U.S. regulators given new powers to dismantle “too-big-to-fail” financial firms are still working to draw up so-called living wills -- a central component of the toolkit needed to prevent future bailouts.
While the Federal Deposit Insurance Corp. gained the authority in the Dodd-Frank Act to seize and unwind systemically important firms, the agency is still pushing to finalize the living wills that outline how to dismantle the firms if they fail.
In the interim, the agency has been developing contingency plans in coordination with the Federal Reserve that would allow them to take over a systemically important firm even if a living will was not in place, according to an agency official who was not authorized to speak publicly about the activities.
Implementing the agency’s new powers “in a credible way is really the major new challenge for the agency,” Martin J. Gruenberg, the FDIC’s acting chairman, said at a July 27 Senate Banking Committee hearing. “In fact, in some sense, it’s a major new challenge for any financial regulator around the world.”
As global markets churn and investors speculate about the health of large banks like Bank of America Corp. and Citigroup Inc., some investors and credit-rating firm Standard & Poor’s say they are concerned that regulators still lack the means to wind down systemically important financial institutions, or SIFIs, and may have to resort to bailouts.
“From our perspective, the most recent financial crisis is not completely over,” S&P analyst Rodrigo Quintanilla wrote in a July 12 report. “Therefore a SIFI without a workable living will could get into trouble in the near term.”
The resolution authority was drafted by U.S. lawmakers in the wake of the 2008 financial crisis that led to the failure of Lehman Brothers Holdings Inc. and a series of ad-hoc bank mergers and bailouts. The new resolution structure, signed into law by President Barack Obama in July 2010, was designed to prevent future bailouts by giving the FDIC authority to liquidate even the biggest insolvent firms.
Former FDIC Chairman Sheila Bair, who left office in July, stated repeatedly that after Dodd-Frank, there would be no bailouts even for institutions as large and sprawling as Bank of America or Citigroup.
The FDIC’s new authority “strictly prohibits bailouts,” Bair said in June 30 testimony to the Senate Banking Committee. “It is a powerful tool that greatly enhances our ability to provide continuity and minimize losses in financial institution failures while imposing any losses on shareholders and unsecured creditors.”
The agency over the past year has conducted a whirlwind of hiring, rule-writing and interagency negotiations in its effort to implement its new powers. It has already laid out the procedure it will use to wind down a firm, including the order in which creditors would be paid.
The most important missing piece are the living wills, regulators have said. Even though the law gives the FDIC and the Federal Reserve, the primary regulator for bank-holding companies, until Jan. 21, 2012 to complete the rule, officials are pushing to finalize it by the end of August.
A draft proposal released in April outlined what the resolution plans must contain, including details of the ownership structure, assets, liabilities, contractual obligations and nonbank subsidiaries. Firms would be required to file plans six months after the joint rule is finalized, and to update and resubmit them each year. Regulators could force firms who filed inadequate plans to divest lines of business.
In the meantime, the agency has focused on building its new Office of Complex Financial Institutions, which includes a group responsible for monitoring the health of the largest banks and how hard they would be to resolve. The office, established in August 2010, has dual responsibilities: planning and working with institutions on their living wills, while also preparing and testing scenarios that would require the agency to deploy its authority in the near future, according to the agency official.
The resolution structure has support from the financial institutions it may one day be used to dissolve. Still, the draft rule on the living wills has been subject to heavy lobbying from financial firms. Wells Fargo & Co., the San Francisco-based lender, filed a comment letter in June listing concerns about disclosure requirements and timelines. The bank also objected to the possibility that some healthy firms would be required to restructure.
“We are also very concerned about the position of some regulators that banking organizations should be simplified for the sole purpose of permitting quicker and simpler resolution following failure,” James F. Powers, senior company counsel, wrote in the June 10 letter to the Fed and FDIC.
Representatives from New York-based Goldman Sachs Group Inc., Morgan Stanley and JPMorgan Chase & Co., London-based Standard Chartered Plc and Barclays PLC, Frankfurt-based Deutsche Bank AG and Spanish lender Banco Santander SA have all met with agency representatives on the new rules, according to disclosures on the FDIC website.
The agency also continues to grapple with how to resolve institutions that have extensive overseas operations. The FDIC is building a division inside the complex institutions office charged with solving what Gruenberg said is the most difficult part of dismantling any global bank -- effective coordination across borders.
“From an operational side, it’s our top priority,” Gruenberg, who was nominated to serve as the agency’s chairman, said at his July confirmation hearing. He added that he expected the international group to be up and running by the end of the year.
The Financial Stability Board, which has been conducting “war game” failure scenarios for more than two years, released a 74-page document in July outlining recommendations and timelines for international agreements on systemic institutions. Michael Krimminger, the FDIC’s general counsel, serves on the FSB’s Resolution Steering Committee. A final FSB proposal will be presented in November at the Group of 20 finance ministers meeting in Cannes, France.
The FDIC, in public statements and in private meetings, has been working to convince investors and analysts that its new resolution powers will prevent a repeat of the 2008 bailouts and mergers.
Wall Street Meeting
Bair and Jason Cave, deputy director of the FDIC’s complex institutions division, met with 18 fixed-income asset managers in New York on March 3 to discuss the “impact on credit markets” of the agency’s new power, according to a disclosure posted on the FDIC website. Participants included Peter Weinberg, founder of Perella Weinberg Partners LP; Seth Bernstein, the head of global fixed income for JPMorgan Investment Management; Ken Leech, the head of the global investment strategy committee for Western Asset Management Co.; Legg Mason Inc.’s bond unit; and Kent Wosepka, managing director and global head of corporate credit at Goldman Sachs’s private wealth management division.
S&P, the New York-based unit of McGraw-Hill Companies Inc., said it believes significant government support still exists for the largest banks. The new powers “will not by themselves prevent future government support for a handful of institutions,” the company said in its July report.
That standoff may persist for a while, said Donald Lamson, counsel at New York-based Shearman & Sterling LLP, a former assistant director at the Office of the Comptroller of the Currency who helped draft the Dodd-Frank law. He said there may be only one thing that will convince the market that the FDIC’s authority is sufficient.
“Until they actually do it, I doubt that anybody is going to believe it really can be done,” Lamson said.