authority “should be totally funded by those institutions that are regarded as systemically important or too big to fail”

TO BE NOTED: From the FT:

"US poised for finance regulation shake-up

By Tom Braithwaite, Sarah O’Connor and Krishna Guha in Washington

Published: May 17 2009 23:30 | Last updated: May 17 2009 23:30

Congress will next month start the biggest regulatory overhaul of the US financial system in decades, bringing into the open a frantic lobbying effort between banks, regulators and policymakers on what it contains and who pays for it.

The House financial services committee, chaired by Democrat Barney Frank, will hold hearings early in June into reforms outlined by Timothy Geithner, Treasury secretary, say people familiar with the timetable.

But the complexity, coupled with a crowded legislative agenda, means one key pillar – a resolution authority allowing a regulator to seize a failing bank holding company – is not likely to be put in place until year-end.

The cost of the resolution authority and a proposed systemic risk regulator could be borne by both large banks and small, according to people involved, in spite of the entreaties from the hundreds of small US institutions that they should not pay a levy.

Cam Fine, chief executive of the Independent Community Bankers of America, said the authority “should be totally funded by those institutions that are regarded as systemically important or too big to fail”. He said he “felt pretty good about where we stand” and was confident of Mr Geithner’s support.

Other smaller institutions such as hedge funds are also expressing concern that they will suffer from severe “haircuts on contracts” entered into as counterparties with the seized institution, according to one lobbyist.

Sheila Bair, the chairman of the Federal Deposit Insurance Corporation, has been lobbying for early introduction of seizure powers that could be used to take over a large systemically important bank if it was severely weakened by another sudden downturn in the economy.

The FDIC has a long-established system of seizing deposit-taking institutions, running them for a short time before winding them down or selling them, all with the aim of protecting depositors. But the largest banks are organised into bank holding companies, which stand outside current powers.

Mr Geithner has said new powers would allow for an orderly winding up of a systemically important institution, avoiding a repeat of the messy fall-out from Lehman Brothers’ collapse last year or the expensive bail-out of AIG, the insurer.

But several people involved say the way the regulation is interlinked means it would be difficult to fast-track a resolution authority specific to bank holding companies. The current timetable envisages the legislation being voted in the House in the summer and in the Senate late this year.

The eventual legislation is likely to leave open the question of which institutions count as “systemically important” and fall under the new authority’s power. People familiar with the plans say there is reluctance to draw up any fixed list or set of criteria; it would be better, they say, to maintain a certain ambiguity in order to maximise flexibility and induce a sense of caution.

Details of the regulatory overhaul – which also includes increased supervision of the retail market for financial products, standardising rules governing deposit taking institutions and increasing oversight of over-the-counter derivatives – are still being debated."

F.D.I.C. currently has the power to seize depository banks, but does not have similar authority for non-banks, including bank holding companies

TO BE NOTED:

"F.D.I.C. Seeks New Power Over Bank Holding Companies

The Federal Deposit Insurance Corporation is talking with lawmakers about speedy legislation giving it power to wind down troubled bank holding companies, but not a broader range of financial firms, Reuters reported.

The Federal Reserve and U.S. Treasury Department have some disagreement with the F.D.I.C. about exactly what new powers the agency should gain, Reuters said, citing a source speaking anonymously because the meetings have been private.

The F.D.I.C. has been meeting in recent days with lawmakers’ staff, at the request of Congress, about so-called “resolution authority.”

“I think just giving us authority over bank holding companies would be easier… than tackling the larger non-bank systemic institutions,” FDIC Chairman Sheila Bair said after speaking to a National Association of Realtors’ meeting in Washington.

Of her agency’s talks with lawmakers she said: “It’s their call. They seem interested and we’re responding to their questions.”

The F.D.I.C. currently has the power to seize depository banks, but does not have similar authority for non-banks, including bank holding companies such as Citigroup and GMAC, which have both received billions of dollars in government aid.

Treasury Secretary Geithner told Reuters on Friday the government would likely have to provide “substantial” additional capital to GMAC.

The Treasury in March drafted a legislative proposal that names the F.D.I.C. as the resolution authority for a broad range of financial firms, but some members of the administration and bank industry groups have opposed such a plan, saying the F.D.I.C. is not properly equipped for such a large task.

The White House is expected in the next couple weeks to give Congress a plan for comprehensive financial regulatory reform. That proposal is likely to call for the Fed to play a central role in regulating systemic risk in the economy, sources said last week.

The F.D.I.C. is seeking quick passage of a separate piece of legislation for resolution authority, as the broad reform legislation will likely not get passed until close to the end of the year, Reuters said, citing the source.

The more narrow definition of resolution authority would also likely increase the chances the legislation could get passed quickly, as it would calm some concerns the Reuters said, citing the source does not have enough experience to handle complicated companies such as insurer American International Group.

But some lawmakers and administration officials want the resolution authority provision as part of the larger reform legislative package because they believe the systemic risk regulator proposal should dovetail with the authority to wind down large financial firms.

Ms. Bair told a Senate Banking Committee hearing last week that the ability to resolve bank holding companies would give the Reuters said, citing the source “a vital tool.”

She also said the lack of that tool has driven the administration’s policy decisions when dealing with large troubled financial firms.

Another source familiar with the F.D.I.C.’s plans told Reuters on Tuesday that the agency was considering seeking to create a new fund to help deal with any resolution of systemically important financial institutions. ( NB DON )

The source, who asked to remain anonymous because the fund is in the planning stages, told the news service that institutions with over $100 billion in assets could be required to pay into the fund on a regular basis.

