Earlier today, in a speech at the Economic Club of New York, FDIC Chairman Sheila Bair urged the reation of a "new resolution regime" for large, systemically important financial institutions, which will do "a better job of imposing loss on investors and creditors, instead of leaving it in the hands of government and the laps of the taxpayer." She observed that
"the bankruptcy process simply does not work for large, systemically important financial institutions in a way that can preserve stability and avoid disruptions in the financial system. The lack of an effective resolution mechanism for large financial organizations is driving many of our policy choices. It has contributed to unprecedented government intervention into private companies. It has fed the "too big to fail" presumption, which has eroded market discipline for those who invest and lend to very large institutions. And this intervention, in turn, has given rise to public cynicism about the system and anger directed at the government and financial market participants."
She asserted that the FDIC's inability to resolve holding companies and other non-bank affiliates of depository institutions has "hamstring the FDIC and our ability to preserve the bank's franchise value, and minimize losses to the Deposit Insurance Fund (which is our number one mandate)." She also described specific weaknesses of the bankruptcy process:
"Bankruptcy is designed to protect the interests of creditors, not to prevent a meltdown of the financial system when a systemically important financial firm gets into trouble. When a firm is placed into bankruptcy, an automatic stay is put on most creditor claims to allow management time to develop a reorganization plan. This can create liquidity problems for creditors who must wait to get their money. For financial firms, bankruptcy can trigger a rush to the door, as counterparties to derivatives contracts exercise their rights to immediately terminate the contracts, net out their exposures, and sell any supporting collateral. When these statutory rights were initially provided in the 1980s and expanded in 2005, they were designed to reduce the risks of market disruption. However, during periods of economic instability, this rush-to-the-door can overwhelm the market's ability to complete settlements, depress prices for the underlying assets, and further destabilize the markets. This can have a domino effect across financial markets, as other firms are forced to adjust their balance sheets."
She recommended the creation of a new resolution regime that represents a "realistic way to close and resolve non-viable systemic institutions" through "an orderly unwinding of the institution in a way that protects the broader economy and the taxpayer, not just private financial interests."
For the first time, Ms. Bair also expressly recommended that the FDIC be given this expanded resolution authority. In her view, there is no need for "another government bureaucracy or program. ... The FDIC is up to the task, and whether alone or in conjunction with other agencies, the FDIC is central to the solution. Given our many years of experience resolving banks and closing them, we're well-suited to run a new resolution program."