The financial reform legislation the House Financial Services Committee is considering contains a provision that would impose a haircut on secured lenders to a large financial institution that ends up in a FDIC receivership. This provision, introduced by Reps. Brad Miller, D-N.C., and Dennis Moore, D-Kan., apparently enjoys the support of FDIC Chairman Sheila Bair and has come to be called the Bair-Miller-Moore provision.
It is easy to understand the FDIC's concern. Secured lenders would be able to grab their collateral and thus remove the choicest assets from the insolvent institution, before the FDIC's could take control over those assets.
This provision could have severe consequences. Secured lenders — which include the Federal Reserve and the Federal Home Loan banks, as well as repo dealers and covered bond purchasers in the future — would be reluctant to make such loans, thus shutting off the borrowing banks from useful sources of liquidity, often at the times that they need that liquidity the most.
Fortunately, there is a simple and sensible solution to this problem. Instead of imposing a haircut, the FDIC should demand a fee. And this fee should apply to secured lending to or borrowing by all FDIC-insured institutions, not just large banks.
The logic of this approach is straightforward. In essence, the secured lenders have gained seniority over the FDIC, without paying for that privilege. The solution, then, is to require that they pay for this privilege.
What is the appropriate fee? Again, the answer is simple and sensible. The fee should be equal to the deposit insurance premium that the FDIC charges for insuring deposits. Again, the logic is straightforward — the secured lenders are effectively getting 100 cents on the dollar in the event of a receivership, just as insured depositors would. So the two groups should pay the same fee — the deposit insurance premium — to the FDIC.
The mechanics for levying this fee are also simple. The FDIC should levy it on all insured banks and thrifts that borrow through pledging assets (i.e., pledging collateral), just as it levies its fees for deposit insurance.
The borrowing banks and their secured lenders will likely not like the idea even of this fee. They would prefer not to have to pay anything extra for this senior borrowing or lending, which is the status quo. But paying the deposit insurance premium equivalent is surely preferable to the proposed haircut. And if a secured lender or the borrowing institution decides that, after the inclusion of this fee, the secured lending or borrowing is no longer profitable, then maybe this specific lending/borrowing isn't a worthwhile proposition for the financial system.