government does not have the authority to seize a bank holding company and place it into receivership (or conservatorship)

TO BE NOTED: From The Economics Of Contempt:

"Bank Holding Companies (Again)

Serial bloviator Simon Johnson writes:

In most countries, the course of action would be clear. The government would take over banks, remove “bad assets” from their balance sheets, inject fresh capital, and put them bank into the private sector. This is essentially what the FDIC does when it takes over a bank. There is some debate about whether the government currently has the power to do this for bank holding companies – Tim Geithner says no, Thomas Hoenig says yes – but if not, this is certainly something the Obama administration could press for.

Let's try this one more time: The government does not have the authority to seize a bank holding company and place it into receivership (or conservatorship). There is no debate about this.

Johnson clearly doesn't understand Hoenig's argument, because he was very clear on this point. Hoenig wrote:

One of the difficulties with all of these options is that while there are time-tested, fast resolution processes in place for depository institutions, today's largest financial institutions are conglomerate financial holding companies with many financial subsidiaries that are not banks.

The bank subsidiaries could be placed into FDIC receivership, but the only other option under current law for the holding company and other subsidiaries is a bankruptcy process.

Even an MIT professor should be able to understand that.

Posted by Economics of Contempt"

Economics of Contempt said...

The regulators got Continental's holding company to agree to a capital injection that gave the government the authority to replace the CEO of the holding company. The government had no authority to simply seize the holding company and replace the management. That's why Hoenig is advocating for a "negotiated conservatorship" of bank holding companies -- because the government would have to get the BHCs to agree to a government takeover.

The only reason Continental's holding company agreed to the government takeover was because the Continental Illinois bank -- which the FDIC did have the authority to seize -- was pretty much its only subsidiary. But today's BHCs own a lot more than just FDIC-insured banks -- Citigroup has over 2,000 principal subsidiaries -- and many (if not most) of their subsidiaries are organized in foreign countries. So even if the government got Citigroup or BofA's holding company to agree to a government takeover, most of the BHC's assets and liabilities would be beyond the power of any receivership or conservatorship. That means the government still wouldn't have the authority to "clean up" the BHC's balance sheet -- because it wouldn't have the power, in particular, to repudiate the BHC's outstanding contractual obligations. And if that's the case, then what would be the point of the government takeover in the first place?

May 8, 2009 2:29 PM

the plan would require those firms seeking government assistance to make the taxpayer senior to all shareholders

TO BE NOTED: From the FT:

"Troubled banks must be allowed a way to fail

Thomas Hoenig

Published: May 3 2009 19:01 | Last updated: May 3 2009 19:01

When the financial crisis began to unfold in 2007, US policymakers reacted quickly out of fear that rapidly evolving events would lead to a global economic collapse. In my view, the policy response to this point has been ad hoc, resulting in inequitable outcomes among firms, creditors, and investors. Despite taking a number of actions to stabilise markets and institutions, uncertainty continues and markets remain stressed.

I believe there is an alternative method for addressing this crisis that deals more effectively with the issues we currently face while also considering the long-run consequences of those actions: the implementation of a systematic plan to resolve large, problem financial institutions.

In recent weeks, I have outlined such a resolution framework for dealing with these large, systemically important institutions. Boiled down to its simplest elements, the plan would require those firms seeking government assistance to make the taxpayer senior to all shareholders, with the government determining the circumstances for managers and directors. These firms would be operated by outside individuals with no conflicts involving either the firm or its competitors.

Non-viable institutions would be allowed to fail and be placed into a negotiated conservatorship or a bridge institution, with the bad assets liquidated while the remainder of the firm is operated under new management and re-privatised as soon as is feasible. This plan is similar to what was done in Sweden in the 1990s and in the US with the failure of Continental Illinois in the 1980s.

This plan has many advantages, including that management and shareholders bear the costs for their actions before taxpayer funds are committed. This process also is equitable across all firms; is similar to what is currently done with smaller banks; and provides a definitive process that should reduce market uncertainty. These are important reasons to implement this kind of resolution process.

In contrast to this suggested approach, the current policy raises a host of issues:

● Certain companies have not been allowed to fail and, as a result, the moral hazard problem has substantially worsened. Capitalism is a process of failure and renewal, and a “too big to fail” policy undermines this renewal and makes the financial system and our economy less efficient.

● So-called “too big to fail” firms have been given a competitive advantage and, rather than being held accountable for their actions, they have actually been subsidised in becoming more economically and politically powerful.

● The US government has poured billions of dollars into these firms without a defined resolution process, adding to our national debt. While there will be some repayment, there also will be losses. The longer resolution is postponed, the greater the losses and the larger the debt burden.

● As these institutions are under repair, the Federal Reserve is making loans directly to specific sectors of the economy, causing the Fed to allocate credit and take on a fiscal as well as a monetary policy role. This is reflected in the fact that its balance sheet continues to swell, which may compromise the independence of the Federal Reserve and make it more difficult to contain inflation in the years to come.

● Failing effectively to resolve these non-viable firms has long-term consequences. We have entrenched these even larger, systemically important, “too big to fail” institutions into the economic system, assuring that past mistakes will be repeated.

Certainly, the approach I suggest for resolving these large firms also is not without substantial cost, but it looks to both the short and long run.

A systematic approach would reduce the uncertainty that has paralysed financial markets; the cost is more measurable and therefre manageable; and there will be fewer adverse consequences compared to the path we are on now.

Because we still have far to go in this crisis, there remains time to define a clear process for resolving large institutional failure. Without one, the consequences will involve a series of short-term events and far more uncertainty for the global economy in the long run.

While I agree that central banks must sometimes take actions affecting the short run, they must keep the long run in focus or risk failing their mission.

