WASHINGTON Even if the Federal Deposit Insurance Corp.'s strategy detailing how it would seize and dismantle a troubled megabank works as promised, experts are worried it could be perceived as a stealth bailout by the government.
Under a plan detailed on Tuesday, the agency would use Dodd-Frank's "orderly liquidation authority" to wipe out a failed parent company along with shareholders while preserving and restructure subsidiaries in a bridge funded by creditor haircuts and industry-backed government loans. The result would be a new, safer holding company under new management and ownership.
The strategy document has sparked questions about whether it can actually work, but even if it does, some warn that a system in which remnants of the old company survive could make it unpopular.
"This doesn't look like a liquidation. It looks like a restructuring or reorganization in which the systemically important financial institution survives to fight another day," said Arthur Wilmarth, a law professor at George Washington University. "Instead of liquidating or breaking up the institution it comes out the other end looking much like it did before in terms of its functions and operations."
Concerns about the perception of the FDIC plan known as "single point of entry" came up during an engaging discussion Wednesday before a committee of top names in the financial services arena that advises the agency on resolution issues. On one side, members such as former Federal Reserve Board Chairman Paul Volcker warned that SPOE could remind some of the government rescues that propped up institutions in 2008.
But others, such as former University of Rochester president Thomas Jackson, said that confuses the issue of Dodd-Frank's intent. Jackson said the FDIC's approach rightly focuses on forcing losses upon shareholders and creditors, rather than preserving government bailouts. Whether the firm survives is beside the point, he said.
"This is a perception issue because I think frankly Congress messed it up by equating [the avoidance of] bailout with liquidation," Jackson said at the advisory committee meeting. "They're completely separate concepts and I personally endorse the direction the FDIC is going which is focused primarily on avoiding bailouts without adverse consequences."
But Volcker, who at the outset praised the FDIC for being "three quarters of the way" to winning faith in the new resolution system, said the agency still faces a perception problem for not having a more explicit liquidation model.
"It has a disadvantage. It looks like the whole company is being protected in some sense," he said at the meeting.
Whereas Dodd-Frank suggested the company would be liquidated, "when I read this, it doesn't sound like a" liquidation, Volcker said.
The FDIC is giving the public 60 days to comment on the strategy document it released Tuesday. Under the "single point" model, creditors of the expunged firm could exchange their claims for equity in the new firm. Certain subsidiaries could be liquidated or downsized to make them safer, and the FDIC along with new management of the bridge firm would take steps to ensure the successor institution poses less risk to the system.
FDIC Chairman Martin Gruenberg said the committee's debate "illustrates the complexity and challenges" in developing the resolution system.
"There are a set of competing public goods or outcomes that we're trying to achieve here, and they're not easily reconcilable," he said during the meeting. "That's part of the challenge and in the best way we can we're trying to address that."
He said obtaining public feedback is crucial.
"The document we released was a document for public comment," Gruenberg said. "We're not saying anything is set in stone here. Our purpose is to lay out as best we can how we envision this process, how we envision utilizing the authorities and how we envision the single point of entry approach being implemented. We're putting that as well as what we think are the issues that have been identified during the course of developing this strategy out for public comment to enhance and deepen our thinking on this."
Arthur Murton, the agency official leading implementation of the new system, said it is wrong to expect the surviving company to look identical to the failed one. The new resolution format was authorized in Title II of Dodd-Frank, but Murton said through the course of a receivership, the firm would become safer, with less risk to the system, so that it could be resolved through the simpler bankruptcy format envisioned by Title I of the law.
"We try in the document to make it very clear that our intent is that if a firm goes into a Title II receivership, it comes out of that process in a condition where it could be resolved under Title I," Murton said.
Both Murton and Gruenberg also stressed that taxpayers would not be on the hook. Although the bridge company would have access to liquidity in the Treasury Department's "orderly liquidation fund", those borrowings would be repaid from assets of the old firm or, if not, assessments on large financial companies.
"The likelihood is that the assets in the failed company would cover the cost. But if the issue came to it, we have the authority" to charge premiums, Gruenberg said. "It's unquestioned."
Yet others echoed Volcker's point.
"Maybe this is the way you want to go, but I think there you have a perception problem," said MIT professor Simon Johnson, also one of the panelists. "You're describing an orderly restructuring process in which a substantial part of the previous business is going to emerge, I would expect, somewhat along current lines, unless you are completely convinced that current lines are crazy, in which case you have an opportunity to change them. This is a non-trivial issue."
But other outside observers said the expectation that all remnants of the prior company would be wiped from memory is naïve.
Karen Shaw Petrou, managing partner at Federal Financial Analytics, said the concern Volcker raised makes political sense, but that he was "substantively wrong."
"The goal of Dodd-Frank ill-expressed in some ways was not necessarily liquidation or resolution. Dodd-Frank's goal was 'bankruptcy-plus,'" she said in an interview. "I don't think the law then says the 'plus' must be vengeful or destructive in that you need to make the entity go away."
The appropriate strategy, she added, should be similar to what happens when an airline or other nonfinancial company goes into bankruptcy, in which public resources are not tapped to bail out the company.
"Creditors and shareholders take a bath, but the planes stay up in the air. The challenge is not the goal, but it's the practical impediments to making this work in a complex financial institution," she said. "I don't think people understand how much they fly on banks just like they do on airplanes."