WASHINGTON — The Treasury Department proposed giving the Federal Deposit Insurance Corp. resolution powers over systemically important financial institutions, but the plan, unveiled Wednesday, raised more questions than it answered.
Those included exactly which institutions would be covered, the mechanics of funding a massive resolution and how a receivership would be carried out.
"There's not enough here to answer any practical questions at all," said Peter Vinella, managing director and global head of consulting for LECG's financial services group.
Treasury Secretary Timothy Geithner is likely to shed more light on this and other regulatory issues when he testifies today in front of the House Financial Services Committee. He hinted in a speech Tuesday he would offer an outline for broader reform, including details on a proposed systemic risk regulator and enhanced consumer and investor protections.
"In the coming weeks we will take additional steps, among them proposing new and stronger rules to protect American consumers and investors against financial fraud and abuse," Geithner said.
But much of the focus Wednesday remained on systemic resolution authority, which policymakers largely agree should be kept separate from systemic risk oversight, a job likely to go to the Federal Reserve Board. The Financial Services Committee could vote as early as next week on a bill to give the government resolution powers.
In a press release, the Treasury said the new resolution powers would build on the FDIC's authority over banks and thrifts, including allowing the agency to provide financial assistance or put institutions into conservatorship and receivership.
The Treasury and the FDIC would decide jointly, after consultation with the Fed and appropriate federal regulators, to take action on a systemically important institution. Though the Treasury did not detail which agency would then have further resolution responsibilities, a spokesman for the department said it is recommending they be given to the FDIC.
It was unclear exactly which institutions would be governed under the new power. The Treasury said it would apply to any financial institutions that have the "potential to pose systemic risks to our economy but are not currently subject to the resolution authority of the FDIC," but critics said that wording was too vague.
"It's not clear to me when you qualify for this status, and that's very important, because the markets need certainty with respect to your status in order to be able to function," said Tom Vartanian, a partner in the Washington office of Fried Frank Harris Shriver & Jacobson LLP. "I think it is fair to say that the question of when an entity qualifies for this status is very important, because the capital markets will want that certainty up front, rather than later."
Even after those institutions are identified, some say there would then be the assumption of an implicit government guarantee.
"It identifies certain institutions as 'too big to fail,' " said Mark Flannery, who chairs the banking department at the University of Florida. "That takes away market discipline."
The Treasury said the decision about whether to assist or seize an institution would be based on whether the company in question was in danger of becoming insolvent, whether its insolvency would have "serious adverse effects on economic conditions" for the country and whether emergency action would avoid or mitigate those effects.
Under the proposal, the FDIC would have the power to sell or transfer the institution's assets, renegotiate contracts and deal with a book of derivatives.
The FDIC has a well-established process for banks and thrifts, but it is unclear, for example, how that process would apply to insurance companies, which are structured much differently.
"How do you position the FDIC to perform that mission as it relates specifically to insurance companies?" asked V. Gerard Comizio, a partner at Paul, Hastings, Janofsky & Walker LLP.
Additionally, observers said hedge funds, bank and financial holding companies and insurance companies have more complex and international operations than most financial institutions.
"A large financial conglomerate could have subsidiaries and affiliates that are engaged in a wide range of businesses around the world," said Charles Horn, a partner at Mayer Brown LLP. "It's probably going to be quite global in its reach. How would the authority deal with non-U.S. obligations and non-U.S. assets?"
A critical unknown is how the resolutions would be funded.
The Treasury said the Deposit Insurance Fund — which funds resolutions of banks and thrifts — would not be used to assist systemically important companies. Instead, the money would be drawn from a mandatory appropriation to the FDIC out of the Treasury's general fund or through assessments on systemically important financial companies.
That may work better in theory than in practice, according to observers, who said it would be difficult to translate the assessment process for banks and thrifts to other companies — and nearly impossible to build a fund big enough to account for the risks of these large institutions.
"I just can't imagine how you could set up an insurance scheme with five to six large, complex businesses," said Amar Bhide, a professor of finance at Columbia University.
The government may decide to treat such a fund akin to a systemic risk exception, under which the FDIC can charge all institutions if it needs to act to save or resolve an institution whose failure threatens the economy. Under this scenario, the FDIC could charge other systemically important institutions after using funds to help a failing company.
"You don't need to have a pool of money to tap immediately," said Gil Schwartz, a partner at Schwartz & Ballen LLP. "It makes much more difference to do it post hoc."
But Flannery said assessments would be more difficult to determine for nonbank institutions than for banks.
"The FDIC's current premium for banks is basically driven by accounting information, not forward information, so … if they were to set up the same accounting base for premiums, it wouldn't reflect risk effectively," he said.
Though there were also concerns raised about whether the FDIC would have the expertise to handle the resolution of a large insurance company such as American International Group Inc., or a investment bank such as Lehman Brothers, several observers said the government had no other acceptable candidate.
"Who else in government has any experience doing things like this?" asked Edward Kane, a finance professor at Boston College. "The kind of forensic skills, negotiating skills, decision-making about what needs to be fixed up before it's sold or what should just be dumped for the best price it can get."
The FDIC has "been exercising those skills, and they're not easy to acquire," he said. "I can't imagine where else in the government you would find this."
The idea of giving the FDIC systemic resolution authority has snowballed since Senate Banking Committee Chairman Christopher Dodd suggested it at a hearing last week. Since then FDIC Chairman Sheila Bair and Fed Chairman Ben Bernanke have made it clear they would support such a plan.
"Due to the FDIC's extensive experience with resolving failed institutions and the cyclical nature of resolution work, it would make sense on many levels for the FDIC to be given this authority, working in close cooperation with the Treasury and the Federal Reserve Board of Governors," Bair said Wednesday.