The writer is president of the Federal Reserve Bank of Kansas City"

although the United States has several thousand banks, only 19 have more than $100 billion of assets

TO BE NOTED: From Bloomberg:

"Hoenig Says Few Big U.S. Banks to Need More Bailouts (Update2)

Share | Email | Print | A A A

By Steve Matthews

April 9 (Bloomberg) -- Government stress tests of U.S. banks’ ability to withstand a deeper recession are likely to indicate that most don’t need more taxpayer money, Federal Reserve Bank of Kansas City President Thomas Hoenig said.

“I would point out, first, that although the United States has several thousand banks, only 19 have more than $100 billion of assets, and that after supervisory authorities evaluate their condition, it is likely that few would require further government intervention,” Hoenig said in the text of a speech in Tulsa, Oklahoma.

The remarks came while stocks rallied worldwide today as better-than-estimated earnings at Wells Fargo & Co. boosted confidence in the financial system and speculation that American banks will pass stress tests. Federal Reserve Bank of Minneapolis President Gary Stern said that while “appreciable strains” remain in credit markets, the resumption of U.S. economic growth “should not be too far off.”

President Barack Obama will get a progress report on stress tests at the 19 biggest U.S. banks when he meets tomorrow with his economic team. The exams, to conclude by the end of April, are designed to show how much extra capital banks may need to survive a deeper economic downturn.

Hoenig didn’t discuss the current U.S. economic outlook or interest-rate policy in his speech.

Speaking in Sioux Falls, South Dakota, Stern said, “while it is still far too early to fully tally results, there has been progress and I anticipate more to come.”

Failing Banks

In his speech, Hoenig repeated his view that the government shouldn’t prop up failing financial institutions. Instead, officials should take over institutions temporarily and wind them down, as they did with the takeover of Continental Illinois National Bank & Trust Co. in 1984.

“There has been much talk lately about a new resolution process for systemically important firms that Congress could enact, and I would encourage this be implemented as quickly as possible, but we do not have to wait for new authority,” Hoenig told the Tulsa Metro Chamber of Commerce. “We can act immediately, using essentially the same steps we used for Continental.”

Treasury Secretary Timothy Geithner and Fed Chairman Ben S. Bernanke last month called for new powers to take over and wind down failing financial companies after the government’s rescue of American International Group Inc. Bernanke and Geithner also called for stronger regulation to constrain the risks taken by firms that could endanger the financial system.

Conservatorship

“An extremely large firm that has failed would have to be temporarily operated as a conservatorship or a bridge organization and then reprivatized as quickly as is economically feasible,” Hoenig said. “We cannot simply add more capital without a change in the firm’s ownership and management and expect different outcomes.”

While the Federal Deposit Insurance Corp. has the power to take over failing deposit-taking firms and wind down their assets, no such authority exists for financial firms that aren’t classified as banks, such as AIG or a hedge fund with extensive links throughout the banking system.

Hoenig said calling a firm “too big to fail” is a “misstatement” because a bank deemed insolvent “has failed.”

“I believe that failure is an option,” he said.

Undoing Stimulus

Answering questions from the audience after his speech, Hoenig said the Fed must be prepared to remove its stimulus in a timely manner to ensure the economy doesn’t face a period of high inflation similar to the early 1980s.

“ You cannot wait until you know for sure the economy is recovering,” Hoenig said, adding that ”employment growth tends to lag” and may not be the best indicator of recovery. “We will watch every indicator of data that suggests we have a recovery under way.”

Hoenig also said if the U.S. manages its economy well, the U.S. dollar should remain the world’s reserve currency.

“It is a matter of running your economy properly,” he said. “When the U.S. does that, and I think we will, I think we will remain the largest, most successful reserve currency on the face of the earth.”

we nevertheless are drifting into a situation where institutions are being nationalized piecemeal with no resolution of the crisis

From Paul Kedrosky:

"Fed''s Hoenig: "Too Big Has Failed"

By Paul Kedrosky · Friday, March 6, 2009 · ShareThis

This is important dissension in the reserve system ranks. Here is Kansas City Fed President Thomas Hoenig explaining why current bank policy has failed, and why we're already nationalizing banks, but doing it wrongly.

We have been slow to face up to the fundamental problems in our financial system and reluctant to take decisive action with respect to failing institutions. ... We have been quick to provide liquidity and public capital, but we have not defined a consistent plan and not addressed the basic shortcomings and, in some cases, the insolvent position of these institutions.

We understandably would prefer not to "nationalize" these businesses, but in reacting as we are, we nevertheless are drifting into a situation where institutions are being nationalized piecemeal with no resolution of the crisis.

Read the whole thing. It is highly recommended.

[KC Fed via CR]

Me:
Don the libertDem

This is bizarre. We've now had Bernanke, Bair, and Hoening, admit that there was no contingency plan for seizing an insolvent large bank. What then was the plan? Surely somebody had to have considered this possibility. We don't let banks just go bankrupt.

Based on the actions in September, with Wachovia, Merrill, etc, the plan must have been to have an insolvent large bank merge with another large bank, at whatever subsidized cost to the government that was necessary. This in effect made Too Big To Fail a government policy. Now that we know large banks are the problem, this makes the current crisis a puzzle without a solution. Plus, since we have encouraged these behemoths, like the B of A and Merrill, to merge, we're sort of stuck propping them up come what may. In other words, to get out of this behemoth created mess, we have to create behemoths in the short term.

Also, in saying that the US taxpayer must fund these behemoth's debts to stop a Calling Run, we've announced that, even as the taxpayers have to spend more money, the investors are actually more important than the taxpayers. At the very least, we need to acknowledge that we need to go back to the drawing board. I'm pushing narrow banking, but anything is better than this. When you need to keep proven buffoons in management because you can't find anybody else, you know that you're in bad shape.