February 1992, hearings took place in Portland, Maine, and in Boston, Massachusetts. Steve Seelig, the director of the Division of Liquidation at the time, and Glassman testified at those hearings.

While the problems at RECOLL were real, the hearings were a setup. No information was provided to the FDIC in advance about the borrowers who would be the other witnesses at the hearings. This meant that the FDIC couldn't research the status of these loans. The borrowers presented one sad story after another, and Seelig and Glassman were left defending the FDIC's actions without having any knowledge of the specific situations. Later, it became clear that borrowers who testified had incorrectly characterized many of the key facts, including whether or not they were actually making their loan payments.

It was against this backdrop that in November 1993, Senator William Cohen of Maine initiated a hearing of the Senate's Subcommittee on Oversight of Government Management. The hearing was titled “Oversight of the FDIC: Are Investors Cashing in on FDIC Mismanagement?” I testified for the FDIC.

A short way into my opening statement, I said, “The implication that we foreclose on people with standard 15- and 30-year mortgages who are making their payments is not correct.” Senator Cohen interrupted me to say that he could categorically contradict that statement because the FDIC had foreclosed on people who were making their payments. I responded that I was not interested in being argumentative or arrogant, only in treating people fairly, and that if he could give me specific examples, I would be glad to look into them. The hearing went downhill from there.

I tried to explain that it was the FDIC's policy and practice to avoid foreclosures if at all possible. If borrowers could not afford to make their monthly payments, then the payments were reduced to an amount that they could afford. The FDIC had foreclosed on only about 1 percent of the home mortgage loans in its possession from failed banks, a relatively small percentage given the generally poor quality of the loans held by insolvent banks. None of these foreclosure actions were situations in which the borrowers were current on their payments.

But there are limits on how far the FDIC could or should go down the road toward loan forgiveness. For every dollar that is borrowed from a failed bank, there is a dollar that has been lent to that bank by someone else who is waiting to get that money back. Loan forgiveness for the customers of failed banks, while often justified by the specific facts and circumstances, also represents money that is not being paid back to someone else.

The Scripps-Howard articles had a quote that referred to the FDIC's loan collection practices as “Robocop in Action.” In the aftermath of our initial experience at RECOLL, we made it clear to everyone who worked at or for the agency that we expected them to use courtesy, politeness, and professionalism as the basis for our conversations with borrowers. We established an ombudsman's office to address any complaints, and we wanted to know if our employees or contractors were acting in a heavy-handed manner.

To help foster a change in attitude within the division, and in how we were perceived by the public, I worked to change our name. The “Division of Liquidation” implied a state of mind more appropriate for how Scripps-Howard had characterized us—that all that we cared about was collecting as much money as we could from the “liquidation” of the failed bank's assets.

Mitchell Glassman and I came up with the more customer-oriented “Division of Depositor and Asset Services.” Our regional offices became known as “Service Centers.” The staff title “Liquidation Specialist” was replaced with “Asset Manager.”

Alas, none of this mattered to Senator Cohen. He held a second hearing early in 1995. I represented the FDIC at that hearing as well, and Bill Dudley represented the Resolution Trust Corporation (RTC). Bill, a long time FDIC employee, was the senior official in the RTC's Atlanta Regional Office and was responsible for, among other matters, the management of loans that had been made by savings and loans (S&Ls) that subsequently had been closed and taken over by the RTC in the southeast. The RTC's responsibilities for failed S&Ls were essentially identical to the FDIC's for failed commercial banks.

This hearing also focused on the alleged mismanagement of assets and mistreatment of borrowers, this time by both the FDIC and the RTC. An earlier panel that day had featured borrowers and other individuals who provided their examples of this mismanagement and mistreatment.

One of those panelists was a woman named Rhetta Sweeney, who testified on her own behalf. Her case became the central focus of the hearing and would become the primary evidence used to depict the FDIC's and the RTC's alleged mistreatment of borrowers from failed banks.

John and Rhetta Sweeney owned two houses on 14 acres of land in the town of Hamilton, Massachusetts. Hamilton is located about 20 miles north of Boston. The Boston Globe called it a “well-to-do town of horse farms and Yankee sensibilities.”

During the real estate boom of the 1980s, the Sweeneys decided to build additional houses on those 14 acres. They entered into a partnership with a company called the Congress Group for the development of their real estate. The Congress Group acquired the existing first mortgage on one of the Sweeney properties to hold off a previously scheduled foreclosure by another lender. But negotiations between the Congress Group and the holder of a second mortgage on the property broke down, and the holder of the second mortgage continued to proceed with the foreclosure proceedings. The foreclosure was scheduled for November 1987.

