FDIC lacks tool to avert bailouts

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 such as 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.
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 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 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.
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. 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. &#8226