FDIC Wind-Down Plan Has Promise, But So Does Bankruptcy Reform: Paper

WASHINGTON — A bipartisan think tank founded by four former senators is endorsing a Federal Deposit Insurance Corp. strategy for implementing Dodd-Frank Act resolution powers, while also arguing that a beefed-up bankruptcy code could also unwind failed behemoths without using the agency's new powers.

A report issued by the Bipartisan Policy Center Tuesday said that "single point of entry" resolutions — the type of cleanup favored by the FDIC for resolving mammoth firms, in which the parent company is closed and subsidiaries are transferred to a bridge firm — "is a viable solution to the too-big-to-fail problem if properly implemented."

The FDIC's "orderly liquidation authority" under Dodd-Frank "contains the tools necessary to resolve" systemically important financial institutions, "including SIFIs that have significant cross-border or global operations," Randall Guynn, a partner at Davis Polk & Wardwell and one of the paper's authors, said at a briefing to unveil the report. Other co-authors included former FDIC official John Bovenzi and University of Rochester professor Thomas Jackson.

But the report — one of several sponsored by the BPC on the progress of Dodd-Frank measures — also recommended several steps that the FDIC should embrace for the plan to work. (The group was founded by former Sens. Howard Baker, Tom Daschle, Bob Dole and George Mitchell to provide a bipartisan voice on policy areas ranging from heath care to national security.)

The paper also said Congress could incorporate the single point of entry process into reforms of the bankruptcy code to make the bankruptcy process more conducive to resolving financial giants.

"Certain improvements should be made to the bankruptcy code so that it can be more effective … to keep OLA as rare as possible," Guynn said.

In 2010, Dodd-Frank gave the government unprecedented power to seize a failing financial firm and put it through a special FDIC-managed resolution if officials thought its bankruptcy could wreck the financial markets. The "single point of entry" plan supported by the FDIC would essentially wipe out shareholders of a failed holding company, and convert creditor claims into equity to recapitalize the bridge firm that inherited its subsidiaries.

The FDIC's single point of entry idea "is a tremendous step forward … for resolving too big to fail because it simplifies an enormously complex process," said Bovenzi, who was formerly the FDIC's chief operating officer and is now a partner at Oliver Wyman.

The strategy has received substantial support from attorneys and other representatives of large banks who see it as a more attractive option than proposals to limit the activities of operating institutions to curb "too big to fail."

But the authors issued several recommendations for the agency to follow. They include ensuring that the capital and debt structure of a parent firm, which would be closed under the FDIC's model, be subordinated to that of its subsidiaries. That would guarantee that the new firm and its surviving affiliates have the resources to operate, they argued.

The paper also urged the agency to clarify how the new entity would be funded through liquidity made available by the government.

"The distinction between providing capital to insolvent firms and providing temporary, fully secured liquidity at above-market interest rates to solvent, sufficiently capitalized (or recapitalized) institutions marks the line between unacceptable taxpayer-funded bailouts and acceptable government-provided short-term liquidity that is fully secured by collateral," according to the paper.

The report says an upcoming policy statement the FDIC is expected to release detailing the OLA process should reinforce the agency's support for single-point-of-entry cleanups and clarify how the "orderly liquidation fund" — a Treasury Department liquidity facility established by Dodd-Frank to help fund resolution operations — would function, among other recommendations.

"The FDIC should explain how the Orderly Liquidation Fund will be used in a SPOE recapitalization to provide liquidity to a sufficiently capitalized bridge financial company and its operating subsidiaries. The OLF is clearly intended to provide fully secured liquidity, and the statute precludes it from being used to provide capital," the paper said. "To reinforce that statutory prohibition, however, the FDIC should confirm in its policy statement that the OLF will not be used to provide capital that insulates shareholders or creditors against losses."

Yet the report expresses just as much support for reforming the bankruptcy code as a means to preventing the kind of chaos that ensued from large firms failing during the financial crisis.

"This report concludes that the FDIC's SPOE … strategy, whether carried out under OLA or the Bankruptcy Code, should succeed in solving a critical part of the too-big-to-fail problem, by allowing any SIFI to fail without resorting to taxpayer-funded bailouts or a collapse of the financial system, if the recommendations contained in this report are implemented," the paper said.

Enhancing federal bankruptcy rules is often supported by critics of the FDIC's authority under Dodd-Frank as an alternative method to resolve large financial firms.

Some of the paper's "recommendations would make the Bankruptcy Code more effective in achieving the same goals, thus drastically reducing the need to rely on OLA," the report said.

Congressional reforms of the bankruptcy process to allow it to meet the same goals as the FDIC's OLA, the paper said, would include provisions outlining the role of federal bank regulators in the bankruptcy of a company. Other recommended changes include authorizing bankruptcy judges to transfer a parent holding company's assets into a few firm and enacting rules allowing the new parent firm created through the bankruptcy process to have access to the Federal Reserve's discount window.

"This recommendation is essential to ensure that SIFIs being reorganized under the Bankruptcy Code have the same access to a temporary fully secured liquidity facility as SIFIs being resolved under OLA," the paper says.