In August of that same year, the Sweeneys borrowed $1.6 million from ComFed Savings Bank, located in nearby Lowell, Massachusetts. To secure this loan they put up both of their houses and their land as collateral. They used about $1.25 million of the money to repay their preexisting debt. About $200,000 was put into a reserve account to pay interest on the new loan. Most of what little was left to develop their property was soon gone.

When the Sweeneys stopped making payments on their loan, ComFed sent them a notice of default. There were negotiations over a new loan, but they were unable to reach an agreement. ComFed then initiated foreclosure proceedings. The Sweeneys filed a complaint in state court, arguing that ComFed had verbally committed to lend them an additional $900,000 in order to complete the project. ComFed denied that there ever was such an agreement.

In March 1990, after a 12-day trial, the jury rendered a verdict in favor of ComFed for about $2 million, essentially the amount originally owed plus interest. Nevertheless, the jury awarded Rhetta Sweeney $65,000 for emotional distress.

The fact that ComFed won the case did not mean that the bank was a model corporate citizen. It was not. The bank was poorly managed, careless in its underwriting practices, and was closed nine months later.

Because ComFed was an S&L, it was the RTC rather than the FDIC that handled the closing and had the responsibility to pay insured depositors the money they were owed. The RTC's money came from the federal government, in other words, from the taxpayers. In order to pay taxpayers back, the RTC would have to collect what was owed by those individuals and businesses that had borrowed money from ComFed, including the Sweeneys.

In 1993, the Sweeneys appealed the original court decision. In January 1994, the U.S. Court of Appeals affirmed the original decision and granted approval for the RTC to conduct a foreclosure sale of the property. The Sweeneys appealed their case to the Supreme Court, but it declined to hear their case.

Nevertheless, Congress and the media were placing enormous pressure on the RTC to show some leniency toward the Sweeneys. Though the Sweeneys were unwilling to provide the financial information needed to determine a fair settlement offer, the RTC offered to reduce their outstanding loan from $2 million to $455,000, and they could keep one of the two houses. They rejected the offer, and the settlement talks broke down.

That led the RTC to purchase the property in a foreclosure sale. The Sweeneys and their tenants (they were renting one house during the period that they were not making any mortgage payments on either house) were ordered by the court to evacuate the property by January 1995. They refused. The RTC proposed several new settlement options, but each was rejected. The Supreme Court also rejected a second request by the Sweeneys for a hearing of their case.

The Sweeneys turned to Congress for help, which led Senator Cohen to hold a second hearing. He was particularly critical of the RTC's actions, charging that a state court had ruled in favor of the Sweeneys, and the RTC had to resort to an inappropriate legal requirement to win their case in federal court.

The legal requirement he was referring to was a 1942 Supreme Court decision called the D'Oench Duhme doctrine, which states that the FDIC (and by inference the RTC) is not bound by oral statements—that contractual agreements must be in writing. The Sweeneys continued to claim that ComFed had verbally promised to lend them more money, and that even though the bank had denied that claim and had refused to lend any more money, ComFed should have been bound by that alleged promise.

Of course, the RTC had no way of knowing who was telling the truth. This is precisely why contractual agreements must be in writing. But regardless of who was telling the truth, verbal commitments do not relieve parties from written contractual obligations. Needless to say, this did not convince Senator Cohen. He threatened to have Congress change the law and make the changes retroactive to cover the Sweeneys' case.

Testifying before Congress on this matter was unpleasant. FDIC employees were trying to mitigate the damage to the general public, taxpayers, and the financial system. They did not deserve to be the focus of congressional anger, or what sometimes appeared to be nothing more than congressional posturing. Nevertheless, these scenes were played out time and time again during the S&L and banking crisis. As the general public became more frustrated with the use of taxpayer dollars to pay for some of the costs associated with failed S&Ls, Congress would regularly bring government employees before it to criticize their performance.

In June 1995, Senator Cohen followed through on his statement that he would pursue legislative changes to the D'Oench Duhme doctrine. The Senate Committee on Banking, Housing, and Urban Affairs held a hearing specifically on the “D'Oench Duhme Reform Act,” as the proposed modifications were called. Senator Alfonse D'Amato chaired the hearing, which focused on the Sweeney case. Senator Cohen himself testified at the hearing. The position of most of the congressional members at the hearing was that the RTC was treating the Sweeneys unfairly. Nevertheless, the proposed law never gained any real support.

