Put together a hedge fund manager, a Nobel Prize-winning economist, a Federal Reserve Bank president, a Federal Deposit Insurance Corp. official and a group of top finance professors, and the odds are poor that they will agree on anything.
New York University's Stern School of Business beat the odds last week. At a forum on how to approach future failures of systemically important institutions, just such a group agreed that a formalized rescue process must be put in place, and must not spare banks or their creditors much pain.
The forum comprised Pershing Square Capital Management's William Ackman, Kansas City Fed President Thomas Hoenig, the FDIC's Michael Krimminger, options whiz Myron Scholes, and academic luminaries Nouriel Roubini and Edward Altman.
Hoenig set the tone with a keynote speech calling for an end to the government's ad hoc approach to handling troubled banks deemed "too big to fail."
"Now is the time to seriously consider a mandatory resolution process based on an objective set of criteria that puts the largest financial organizations on notice they won't receive a disproportionate subsidy or guarantee," he said.
The process Hoenig envisions would put bank executives on notice as well. He advocates the installation of new management at any bank that requires a restructuring shepherded by the government.
So did Ackman, who views replacing executives and directors as a key piece of rehabilitating troubled banks. Under his proposal, systemically important firms that fail to raise the capital required of them by regulators would fall into conservatorship, work with bondholders to convert debt into equity, halt dividend payments and share buybacks and emerge in 30 days with a healthy capital structure and new management.
"Oh, and by the way, there are no golden parachutes in this paradigm," quipped Ackman, who proposed similar ideas for restructuring Fannie Mae and Freddie Mac last summer, less than two months before the mortgage-finance companies were rescued by the government.
The biggest difference between Ackman's bank-restructuring plan and the ad hoc approach taken thus far in the bailout of big institutions would be the role of the taxpayer. Instead of pumping public money directly into firms, Ackman would call on existing investors to come up with the necessary capital — mainly by swapping debt for equity and, in some cases, equity for out-of-the-money warrants.
The only risk to the taxpayer would come in the form of a government guarantee of the bank's deposits and loan commitments during the 30-day conservatorship, he said.
"Most financial institutions, particularly the big, systemically important ones, have all the capital they need," Ackman said. "The problem, however, is [that] most of the capital is debt. There is not enough equity."
The outspoken hedge fund manager's proposal drew a few points of disagreement from his fellow panelists.
Scholes argued it would be impossible to sort through the complicated assets of a complex financial institution in just 30 days and said the recapitalization process might go more smoothly if debt agreements simply included provisions for converting bonds into equity automatically in the event of conservatorship.
Krimminger, a special policy adviser at the FDIC, suggested that settling on valuations in a restructuring would be challenging, to say the least, and Altman warned that debt exchanges often fail to keep restructured companies healthy for long.
Roubini, meanwhile, proposed that, though receivership is a good option for preserving taxpayer money in the case of a solvency crisis, forbearance might be a better option in the case of a liquidity crisis.
And a paper he cowrote on the subject took a broader view of "too big to fail" than did Hoenig, who suggested excluding hedge funds from the definition and limiting the safety net to firms essential to the payments system and the provision of liquidity.
The panelists' basic principles, however, were in sync.
"All of these plans on some level create some kind of new bank that is owned by the debtholders, and the debtholders in some circumstances are going to lose a lot of money," NYU finance professor Matthew Richardson — who moderated the forum and worked with Roubini and fellow professor Viral Acharya on the paper — said in an interview. "The general belief from everyone on the panel is that creditors have to take a hit."
The discussion might have been more heated had a large financial institution been represented on the panel.
The banks, Richardson conceded, "are the big losers in these plans because now all of a sudden the costs are borne by them and, if they don't want to bear the cost, then they have to change the way they behave."
But to the panelists, making a restructuring painful for the bank is the best way to ensure better market discipline than the industry showed in the years leading up to the current crisis.
Ideas like theirs are no doubt under consideration in Washington, where other options being weighed by officials may include more stringent capital requirements for systemically important institutions and a process in which banks could write their own rules for how they would operate in receivership.
The details are far from being decided, but the panelists had little doubt that a formal process of some kind would be adopted.
"I do think they are going to come up with a regime," Richardson said.
"You really want a system in place that makes the probability of getting [to a systemic failure] much lower."
