Seizure Strategy for Failed Financial Firms Released by FDIC

The Federal Deposit Insurance Corp. released its strategy for dismantling big failing financial institutions even as board members said the plan continues to face major obstacles.

The FDIC’s guidance, opened for a 60-day public comment period today, illuminates a key power bestowed on the agency by the 2010 Dodd-Frank Act: the authority to seize and restructure a large, failing financial company. The FDIC will seize a U.S. firm at the parent-company level, impose losses on shareholders and give creditors equity in a new holding company, according to the strategy.

“The FDIC must resolve systemically important financial institutions in a manner that holds their shareholders, creditors and culpable management accountable for their failure while maintaining the stability of the U.S. financial system,” Chairman Martin Gruenberg said at a board meeting today in Washington. “Unsecured creditors and shareholders must bear the losses.”

Board members including Vice Chairman Thomas Hoenig have cited serious potential problems with the strategy. Hoenig said the FDIC “must address a series of obstacles,” such as international cooperation, the competitive advantage to banks that could be recapitalized with public funds and the sufficiency of equity and debt to absorb losses.

“Although assumed to be sufficient, the amount of equity and debt necessary to assure the bridge company will be well capitalized has yet to be defined and leaves a critical component to the strategy unaddressed,” Hoenig said, referring to an intermediate step in the restructuring process.

FDIC Authority

In an effort to ensure that the biggest banks will no longer be considered too big to fail, Dodd-Frank gave the FDIC authority to dissolve large bank holding companies or other systemically important financial firms, as it has long done with depository institutions. The power is only supposed to be used if a firm’s sudden end would threaten to crash the wider financial system and can’t be safely handled in bankruptcy.

The FDIC will tap into public money as a last resort in a big-bank collapse, according to the strategy document.

“If the customary sources of funding are not immediately available, the FDIC might provide guarantees or temporary secured advances” from an emergency government fund, the agency said. Any withdrawals from the fund would be replaced by future fees on other big financial firms.

Sustaining Subsidiaries

The strategy also depends on healthy domestic and international subsidiaries being allowed to continue doing business while the parent company is liquidated. It requires other nations -- particularly the U.K. -- to come up with similar systems in which home-country regulators handle their native bank failures.

To date, the FDIC and U.K. regulators established a joint white paper outlining their intention to cooperate in a failure, even as the details haven’t yet been made final. The agency has worked on similar agreements with German and Swiss counterparts and has also been in talks with China and Japan.

The cross-border arrangements have “not been tested under crisis,” Hoenig said, adding that governments are inclined to capture the assets in their jurisdictions when a firm collapses. “It is to their citizens’ financial security that sovereigns owe their first allegiance and is a natural reaction when managing through a financial crisis.”

The Federal Reserve has been working on a rule to ensure bank holding companies keep enough long-term unsecured debt to absorb losses and make such a plan viable.

To contact the reporter on this story: Jesse Hamilton in Washington at jhamilton33@bloomberg.net

To contact the editor responsible for this story: Maura Reynolds at mreynolds34@bloomberg.net

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