Among the noteworthy legacies left by Sheila Bair is a committee of outside experts advising the Federal Deposit Insurance Corp. on how to resolve systemically important institutions.
It includes luminaries from government and business like Paul Volcker and John Reed, who happened to flank Bair’s successor, Marty Gruenberg, at an all-day meeting Wednesday called to debate the agency’s “single point of entry” approach.
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This was not your typical Washington meeting where everyone politely avoids rocking any boats. Phones were left alone, email went unchecked, no papers were read.
Committee members – 19 men and two women – engaged from the start, going right at fundamental pieces of the FDIC’s plan to take over a troubled giant at its holding company while allowing its subsidiaries to continue operating.
After a pretty rough morning, Gruenberg joked: “I don’t think anyone would ever accuse this committee of being a rubber stamp.”
It was refreshing, but also unnerving because some of these experts clearly doubt SPOE can work.
Volcker kicked off the skepticism by asking the FDIC staff whether the strategy isn’t contrary to the intent of Congress laid out in Title II of the Dodd-Frank Act.
Volcker, who still commands any room he’s in, said the 2010 reform law envisions any company seized under Title II would be liquidated.
“When I read this, it doesn’t sound like a liquidating situation,” he said. It sounds more like the FDIC “takes a little cancer out” and “the rest of it goes on as the Great Universal Bank of the US.
“A lot of people look at this and they say, ‘This is a fancy way to subsidize or temporarily assist the company so it can continue in its new life.’ ”
Volcker added: “That’s what happened last time.”
Other committee members barged through the door Volcker opened.
Simon Johnson, the MIT professor who may be the nation’s leading advocate for breaking up the big banks, said the entities would be “liquidated” in a legal sense only.
“What you are describing is an orderly restructuring process along current lines,” he said. “You don’t mean liquidation in the traditional sense of the word.”
Peter Fisher, a senior director at BlackRock, jumped in to question the FDIC’s decision to force holding-company creditors to absorb all the losses. He argued such a focus would reduce market discipline of a firm’s operating subsidiaries.
The more assurance that we’re going with the holding company, the less counterparty discipline you’re going to have,” Fisher said.
As several other members jumped in with similar concerns, Art Murton, director of the FDIC’s Office of Complex Financial Institutions, tried to regain the floor. But it was H. Rodgin Cohen, the legendary Sullivan & Cromwell partner, who redirected the debate.
“Maybe counterparties do not understand this,” Cohen said. If an operating subsidiary suffers huge losses, “there will be multiple points of entry.” In other words, the FDIC will seize the unit and its creditors will lose money.
Don Kohn, the former Fed vice chair who is now a senior fellow at the Brookings Institution, jumped in on Cohen’s side, calling SPOE a step forward and noting that market discipline on banks is much better today than it was two years ago.
Fisher finally brought the discussion back to Volcker’s concern: Is SPOE true to Dodd-Frank’s intent? Will the FDIC liquidate these companies or simply restructure them?
“Our intent if a firm goes into a Title II resolution it that it comes out of that process in a way that it could be resolved under Title I,” Murton said.
In English, that means any systemically important institution taken over under the SPOE process will be restructured, which could include the sale or shuttering of key subsidiaries.
But that’s tricky, too, because as an FDIC staffer told the committee, the restructuring plan would be made public. While that pleases transparency hawks, what will it do to the value of those units? They will be worth less the minute the market finds out they are on the block, said Richard Herring, a professor at the University of Pennsylvania’s Wharton School.
The FDIC invited two executives from Moody’s to address the committee. Citing the FDIC’s work on SPOE, the rating agency recently declared the biggest banks were less likely to be rescued by the government.
But the agency didn’t get quite the boost from this testimony that it expected as various committee members questioned the rating agencies’ shaky track records. The body blow came from Douglas Peterson, the president of Standard & Poor’s Rating Services, who is a member of the committee.
While he agreed the FDIC had put the U.S. “way ahead of rest of world” as far as resolution planning goes, S&P does not agree with Moody’s.
“These plans are just being rolled out. They have not been tested,” Peterson said. “We continue to believe, for the largest systemic banks, if something happened tomorrow there would be government support.”
Clearly the FDIC has a lot of work to do, but the agency should get mountains of credit for inviting input in such a visible, and at times painful, way.
Gruenberg could have wrapped up the meeting with the perfunctory “thanks for being here, don’t let the door hit you on the way out.” But he didn’t. He said his staff would follow up with each member to get more details on their biggest concerns.
“You couldn’t buy this kind of input,” Gruenberg told the assembled experts. He sounded sincere.
“This is not an easy thing to deal with, but it is terribly important,” he said, adding modestly, “We have work to do, but I think we’ve made some progress.”
Gruenberg is clearly committed to an SPOE process that can work. The question remains, however, whether that’s possible.
If it’s not, the next likely options are breaking up the big banks or ring-fencing their insured depositories.