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Is Too Big to Fail Over?

By: Bill Poquette

The public speeches of top regulators in recent weeks have included frequent references to the too-big-to-fail remedies embodied in the Dodd-Frank Act — how they will work, or how they are supposed to work.

FDIC Chairman Sheila Bair, in remarks at a Harvard University forum on Oct. 20, reminded the audience that prior to Dodd-Frank, neither bank holding companies nor non-bank financial companies were subject to an FDIC-like receivership authority. “These entities were subject to the commercial bankruptcy process, where it takes a long time and a lot of money to determine what creditors ultimately stand to collect,” she said. By contrast, the FDIC receivership process for insured banks and thrifts sorts most of this out over a much shorter time frame and generally returns the failed institution to private hands right away, she pointed out.

For the first time, the FDIC now has a similar set of receivership powers to close and liquidate systemically important financial firms that are failing. “In resolving failed banks, federal law has long given the FDIC discretion to pay certain creditors more than others when necessary to maintain essential operations or to maximize recoveries,” she said.

Dodd-Frank gives her agency similar discretion in resolving non-bank financial institutions, Bair added. “Our proposed rule makes clear that some creditors will never be deemed essential to operations or maximizing value. It states clearly that shareholders, subordinated debt and long-term bondholders will never qualify to receive additional payments above their liquidation value under the statutory priority of claims. By ensuring that all creditors know they are at risk of loss in a failure, this proposed rule is a solid first step in implementing the resolution authority under Dodd-Frank and ending too big to fail.”

A month earlier, Federal Reserve Board Chairman Ben Bernanke had returned to Princeton University, where he formerly headed the economics department, to discuss “Implications of the Financial Crisis for Economics,” including understanding the problems created by the too-big-to-fail institutions.

“The problem of too big to fail can only be eliminated when market participants believe authorities’ statements that they will not intervene to prevent failures,” he said. “If creditors believe that the government will not rescue firms when their bets go bad, then creditors will have more-appropriate incentives to price, monitor and limit the risk-taking of the firms to which they lend.”

The new resolution regime, under which large, complex financial firms can be placed in receivership, should help restore market discipline by putting a greater burden on creditors and counterparties to monitor the risk-taking of large financial firms, he told the Princeton forum.

I suspect Acting Comptroller of the Currency John Walsh got it about right in comments at the annual American Bankers Association convention in Boston last month. Before expressing his opinion that Dodd-Frank provides a stronger set of tools, which he hopes will be equal to the task, Walsh spoke this caveat: “I can’t honestly say whether we’ve put too big to fail behind us. We won’t really know until the next crisis.”

Bill Poquette is editor-in-chief of BankNews.

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