Treasury Proposes “Resolution Authority” For Systemically Significant Financial Companies
Part of Anticipated Comprehensive Federal Regulatory Reform
The Obama Administration’s proposed comprehensive Federal regulatory reform to address the gaps and weaknesses that have been exposed over the past 18 months in the existing regulatory system for the financial markets is beginning to take form. In testimony last week before the House Committee on Financial Services, Treasury Secretary Timothy Geithner explained the need for “comprehensive reform. Not modest repairs at the margin, but new rules of the game. The new rules must be simpler and more effectively enforced and produce a more stable system, that protects consumers and investors, that rewards innovation and that is able to adapt and evolve with changes in the financial market.”
As proposed by Secretary Geithner, the Administration’s plan for comprehensive reform includes four broad components:
· addressing systemic risk;
· protecting consumers and investors;
· eliminating gaps in regulatory structure; and
· fostering international coordination.
In connection with his testimony last week, Secretary Geithner detailed the proposed framework relating to the first of those four broad components — systemic risk. He indicated that the necessary reform to address systemic risk would consist of six principal elements: (i) one central regulator for systemically important firms; (ii) higher standards for capital and risk management for those firms; (iii) registration of private pools of capital (such as hedge funds, private equity funds and venture capital funds) satisfying thresholds to be determined; (iv) a comprehensive framework of oversight, protection and disclosure for the OTC derivatives market; (v) reform of the framework dealing with money market funds; and (vi) resolution authority over systemically significant nonbank financial firms whose failure threatens the overall financial system or U.S. economy.
This last element – resolution authority – addresses the deficiency identified over the last few months in the ability of Federal regulators to deal with systemically significant insurance conglomerates like AIG, and major independent investment banks and holding companies like Lehman Brothers and Bear Stearns, and other nonbank financial institutions that have failed or are in danger of failing. Unlike in the case of Washington Mutual, IndyMac and Wachovia, and other commercial and savings banks, nondepository financial institutions are not subject to an orderly resolution by the FDIC or another Federal regulatory authority. As a consequence, Treasury and Federal regulators presently possess very limited tools to resolve significant troubled nonbank financial firms, through infusions of loans or capital; leaving the ultimate resolution of these types of financial companies to Federal bankruptcy judges utilizing laws and tools designed to focus on the failing company itself (and its creditors) rather than on the stability of the overall financial system or broader economy. Transferring resolution authority to Treasury and Federal regulators is anticipated to facilitate the ability to resolve these troubled companies in a manner that would limit systemic risk and minimize the cost to taxpayers.
To resolve this gap in the United States regulatory structure, Secretary Geithner has proposed legislation, entitled the “Resolution Authority for Systemically Significant Financial Companies Act of 2009”. This legislation, if enacted, would expand the FDIC’s authority by allowing it to put any systemically significant financial company into conservatorship or receivership and then administer its orderly resolution. Bankruptcy court jurisdiction over such systemically significant firms would be eliminated.
The proposed Resolution Authority legislation reflects some of the lessons learned from the Lehman Brothers and AIG crises. In the case of Lehman Brothers, a disorderly bankruptcy of a systemically significant nonbank financial institution wreaked havoc on the broader financial system and ignited a worldwide loss of confidence in other systemically significant financial institutions (including money market funds and commercial banks), irrespective of the actual financial condition of those other institutions. In the case of AIG, while the Federal Reserve Board had adequate authority to address AIG’s liquidity problem, the Federal Government lacked the tools needed to address AIG’s capital problems absent new authority from Congress. Limited authority ultimately was granted, but only to Treasury, under the Emergency Economic Stabilization Act of 2008. Even now, the Federal Government is constrained in its ability to force AIG into an orderly process of conservatorship or receivership.
As proposed, the Resolution Authority legislation would establish an overall structure to trigger the ability of the FDIC to seize a systemically important financial company, and to enable the FDIC to manage the process once that trigger has occurred. The proposed structure for triggering the seizure of troubled nonbank financial companies is new. It would require the Secretary of the Treasury, in consultation with the President and upon the recommendation of the Federal Reserve as well as the respective financial company’s appropriate Federal regulator (FDIC, SEC or CFTC, depending on the business of the particular troubled company or its affiliates), to determine whether (1) the particular financial company is in default or is in danger of default (as measured by certain criteria, such as an imminent bankruptcy filing or critical undercapitalization), (2) the failure of such financial company and its resolution under otherwise applicable Federal or state law would have serious adverse effects on overall financial stability or economic conditions in the United States, and (3) any actions or assistance under the Resolution Authority legislation would avoid or mitigate such adverse effects.
If such determination were to be made, then the FDIC, with the approval of the Treasury Secretary, would be permitted to utilize a variety of new resolution powers. These resolution powers would include the ability to infuse debt or equity capital into the failing financial company, purchase assets from it, assume or guarantee its obligations, sell its assets, or (subject to limited judicial review) seize such troubled company under conservatorship or receivership. Many of these powers are analogous to those already available to the FDIC in resolving troubled insured depository institutions. Conservatorship or receivership would terminate any bankruptcy proceeding then pending against the seized company, and would provide the FDIC with broad powers to operate, reorganize or liquidate the seized company, including expanded powers to recover fraudulent conveyances to insiders and employees, as well as authority to dispose of assets and enforce, renegotiate or reject existing contracts (with certain exceptions, including certain types of qualified financial contracts).
The Resolution Authority legislation, as proposed by Secretary Geithner on behalf of the Obama Administration, is awaiting formal sponsorship in the Congress.
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