WASHINGTON — The creation of a fund to pay for the resolution of a systemically important institution is turning into one of the more difficult challenges in the regulatory reform debate.
Although the House and the Senate bills currently would require an assessment on larger institutions after a systemic collapse, the House Financial Services Committee is expected to shift to a prepaid system that would force firms to pay into a new fund prior to a large failure.
But that move is raising other questions, including how much firms should be charged, how they should be assessed, how quickly to build the fund and how big it needs to be.
"I don't think you are going to come up with an optimal solution here," said Tim McTaggart, a partner at the law firm Pepper Hamilton LLP. "You are going to come up with a pragmatic and political solution."
After urging from the Federal Deposit Insurance Corp., Rep. Luis Gutierrez, D-Ill., is expected to introduce an amendment next week that would require banks with more than $10 billion of assets to pay into a new systemic resolution fund. House Financial Services Committee Chairman Barney Frank has said he supports the move.
Although much is still unclear about the amendment, sources said they expect the fund to be capped at $200 billion, with an option to borrow an additional $200 billion from the Treasury Department, if necessary. (Congress would need to approve funds over that amount).
Whether that is enough, however, is already the subject of debate. The Deposit Insurance Fund, which would remain separate from this new systemic resolution fund, reached its high of $52.8 billion in early 2008 and was insolvent less than two years later.
Some observers suggested that the new fund would have to be huge to pay for the failure of a systemic institution.
"It has to be really big or else it's not a credible threat," said Bob DeYoung, a professor in financial markets and institutions at the University of Kansas School of Business and a former FDIC official, who said $200 billion was too small. "Without a really big pot of money, banks may still feel like they are too big to fail."
Bert Ely, an independent consultant in Alexandria, Va., said no one knows what level will be needed. "They are pulling numbers out of the air."
But many worry that the bigger the fund, the more money is being funneled out of the banking system at a critical time — and the more attractive it will look to other parts of the government seeking funding for unrelated projects.
"That's a huge amount of money to take out of the economy," said Donald Ogilvie, the independent chairman of the Deloitte Center for Banking Solutions. "The counterargument is, is this worth it?"
William Isaac, a former FDIC chairman, called it "a big slush fund."
"It's going to be Tarp 2 or worse," he said, referring to the $700 billion Troubled Asset Relief Program. "I just don't understand why we would want to build a great big fund and take capital out of these financial institutions at a time when we need capital."
Some also questioned the idea of any cap at all, arguing it makes more sense to continue building the fund.
"The lessons of the DIF to my mind is to keep building it up and quit thinking if you ever got to [a certain amount] you should start rebating," said John Douglas, a former FDIC general counsel and now a partner at Davis Polk & Wardwell.
"In a time of crisis you can't have too much."
How long it would take to reach $200 billion depends on the assessment's size and what it is based on.
The Senate bill has no detail on these questions, but the House amendment would tie the premium to "nondepository assets," according to Frank. Sources said the goal is to base the assessment on funding that comes from sources other than domestic deposits, which DIF already assesses.
In theory, the burden would fall heaviest on institutions like Citigroup Inc., where roughly 28% of liabilities are comprised of deposits. By contrast, roughly 85% of the liabilities at KeyCorp's KeyBank are deposits.
Government officials privately estimate the pool of money assessed totals between $10 trillion and $15 trillion — and predict that the fund would not reach its maximum level for at least a decade.
Still, that would largely depend on how Congress or the FDIC defines what should be covered, and how fast lawmakers want the fund to reach capacity.
"How you define the nondepository assets is going to be the key," said Ron Glancz, a partner at Venable.
"It's fraught with a lot of controversy as to which assets would be taxed for this nondepository resolutions fund."
Under the Gutierrez amendment, the FDIC would also be free to levy assessments on risk-based assets that would be defined through rulemaking. But it is unclear what factors the agency might use — such as a company's leverage ratio or concentration in collateralized debt obligations — and regulators may need to be flexible.
"What's risky today may not be risky tomorrow. It's a judgment call," said Lawrence Kaplan, a lawyer at Paul, Hastings, Janofsky & Walker LLP. "And we understand certain financial products, it might have to be revisited."
The task is particularly tricky when talking about both bank and nonbank systemic institutions, Ely said.
"The range of institutions that this is potentially subject to the systemic-risk issue are so diverse that there is no logical way to have a logical assessment based on risk," he said.
That has led some to conclude that prefunding a systemic resolution is too complicated and propose assessing institutions after the fact, when it is clear how much money is needed. That is a view shared by Treasury Secretary Tim Geithner, who also warns that creating a big pot of money will foster market laxity about the largest institutions.
"If you create a fund in advance, there's a risk you're going to create more moral hazard," Geithner said at a hearing earlier this month. "People will live with the expectation where the government will come in and protect them. We don't want to create that expectation. That's why we think it's better to do it after the fact."
But some said that would be just as complex and has its own drawbacks.
"In some ways it would be easier to prefund than postfund because you can start funding while the institutions are strong," said Doug Elliott, a fellow at the Brookings Institution.
"Where if you do it after the fact you are almost certain to do it when institutions are weak and less funds are available."