It was around this time we found out that Senator Cohen wasn't exactly a neutral party. He had been John Sweeney's college classmate. This wasn't nearly as bad a situation as the “Keating Five,” in which five U.S. senators inappropriately supported Charles Keating in his effort to hold back federal bank supervisors. Nevertheless, it seemed to us to be inappropriate for the senator to be involved at all in the Sweeneys' case.

By year-end 1995, the S&L crisis had abated, and the RTC and its staff and remaining workload were merged into the FDIC. The Sweeney case now belonged to the FDIC. In an attempt to resolve the matter once and for all, the FDIC offered to sell the Sweeneys the main house and one acre of surrounding land for $1.

The offer wasn't made lightly. We knew it wasn't fair to other, more responsible borrowers who would never be offered such a deal. But the matter had gone unresolved for years, the cost to taxpayers was growing, and the Sweeneys still had the overwhelming support of Congress and the media. Regardless, the Sweeneys refused the offer.

While the Sweeneys had an ally in their congressman, Peter Torkildsen, he was defeated in November 1996 by John Tierney. Early in his term, Congressman Tierney asked me if the FDIC would be willing to engage in some new negotiations to try to resolve the matter. I agreed, but told him that I was skeptical, given the Sweeneys' past behavior, and I didn't know what more we could offer. The congressman and I had several straightforward and constructive meetings, and an agreement was eventually reached on a person to serve as mediator. The discussions did not go well. The supposedly quiet discussions were reviewed for the world to see with daily updates on the Sweeneys' Internet site.

Chairman Hove, in the interest of being as cooperative as possible, stated that the FDIC staff would review any offers submitted on behalf of the Sweeneys within one hour of their arrival. We began receiving settlement offers at the FDIC's headquarters building at 2 a.m. When the offers arrived, the security guards called a senior staffer, Stan Ivie, who dutifully drove into work to review the letters within the allotted time frame. His reviews noted that each of the proposals consisted of a demand that the FDIC pay the Sweeneys a substantial amount of money rather than the reverse. After a few such middle-of-the-night excursions, we came to our senses and began to let the letters sit, and Stan sleep, until the next day's normal business hours.

When the negotiations broke down, the Sweeneys decided to barricade the property. They appealed over the Internet to groups with anti-government feelings for help in preventing an eviction. A few showed up to lend support. A large sign was posted on the front lawn saying “Federal FDIC Fraudulent Eviction Zone.” John Sweeney stated, “These are bureaucrats that have got their backs up, and we are paying the price.”

The matter was now in the hands of the U.S. Marshal's Service, the enforcement arm of the federal courts. Doing everything they could to avoid any prospect of armed resistance and violence in this situation, the U.S. Marshal's Service requested, and the District Court ordered, the parties back to mediation in January 1997. The eviction was put on hold. There was no further progress. The judge ended the mediation attempts and lifted the stay of eviction in July 1997.

The Marshal's Service stated that they would seize the property at an undisclosed time. They did not want to disclose a time because their absolute priority was to ensure that the eviction would occur without any violence. It was not clear if the group gathered to defend the Sweeney estate would resort to violence, but it was not out of the question either. Adding to the concern, the local high school was located just across the street.

The prospect of potential violence turned this into an even bigger news story. I flew to Boston with Phil Battey, the FDIC's press person, to meet with various local media representatives to explain our side of the story. The meetings felt like interrogations. There were several reporters in the room, and they asked pointed questions that still showed a clear sympathy with the Sweeneys' position.

I walked through the history of the case, giving them a perspective from the taxpayers' point of view. I don't believe they had fully appreciated the other side of the story before. It had been too easy to portray the story as the heartless federal government going after an innocent family. As the discussion went on, I felt that their views were beginning to shift, and the Boston Globe called on the Sweeneys “to abandon their fantasy of a government conspiracy and their pseudo-populist posturing, to own up to their responsibilities, to admit their mistakes in a mature fashion, and to get on with life.”

In February 1998, 11 years after the Sweeneys first borrowed money from ComFed Savings Bank, the U.S. Marshals evicted them. No one was injured. The property was subdivided into two lots and sold, reducing the overall cost to taxpayers to just over $2 million.

