Why FDIC is Running Out of Time for Resolution Planning

Quoting Thomas Edison, Marty Gruenberg recently said, "Vision without execution is hallucination."

It's a clever quote and the chairman of the Federal Deposit Insurance Corp. was trying to convince an audience that his agency is well on its way to ending too big to fail via its strategy to resolve giant firms that get into trouble.

But for folks following this policymaking closely, the quote backfired.

(To see more posts from Barb Rehm's Blog, click here.)

It's been nearly two years since the FDIC unveiled its so-called "single point of entry" approach, which is designed to implement the Dodd-Frank Act's mandate for orderly liquidations of systemically important financial companies.

Nearly four months after that unveiling, in May 2012, Gruenberg made a big splash with his first speech on the idea at the Federal Reserve Bank of Chicago's annual bank policy conference.

Since then Gruenberg and other FDIC officials have given numerous speeches that largely say the same thing: Single point of entry will end "too big to fail." It's almost as if saying it often enough will make it true. That's not a hallucination, but it's close enough.

Don't get me wrong. The FDIC deserves a ton of credit for coming up with the idea and for its initial rollout. But 18 months have gone by since Gruenberg sketched the plan. It's time for more progress and that means more details.

Gruenberg said they are coming – and soon.

"I can see why there may be impatience, but I think we've established credibility so far and I think we are very close to building on that," Gruenberg said in an interview last week(Nov.27). "We've been moving step by step in what I think is a thoughtful way that will strengthen [the process] and add credibility."

Gruenberg has been around the policy block more than a few times, and he's earned a reputation for thoughtful, gradual leadership. And it's not as if he can act solo; Gruenberg needs a majority of his board to join him. But the longer the FDIC takes to put some meat on the bones of its single point of entry idea, the greater risk it runs of the policy simply imploding.

"If we don't see any of the operational execution by very early in the first quarter of next year, it will collapse," said Karen Shaw Petrou of Federal Financial Analytics. "It ceases to be credible."

Petrou's firm analyzed the FDIC's strategy for resolving large banks in an October 2012 report. It was largely complimentary, but the report noted a number of holes that needed filling.

"More than a year later, I could write the same paper," Petrou said. "This is taking too long. The single point of entry is, in its broad framework, credible but there are really significant issues" that need clarification.

For readers in need of a refresher, this is how single point of entry is supposed to work: FDIC seizes an institution considered crucial to financial stability at the holding company level (that's the "'single entry point"). The FDIC sets up a bridge company that continues to operate the holding company's various subsidiaries pretty much business as usual. The FDIC wipes out shareholders, ousts management and develops a plan for resolving the company that's executed by the bridge entity. In the end, the world has one fewer systemically important financial company as its parts are sold off or liquidated.

Taxpayers finance none of this. The bridge company is capitalized by the holding company's owners and creditors.

So far, so good. But many details are lacking.

Art Murton, the director of the FDIC's Office of Complex Financial Institutions, speaking at The Clearing House annual conference in New York on Nov. 21, said a policy statement fleshing out single point of entry would be released for public comment in December. (His predecessor, Jim Wigand, had promised the same document by yearend 2012.) Among his list of unanswered questions, Murton listed these: how the bridge company would be governed; how it would pay claims; how the troubled firm would be restructured so "we never have this happen again."

Murton also asked what would happen if there isn't enough money at the holding company to capitalize the bridge company. In that case, the FDIC could tap the "Orderly Liquidation Fund," a creation of Dodd-Frank designed to prevent another taxpayer bailout of banking. The reform law requires other systemically important firms to repay any money dished out by the Fund and the FDIC will have to figure out how to do that.

But one of the bigger questions looming is one the FDIC can't answer: how much equity and debt will large financial holding companies have to hold?

In the convoluted world that is federal banking regulation, the FDIC is not drafting this rule. The Federal Reserve Board is because it oversees holding companies.

Mark Van Der Weide, the Fed's deputy director of supervision, speaking at the same conference, said the Fed would publish its proposal for holding company debt "in the next few months."

Van Der Weide acknowledged that as creditors realize how single point of entry will work, they will demand higher rates and that in turn will encourage banking companies to cut back on this type of borrowing. Before that happens, the Fed wants to establish a floor and ensure, as Ven Der Weide put it, that the right amount of debt and equity are held by the right investors.

"They have to create the impression they can handle it all at the holding company," said Dick Herring, a finance professor at the University of Pennsylvania's Wharton School, in an interview. "That means an awful lot of convertible debt — a lot more than we have now."

Some industry experts expect the number to be north of 20% of risk-weighted assets.

In addition to "how much," there are plenty of other details still to be filled in.

Van Der Wiede said the Fed will have to decide which firms must comply with the holding company debt requirement and then lay out minimum terms and conditions such as the duration of the debt. He said it would be at least six months and more likely a year. The Fed also may limit who may invest in this debt. (Presumably other banks will be barred from buying this holding company debt to prevent the system from becoming even more interconnected.) Finally, Van Der Weide said the Fed's proposal will contain provisions governing the structure of these systemically important firms. He didn't get specific but did say regulators want to be sure that capital can more "up and down the organization." In other words, money can be funneled up from well-capitalized units to the holding company and back down to subsidiaries that need it.

Unlike other parts of Dodd-Frank, large bank executives have a keen interest in single point of entry being adopted quickly.

The sooner the FDIC can make a case that it can liquidate a giant financial firm without causing chaos in the markets, industry leaders will have a stronger case when they argue additional layers of prudential standards or capital surcharges are not needed.

"I agree the longer it takes and the more details we need, the less likely it gets," Herring said. "But the big banks are a powerful lobby and they don't see anything they like as an alternative."