So Mike Konczal has been writing some important posts on resolution authority, and some e-mail conversation led me to realize that we're still confused about the details of the resolution mechanism. I reached out to some Senate aides who are familiar with the legislation and asked them run me through the details. Wonky!
To start: the legislation tries to make it difficult for regulators to prop up banks; for instance, the Federal Reserve can't lend to individual institutions. So if a bank runs into trouble and regulators decide that normal bankruptcy is too risky for the system as a whole, they give three bankruptcy judges 24 hours to determine if the bank is insolvent. If it is insolvent, the treasury secretary appoints the FDIC to be receiver. At first glance, this is the only way for taxpayer money to end up in the system, so the administration will be held politically accountable for the decision.
Next, there is a $50 billion insurance fund that will come from money assessed from banks based on the amount of risk that they carry. This is the banks' "skin in the game," and it is the first money that will be spent in the case of liquidation. It is primarily intended to allow the receiver to maintain the operations of the company while its assets are parceled out in order to avoid a fire sale. This does not necessarily entail paying off counter-parties but rather will allow them to hold various contracts, like the AIG derivatives, by posting margin rather than simply paying off their full value.
But that's not all the money there is -- Mike is rightly worried that the Fund is too small, and that's where the next step of receivership comes in. The legislation allows the FDIC to assess the institution and then borrow up to 90 percent of the FDIC's valuation of its unsecured assets -- not whatever numbers the bank has on the books -- from the Treasury in order to complete the receivership. Finally, there is a post-event mechanism to recoup any losses, similar to but more narrowly structured than the president's TARP recovery tax. On the whole, my sources say, the process has many similarities to a Chapter 7 liquidation -- management and shareholders are wiped out, and bondholders will get similar treatment to a bankruptcy; they will not, I was told, get 100 cents on the dollar.
All throughout this process, there are reporting requirements to Congress early on in the process to keep regulators from hiding what they're doing from Congress.
One other note on this: While funeral plans, which would require big financial companies to maintain strategies for winding down their firms, are certainly not the be-all end-all of the Dodd bill, they're not quite as weak as Mike characterizes them -- while they are certainly still ripe for gaming, they're not just whatever the company wants to write and submit. Regulators will need to approve these plans well in advance and work with the banks to ensure they meet specific standards, or else they can make changes to the company. This also forces more accountability on regulators, who won't be able to claim they didn't discuss winding down a firm until it was too late.
Obviously, all of this raises the question, will regulators employ these authorities and do a rigorous job enforcing them? Everyone I speak to about this says appointing enthusiastic regulators is a necessary, not merely sufficient, condition, to a successful regulatory regime and that the temptation always exists for regulators to push off hard decisions. That, though, is the whole point of creating structures that force them to make the right calls.
-- Tim Fernholz