This particular story is extreme. Congressional intervention, coupled with intense media scrutiny and resulting public pressure, dramatically altered the usual dynamics associated with determining whether a loan modification was appropriate, resulting in what could have been an unfair result. Nevertheless, the story is emblematic of the challenges that arise when deciding whether to foreclose on a property.

Historically, the FDIC has tried to avoid foreclosures. However, financial benefits given to borrowers must be paid for by others (typically those who lent funds to the bank, including uninsured depositors). By law, the FDIC must look out for the rights of those who lend money to a failed bank as well as those who borrow money from a failed bank. This is a legal requirement that does not apply in other situations across the federal government. Basic fairness and cost effectiveness strongly suggest that the FDIC (or any government agency) should have clear, justifiable, and easily explainable reasons why it would spend other people's money (whether it be lenders, taxpayers, or the deposit insurance fund) in order to benefit borrowers.

The criteria used by the FDIC in deciding whether to provide debt relief to a borrower is if it is expected to lower the amount of loss to the creditors of the failed bank compared to the available alternatives. In other words, in a potential foreclosure situation, is a loan modification expected to be the least costly option for whoever is paying the bill? If the answer is yes, then “bailing out” the borrower is an acceptable course of action.

When IndyMac was under the FDIC's control, the agency provided loan modifications to homeowners who demonstrated that they could not afford their current payments, they could afford a reduced payment, and the losses to the FDIC and the failed bank's creditors were expected to be less than the cost of the alternatives, including foreclosure. In these situations, distressed borrowers were made better off without making anyone else worse off. The loan modification procedures used by the FDIC at IndyMac were successful and subsequently were adopted by many banks across the country.

In the aftermath of the 2008 financial crisis, some expressed concern that insufficient efforts were made to provide relief to homeowners facing foreclosure, particularly compared to the widespread bailouts of failing bank creditors. Expressed differently, why are banks getting bailed out while individuals are not? Conversely, others believed that the government's loan modification efforts were too expansive. Their point was: why are we rewarding individuals who took on more debt than they could afford, while more responsible homeowners are offered no such relief?

My standard strikes a balance between these two viewpoints. However, I believe that the subsequent federal government foreclosure prevention programs went too far. These programs provided taxpayer payments to lenders for losses they suffered when homeowners defaulted on their mortgages a second time. The subsidies benefited both borrowers (more of whom were given a second chance) and lenders (who were given the financial incentive to provide more borrowers with a second chance). However, the programs provided no direct benefit to taxpayers who had to foot the bill. Thus, the taxpayer-subsidized programs did not meet the criteria of making no one worse off.

I would further argue that the standard for determining whether to bail out failed-bank creditors should be the same one used in deciding whether to bail out failed-bank borrowers. In both cases, the key issue is determining whether the financial relief is expected to be less expensive than the alternatives (making no one worse off).

As I noted in Chapter 2, some of the creditor bailouts that took place during the 1980s were warranted because they were in everyone's best interest. That happened in cases where it was clear in advance that the alternatives were likely to be worse for those paying the bill.

The more problematic scenario is when a bank failure is likely to trigger a system-wide panic and drag down other banks. A creditor bailout still may be warranted because it is the best alternative for those who have to pay the bill. That doesn't mean it is fair. We need to end the too-big-to-fail problem before the best available solution could also be perceived to be a fair solution.

There are analogies between creditor bailouts and borrower bailouts. In the Sweeney case, there were undesirable factors (excessive political, media, and public pressure) that effectively limited the potential solutions, creating what could have been an unfair result. The FDIC's choice was between steadily increasing the cost to taxpayers or letting an uncooperative borrower get a much better deal than what would be offered to others in more deserving circumstances. The offer of $1 for a house and an acre of land may have been necessary under the circumstances, but it certainly wasn't fair.

We need to develop clear government-wide criteria and a set of standards for determining when bailouts are appropriate. If one standard is that bailouts occur only when no one is made worse off as a result, then we have achieved the first step in removing financial regulators from the inherently unfair task of choosing winners and losers with other people's money.

We should also identify and remove operational constraints that limit the available options. That starts with ending too big to fail. As long as we continue to bail out creditors at insolvent big banks, then arguments easily can be made that it's unfair not to bail out creditors at insolvent small banks, distressed homeowners, other distressed business owners, and so on. Inevitably, the government will be picking winners and losers with other people's money. Inevitably, those not getting bailed out will feel disadvantaged, adding to the view that the government's actions are unfair, which further erodes the credibility of government officials and the federal government itself.