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— Regulatory —
After House Financial Services Committee Chairman Barney Frank, D-Mass., unveiled the bill last week, Geithner told lawmakers that receivership powers would allow the government "to unwind, dismantle, sell, or liquidate the firm in an orderly way that protects the financial system at lowest cost to taxpayers. Shareholders and other providers of regulatory capital of the failing firm would be forced to absorb losses, and managers responsible for the failure would be replaced."
The approach, he said, would reduce the risk that a chaotic failure would cause panic and maximize recovery of the value of the failed firm's assets. Geithner said the power should be permissible only if a firm is in default or in danger of imminent default and intervention would mitigate the failure's expected adverse effects on financial stability. Officials say they could sort through contracts and financial dealings with counterparties and unwind those positions, stem systemic threats to other financial institutions and ensure that contracts are maintained until they can be sold to another institution. While much talk has been about so-called resolution powers, the mechanics of how such a process would work have gotten little attention. Though analogous to the approach the Federal Deposit Insurance Corp. uses to take over failed commercial banks, there are big differences between traditional lenders with insured deposits and the complex financial institutions the proposed bill covers. Whether large or small, all commercial banks are basically in the same business: taking deposits and using the money to make loans. Their failures are handled much the same way. Financial conglomerates, on the other hand, come in any number of shapes: investment banks, broker-dealers, asset managers and insurers. Most have multiple lines of business, may own an insured depository institution and have trading desks with billions of dollars in bets with thousands of counterparties that require sorting out one by one. The bill would tap the Treasury secretary to oversee a council of regulators whose job would be to guard against brewing risks in the financial system. Should a major firm fail anyway, the FDIC would be appointed its receiver. In consultation with the Treasury, the FDIC could make loans to or purchase the firm's obligations. It might also take a lien on or purchase any of its assets, acquire any type of equity interest or security and sell or transfer all or any part of its acquired assets. The FDIC would have to make sure shareholders of the firm receive no payment until all other claims are fully paid. Unsecured creditors would have to bear losses as well. The FDIC would have authority to rule on claims on the firm's assets and could rely on its existing rules for insured depository institutions or could issue a rule governing the allowance and disallowance of claims. How well the FDIC sorts out competing claims in the first few failures will be a major factor in the new regime's acceptance, says Thomas Vartanian, a partner at Fried, Frank, Harris, Shriver & Jacobson LLP. "The market needs as much certainty as possible for it to work efficiently," he says. "If the FDIC establishes rules that make it possible to predict who gets wiped out and who may have something left, the market can work based on that." Kevin Petrasic, of counsel with Paul, Hastings, Janofsky & Walker LLP, adds, "Critically important is that the process is viewed as fair and equitable. If it's not, there will be tremendous resistance that will politicize it." The FDIC will likely have to strike a balancing act if it must weigh between consumer claims and those of the firms' business partners. "That's where things get tricky," Petrasic says. Given that the taken-down firms will likely be considered systemically important, their business counterparties may risk financial collapse if they don't receive some significant percentage of their claims. Petrasic points to the threats faced by auto parts makers when the Big Three faced collapse. Petrasic predicts that no matter how the rules are devised, these types of resolutions will be more ad hoc than interventions at failed depository institutions. "At the end of the day, regulators don't know the impact of a particular entity until they're in the thick of it. A firm has many products out there that people depend on for their businesses." |
Treasury Secretary Timothy Geithner and Federal Reserve Board Chairman Ben Bernanke have repeatedly insisted that the authority to take down failing nonbank financial conglomerates in an orderly way needs to be the centerpiece of financial overhaul. This week, the House Financial Services Committee will get them one step further in that goal: The panel will vote on legislation that would give the government new power to seize and dismantle failed investment banks, insurance firms and other financial conglomerates.
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