Resolution Authority for Non-Banks

In order to manage the economy in financial crisis, the White House has proposed the creation of a resolution authority to work with the FDIC to deal with failing Tier 1 Financial Holding Companies and other major banks. The goal of this proposal is to clarify the role of government and provide a statutory framework that avoids the uncertainty that accompanied the impending failures of Bear Stearns, Lehman Brothers and AIG.

Currently, the FDIC can only take failing bank holding companies into receivership (as it did with IndyMac Bank in March 2008 and Washington Mutual very briefly six months later), but not other financial institutions such as hedge funds, insurance agencies or other investment firms. This proposal would grant the resolution authority special powers to take over any problematic financial institution labeled Tier 1 and break it apart or limit its activities.

The details, though, is where this whole thing gets bogged down. To begin with, the combination of resolution authority with Tier 1 ideas basically codifies the concept of too big to fail. Resolution authority alone doesn’t do this, but the proposal is a bad idea if established in concert with everything else. Even the SEC gets this:

“Structured correctly, a credible resolution regime could force market participants to realize the full costs of their decisions and help reduce the ‘too big to fail dilemma,’ ” Mary L. Schapiro, the chairwoman of the Securities and Exchange Commission, testified over the summer. “Structured poorly, such a regime could strengthen market expectations of government support, as a result fueling ‘too big to fail’ risks.”

The best way to structure a resolution authority is going to have to be outside of a framework that identifies and names firms that are too big to fail. We should bolster the bankruptcy laws to create a rapid process to move banks through insolvency. The problem right now is that the bankruptcy process is too slow for these kinds of issues, tying up capital, freezing trades and deals. The GOP has proposed a new type of bankruptcy law to help wind down distressed non-bank financial institutions. Their plan would create a new Chapter 14 bankruptcy proceeding that would build on Chapter 11 law by expediting the hearing process. The point of relying on bankruptcy is explicitly because the GOP believes a resolution authority “could place politics over sound regulation and give firms the incentive to grow even bigger.” This is one area I think the Republicans have actually brought a good idea to the table, even if it isn’t totally thought out yet.