WASHINGTON — After Congress wraps up debate on creating a federal agency to police consumer financial products, lawmakers will focus on what to do when systemically risky firms falter.
Seven months after President Obama declared such resolution legislation a top priority, the issue remains stalled. That's partly because policymakers are focusing on other reforms but there are also serious questions over who should hold resolution power, which firms would be covered and how costs would be covered.
Critics, including senators from both political parties, are concerned the Obama administration's reform plan gives the Treasury Department too much authority. It would be able to dissolve, conserve or prop up a troubled firm.
"If you read the fine print" of the administration's bill, "they're giving themselves the ability to make the decision" of when a firm has failed, Sen. Bob Corker, R-Tenn., said in an interview.
"They're also giving themselves the ability to use taxpayer money to prop up a company. Everybody immediately sees the moral hazard that that creates, and certainly the opportunity for those large entities that already have tremendous market share to grow and grow and grow."
Resolution power was once considered the simplest core of the broader regulatory reform effort.
In March, when President Obama said he had asked House Financial Services Committee Chairman Barney Frank and Senate Banking Committee Chairman Chris Dodd to quickly pass a stand-alone resolution bill, there appeared to be consensus around the issue.
Obama said in a speech then that his administration would move a bill "on a fast track" to create a "resolution authority that would be similar to the" Federal Deposit Insurance Corp.'s handling of failed banks.
A week after Obama's remarks, the Treasury unveiled a draft bill that would enable it — after consulting with other agencies — to appoint the FDIC as a receiver for financial holding companies considered vital to the financial system's functioning. (A July version would give the Securities and Exchange Commission receivership duties for such securities firms.)
But observers cited two main reasons why the effort stalled. For one, the financial markets stabilized, mitigating fears that new resolution powers were needed immediately.
"At the time it was felt the FDIC needed these emergency powers as fast as possible because they did not want another AIG," said Paul Miller, managing director in the financial institutions group at Friedman, Billings, Ramsey & Co. Inc. "Six months later, … nobody is failing anymore and credit spreads are back to normal. That sense of urgency has been taken off the table."
But lawmakers also found it difficult to consider a resolution bill without a broader regulatory reform package. For one thing, it was unclear which firms should be considered systemic and how they should be regulated.
"We honestly thought we could fast-track this because it was something the federal government needed to deal with any crisis that might arise," said Steve Adamske, a spokesman for Frank. "Unfortunately, we couldn't necessarily wind down systemically important institutions without figuring out what those systemic institutions were."
As a result, Adamske said the committee is unlikely to consider a resolution authority until the end of its series of votes on other reform elements, including the creation of a new systemic risk regulator, itself a controversial issue. (Regulating these systemic firms is separate from resolving them once they get into trouble.)
Under the administration's plan, the Treasury and the Federal Reserve Board would define "Tier 1 financial holding companies," but Frank and others have opposed creating such a "too big to fail" list that might give such firms an advantage over smaller competitors. While all bank holding companies could be subject to resolution powers, it is unclear how many nonbanks, like American International Group Inc. and others, would fall into that category.
Observers said that has to be clearly defined.
"It's so complex and uncertain, and you never know what was systemically important and subject to bankruptcy or the new resolution authority," said Ralph "Chip" MacDonald, a partner in the law firm Jones Day.
Concern has also grown about the administration's approach to resolution powers. The latest draft from the Treasury would give it the ability to determine when a special resolution process for a failed firm is needed to prevent a systemic problem.
Under the plan, the Treasury would appoint a receiver, such as the FDIC, which could take several actions, including providing a company with financial assistance in the form of loans or guarantees.
Corker and others said such broad discretion gives the Treasury too much leeway to keep financial companies afloat indefinitely.
"We've got to come up with a resolution mechanism that doesn't conserve, it receives," he said. "In other words, when you move into that mode, you are out of business. It's over. The stockholders are gone. The board is gone. The CEO is gone. The company is over."
Corker has introduced a bill with Virginia Democrat Mark Warner that would give the FDIC the authority to trigger and handle the resolution of bank holding companies. The bill would explicitly put the FDIC in the driver's seat, and allow it to operate without being "subject to the direction or supervision of any other agency or department." (Currently, the FDIC resolves the bank itself, not the parent company. The Corker/Warner measure does not address how to resolve financial firms that do not own a bank.)
The bias, Corker said, would be the same for bank holding companies as it is now for banks: toward unwinding the institution and selling off its assets.
It's an approach also favored by the FDIC. Michael Krimminger, a special policy adviser at the agency, warned that too much discretion to prop up institutions is dangerous.
FDIC Chairman Sheila Bair "has been out in front stating that she believes 'too big to fail' should end," he said. "She has also stated that we think that there should not be assistance for individual open institutions, such as loans and guarantees and other sorts of things. We do believe there are some changes that should be put into place in legislation to accomplish that."
The overall goal should be on unwinding the institution in an orderly way, not indefinitely keeping it afloat, he said.
"We need a process in place that allows for continuity in the systemically significant functions or operations of one of these large institutions, but one that does not continue the existence of the entity if it's insolvent," he said. "If they can't function or are insolvent, they should be closed."
Instead of giving power to the Treasury or the FDIC, however, Krimminger said the authority to appoint a systemic resolution should not rest in one agency. "We never wanted to have sole authority to trigger the decision," he said. "In our view the ultimate decision always needed to involve several different parties, like the current systemic-risk process does."
Another big question is how to pay for resolutions, which by definition will be expensive.
In its initial March proposal, the Treasury suggested that the FDIC could charge fees on firms through assessments to recoup the costs of a resolution after it occurred. But the FDIC and some industry representatives have called for a prefunded system.
"If you don't prefund it, the concern is that the firms that fail aren't paying for it," said Karen Thomas, head of government relations for the Independent Community Bankers of America. "Firms that operate in a responsible manner end up paying for losses due to firms that were mismanaged and failed."
All of these issues may take substantial time for Congress to work out, observers said.
The American Bankers Association is offering its own resolution plan designed to deal with some of the issues raised by critics. Under the plan, the administration would have the ultimate authority to decide when a systemic firm should be resolved, acting on the recommendations of several government bodies. The resolution would be handled by a special agency, which would be staffed and overseen by the FDIC.
The ABA would leave it to this new body to write rules that would dictate what types of actions could be taken in receivership, based on existing bankruptcy principles. Any cost from the receivership would be assessed over time on all financial firms.
Wayne Abernathy, the executive director for financial institutions at the ABA, said the group's plan would be balanced.
"You have to make sure that you provide enough flexibility, because you don't want to hardwire everything," he said. "But in the end people need to know what the basic rules are so that they understand there's fairness, and they need to understand what's coming out at the end."
