The Federal Deposit Insurance Corp. knows it must put some meat on the bones of its process for dismantling large financial firms, but is struggling to strike the right balance between providing too much detail and not enough.
“One issue is flexibility versus certainty,” says Jim Wigand, who heads the FDIC’s Office of Complex Financial Institutions. “But there is also the tension of providing enough information so that the marketplace and stakeholders know what to expect versus getting too granular, providing too much information and not in the right area.”
In an interview last week, Wigand says the agency has narrowed its focus to a handful of issues and will propose a policy statement by yearend. He expects a final version within three or four months of proposal. (Assuming the agency waits until yearend — though Wigand emphasized it could come earlier — a final statement would be in place by April 30.)
The FDIC arguably got the biggest job doled out by the Dodd-Frank Act: resolving systemically important financial companies that fail.
The orderly liquidation process is mandated by the 2010 reform law, and a year ago the FDIC sketched its approach by unveiling its “single point of entry” plan.
It envisions the government seizing a failed giant at the holding company level and continuing to operate its subsidiaries. Shareholders would be wiped out, management would be replaced and a plan for resolving the company would be created and executed by a bridge company.
Wigand was unequivocal when asked if a company leaving the Orderly Liquidation Authority process would resemble the one that entered.
“The answer to that is a definite no,” he says. “This company has to be nonsystemic as it exits the overall process.”
Assets may be sold, whole lines of business may be spun off, but the company will be smaller and simpler when the FDIC is finished. The process may take longer than the six months that the FDIC anticipates running any bridge company, so Wigand says the FDIC could continue to influence the company’s operations through a supervisory agreement.
“It needs to be done ‘orderly,’ and that means months, if not years, and that will be built into this process.”
The FDIC was widely praised for both its creativity and practicality in coming up with single point of entry. But like any big idea, plenty of details remained unanswered. The agency promised to clarify via a policy statement exactly how a resolution would work in practice.
But the FDIC missed its self-imposed yearend 2012 deadline, and the delay is undermining the agency’s credibility. (Wigand disagrees, saying “being thoughtful is better than rushing through the process.”)
Wigand blames the delay on two key factors: the job is harder than the FDIC expected and it has had to coordinate with outsiders, including other regulators and people in the market.
“We have a list of all of these tasks that we need to address associated with implementing OLA and that list is huge,” Wigand says. “But what we’ve done is culled it down to the key tasks that we believe need to be addressed in this particular policy statement.”
Perhaps the biggest task on that list is how the failed firm will be recapitalized.
The way it’s set up, OLA can’t work unless these giant companies have enough long-term debt at the holding company level. It is that debt that will be converted into equity of the bridge company.
“This is a structural subordination,” Wigand says in describing a potential OLA. “This company operates from the top. It is the shareholders of that top company that elected the board, it is basically the investors, those bond purchasers, that have lent money up at the top.”
Because the largest firms use such complex structures, the FDIC had no choice but to go in at the holding company level. As Wigand put it, these firms are “so interconnected at the operating company level that you can’t allow one of those op-cos to fail independently without blowing the whole thing up.
“So if that is the choice of how this company operates, as a single enterprise, then that’s the way it’s going to fail. It’s going to fail from the top down. It’s going to be the holding company that fails first, and only in the event that there is an insufficient amount of bail-in debt at the top, then you go to your next level.”
I asked Wigand if that is his way of saying people can stop worrying about haircuts on short-term creditors or derivatives contracts. His answer? Probably.
“The long-term debt at the top will effectively be providing support to those operating companies.”
But that is only true if there is enough holding company debt.
“That’s the one point that we can’t forget,” Wigand says.
“If there is an insufficient amount of bail-in debt at the holding company level, then an operating company will need to go into resolution. Because at the end of the day, the creditors of the firm are going to have to bear the cost of its resolution.”