For all the hand-wringing over Too Big to Fail, the debate glosses over an important distinction.

Bailouts are indeed over for individual institutions and they will never end for the industry as a whole.

Barbara A. Rehm

And that is how it must be.

When an economic crisis hits and threatens our financial system, the government will step in with aid because the country needs a functioning banking system. But the Dodd-Frank Act, via the orderly liquidation authority in Title II, prevents government rescues of individual institutions.

Congress gave this job of ending TBTF to the Federal Deposit Insurance Corp., and the agency put Jim Wigand, a 28-year agency veteran, in charge.

"Without a credible resolution strategy that is understood by the marketplace, you cannot end too big to fail," he says. So in an interview this week, Wigand put some meat on the bones of the agency's plan to take Dodd-Frank from law to reality.

The agency rolled out its strategy to its Systemic Institution Advisory Committee in January and has been quietly vetting it since. Acting Chairman Marty Gruenberg raised its public profile by outlining the approach in a speech to a Chicago Fed meeting last week.

Here is how the FDIC envisions the future: when a financial giant becomes insolvent – be it a bank or any company designated a systemically important financial institution, SIFI for short – the parent company will be seized. Subsidiaries and affiliates will continue to operate, and their obligations honored. Shareholders will be wiped out, management will be fired and the board dismissed.

The entire company will be placed into a receivership and a bridge bank will be created. Losses exceeding shareholder equity will be absorbed by creditors and any remaining creditor claims will be converted into an ownership stake in the bridge bank.

Once the company is stabilized, the creditor-owners will take it public.

Those are the bones. Here's the meat.

The FDIC plans to turn the bridge bank over to an interim board and chief executive immediately while continuing to exert influence through a supervisory agreement.

"We don't want to run into some of the issues associated with unclear governance, where there are questions as to who is controlling the company, who is providing direction, and how public policy interacts with the operations of the company," Wigand says. "So our objective is to turn over the day-to-day operations of the company to the new board and CEO and have it very clear that they are running the company." The agency is assembling a pool of qualified CEO and director candidates now.

"We will get an acknowledgement of interest in serving in this capacity," Wigand says. "This will allow us to enter into both compensation and indemnification arrangements" before a company ever gets into trouble. [Potential candidates will not be told which company they are being considered for and any conflicts of interest would disqualify them.] You may be wondering why the FDIC intends to take over entire holding companies? Why not simply seize whatever units are dragging the company down?

The short answer is our giant financial firms are an organizational mess.

"There really isn't any other way to credibly resolve most domestic SIFIs," says Wigand. "Given the structure of U.S. financial companies and the fact that business lines do not neatly align with legal entities, and funding structures do not align necessarily with either business lines or legal entities, there really isn't any other approach that would give either policymakers or the market comfort that the subsidiaries' critical operations would continue." This problem might be resolved by the living wills Dodd-Frank requires. The first of these plans for unwinding an insolvent company is due in July. And the process of writing a living will may lead boards to acknowledge absurd complexities and streamline their companies. This may be wishful thinking, but living wills could pave the way to resolving insolvent banking companies under bankruptcy code.

"There certainly is a strong possibility that living wills will rationalize that alignment. Time will tell," Wigand says. "It would certainly make it easier under the bankruptcy code." Bridge banks will have plenty of capital because they will get all of the company's assets and next to none of its liabilities. But the bank is likely to need liquidity, and Dodd-Frank lets the FDIC tap a line of credit to the Treasury. But the law also says the FDIC must recover any losses incurred by this "orderly liquidation fund" via a fee on large banks.

Wigand, whose formal title is director of the FDIC's Office of Complex Financial Institutions, predicts such a fee will never be levied because he does not expect any such losses.

"You would have to exhaust all of the equity created in the bridge," he says. Assessing the industry for a loss to the Orderly Liquidation Fund is "highly improbable." You would have to exhaust all of that equity. You would have to take all the assets of that company and blow through them before you would need to assess the industry. It's highly improbable." In fact, Wigand expects the bridge bank will be able to fund itself by issuing debt, and says the Treasury line can be used to guarantee the debt, if needed.

He expects bridge operations to last four to six months. "To go through the claims process and to have the new voting shareholders identified and have them exercise their rights and elect a board – all that will take time," Wigand says.

The FDIC also wants to avoid fire sales and loss of franchise value. "We don't want to force distressed asset sales and try to force the divestiture of business lines in a non-rational way." But that's not to say the FDIC will be hands off after the firm is returned to private-sector hands. Those supervisory agreements can contain detailed instructions for the firm's future.

"If policymakers deem that the company needs to be broken up, instead of trying to do that over six months, which is highly improbable, it could be done over three years or four years as a private entity," he says. "As part of that supervisory agreement, the company could have to divest certain business lines or unwind certain activities." Wigand's unit has 135 full-time employees, with plans to hire 50 more. But it is ready to execute a mega-bank resolution. "Can we resolve today? The answer is yes. Will it look better a year or two from now? The answer is definitely yes." The FDIC learned an important lesson from AIG's rescue and Fannie Mae's and Freddie Mac's conservatorships, which have no clear end in sight.

"An exit strategy is necessary for market confidence and clarity," Wigand says.

The FDIC's exit strategy is the supervisory agreement, which will apply to the bridge and the company that emerges from it. "It will likely have to be changed and amended," Wigand says of the agreement, "but it is really the vehicle through which the change in the firm will take place post-resolution." It's pretty clear the FDIC has no intention of letting huge firms get bigger.

"Today there is much greater concern [versus 2008] both from investors as well as the regulatory community about allowing already systemically important firms from becoming more so," he says. "We don't think that it is practical for a substantial business line, much less the whole firm, to be acquired in a resolution." It is important to remember that resolution will not occur in a vacuum. Supervision comes first and it is the key to keeping mega firms from faltering. Wigand also cautions against confusing too big to fail with other concerns.

"We are well on the way to demonstrating that there is a capacity for resolving systemically important financial companies, but that doesn't necessarily answer the question as to whether those companies are too big to manage or too big to regulate," he says.

Wigand steered clear of commenting on JPMorgan Chase's $2 billion trading loss or the systemic threat it poses.

"Financial intermediation involves risk. It does. It's what the industry is about," he says. "The key question then is, is the risk appropriately understood and managed? That's always the big challenge." Wigand circled back to what ending TBTF means – and what it doesn't.

"Title II is designed to deal with resolving a SIFI or two. It was not intended to address the failure of multiple companies in the financial services industry because of an economic or financial collapse," he says.

Dodd-Frank cracked the window for future bailouts by allowing broad-based assistance in an economic emergency.

"It is about saving the financial economy, not saving a firm," Wigand says. "What Title II is saying is, 'Let's not save the firm because only by saving the firm can you save the financial economy.' Dodd-Frank flips that around and says, 'If necessary we need to save the financial economy and as a consequence of that you will save firms.

"There is a difference."

Barb Rehm is American Banker's editor at large. She welcomes feedback to her column at Barbara.Rehm@SourceMedia.com. Follow her on Twitter at @barbrehm.

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