The administration has shifted its focus in recent days to financial regulation reform, after the government released last week the results of stress tests on the 19 largest U.S. banks.

The government is driving to tighten regulation of banks and markets to prevent another financial crisis like the one that is currently ravaging economies worldwide.

National Economic Council Director Lawrence Summers, a senior adviser to President Barack Obama, is leading the effort on regulatory restructuring.

The administration hopes the House Financial Services Committee can approve the broad legislative package by July 4, with the goal of final passage by the end of the year."

Creditors probably do have to pay — this legislation will simplify and help manage that process

TO BE NOTED: From the WSJ:

"The Obama administration is seeking broad new resolution authority for banks, Peter Boone and Simon Johnson argue that the powers should be approved by Congress and used quickly and decisively. Boone is chairman of Effective Intervention, a U.K.-based charity, and a research associate at the Centre for Economic Performance, London School of Economics, and Johnson is a former IMF chief economist, and is currently a professor at MIT Sloan School of Management and a senior fellow at the Peterson Institute for International Economics. They run the economic crisis Web site http://BaselineScenario.com.

The Obama administration last week proposed draft legislation for a “resolution authority” that would effectively permit the government to liquidate or restructure large systemic financial institutions. If passed by Congress, these powers would allow the governments to treat nonbank financial institutions more like regulated deposit-taking banks. This authority offers a clear path to recapitalize institutions without using taxpayer money and therefore avoiding some dimensions of moral hazard but, if implemented poorly, the existence of this “nuclear option” can cause panic in financial markets and substantially delay recovery. This fear may be with us already — despite all of the material and moral support already on the table, the market is pricing in the highest ever risk of default for Citigroup senior debt, i.e., about a one in three chance over the next five years. (See the credit-default spreads for major banks.)

Imagine what happens when these powers are passed. The U.S. Treasury and FDIC would immediately have the tools need to walk into America’s largest financial institutions, such as Citibank or Bank of America, and liquidate them, or rewrite their contracts and capital structures. Such powers are clearly useful: if the banks are undercapitalized, and private money is not available, then the government could force creditors to swap claims into equity, thus instantly recapitalizing the banks while avoiding use of taxpayer funds. With such steps, the problem of moral hazard, where creditors to banks are bailed out by taxpayers, would at once be forgotten. Shareholders in banks would lose through dilution, some (unsecured?) creditors would lose with debt-equity swaps, while the nation would be better off having a well-capitalized banking system. The banks would remain private but now be controlled by (ex)creditors.

However, today these powers don’t exist, and none of us know exactly how this authority would be used if it ever lands on Mr. Geithner’s desk. We’ll now have a healthy debate in Congress and then see revised versions passed and signed into law. But as this debate proceeds, creditors and shareholders in all such institutions will be nervous. We’ll be giving the Treasury a “nuclear option” and no one can be sure who is safe. A natural reaction by clients and investors of these banks will be to edge towards the exit immediately and to stay away until the dust has settled. It won’t matter whether institutions are solvent: Due to the uncertainty and risk of losses, investors and clients may run. We’ve seen repeated waves of such panics over the last year, and we can live through them, but each successive one hurts the institutions we are trying to save and delays recovery.

What should the administration do to prevent the panics that can ensue from this legislation? First, if they plan to use it soon, they need to pass this legislation quickly. There is good logic behind requiring creditors to bear part of the cost of restructuring, but we can’t afford to have this hanging over credit markets for months to come.

Second, once passed, the new authority should be used. There is no point in incurring the political and financial costs of passing this legislation now unless it is really needed.

Third, as in any major crisis, the aim should be to use this weapon once and decisively. If the government first hits one “weak” institution then another, and piecemeal restructures the sector, then investors and creditors will constantly “game” the system. This will drive down share and debt prices, forcing the government into action, gradually moving down the chain of institutions. We’ve seen this with successive panics at Bear Stearns, Lehman, AIG, Citigroup, etc. The most solvent institutions today could be made insolvent through higher credit costs brought on by the uncertainty, and the recession will be deeper.

To be decisive, the government needs to implement this authority on large scale at once. For example, they could use a very rigorous stress test to triage institutions (i.e., more serious than the current stress test). Those that would be clearly insolvent in the face of a severe recession can be intervened over a weekend. The government could force a debt-equity swap to recapitalize the institutions, and then reopen them the following Monday as highly capitalized entities. While not all creditors with the same seniority would be treated equally — this would be a major difference and potential advantage relative to bankruptcy — the benefits of rapid actions can be justified for the economy as a whole. The institutions that are solvent, but require more capital, could be given a short timeframe to raise funds in private markets. If they cannot raise funds, the government could still intervene. With a gun to their head, there is no doubt they will find new capital, at very low share prices, that will ensure they are highly solvent.

This route to recapitalization would not be pleasant. Bank shareholders and creditors will cry foul. There will be several months of turmoil in markets, and there will be substantial disruption since bond holders and some creditors may be required to take losses when they receive equity. It will also send shockwaves to other undercapitalized institutions around the world, and could lead to their share and debt prices falling in anticipation that other governments will follow America’s example.

However, it is surely better than doing nothing, or too little, and waiting to see what happens. America needs a well capitalized financial system to restore confidence in general and the flow of credit in particular. Given there is little chance of new funding for banks from Congress, there is no easy path to recapitalize banks. Creditors probably do have to pay — this legislation will simplify and help manage that process. Let’s hope the Treasury understands how to use the weapon it is seeking."