The FDIC has developed a new strategy that it believes will avoid a major blow to the economy the next time a big bank or financial firm fails. The agency proposes to do this by seizing the firm’s parent company while allowing its healthy subsidiaries to continue operations. FDIC Acting Chairman Martin Gruenberg outlined the agency’s strategy in a speech last month. Under the 2010 financial overhaul law, the FDIC has the authority to seize and dismantle big financial firms that could collapse and threaten the broader system. The FDIC’s goal is to avoid another taxpayer bailout of Wall Street banks in the event of another financial crisis. It should be noted that the agency’s power extends to financial firms other than banks, such as insurance companies.
Under the strategy, the FDIC would take over a failing firm’s parent company, but it would allow healthy subsidiaries of the firm to continue operating. Gruenberg believes that would reduce disruption and permit normal financial transactions. Because the subsidiaries would keep operating, their trading and other relationships with other big financial institutions would also continue normally. That would “mitigate systemic consequences,” according to Gruenberg. If the FDIC’s strategy works it would reduce the chance that big financial firms closely connected to each other would fall like dominoes. That seems like a good thing and hopefully it will be.
When the FDIC shuts down a firm’s parent company, the agency would transfer the parent’s assets, especially holdings in its subsidiaries, to a new “bridge” company under the new plan. The firm’s shareholders would lose their investment and the firm’s creditors would receive equity stakes in the “bridge” company. The FDIC’s goal would be for the bridge company to become a healthy company in private hands. The FDIC had this to say about the plan:
We believe this strategy holds the best possibility of achieving our key goals of maintaining financial stability, holding investors in the failed firm accountable for the losses of the company, and producing a new, viable private-sector company out of the process.
In explaining its new strategy, FDIC officials cited the example of Lehman Brothers, whose collapse in September 2008 resulted in the biggest bankruptcy in U.S. history. It precipitated the financial meltdown that plunged the economy into the Great Recession. Despite Lehman’s extensive losses, it was pointed out that there were substantial valuable assets in some of its subsidiaries. That was especially true with its European operation based in London. When Lehman failed, the London-based operation had to be dissolved under British law. The new FDIC strategy would permit such an operation to continue.
The American Bankers Association, the industry’s biggest lobbying group, believes the FDIC’s strategy is an important step toward ending the doctrine of “too big to fail” and government bailouts of big financial institutions. Frank Keating, the group’s president and CEO, said in a statement:
In any failure, it’s the equity owners that should take losses. This strategy assures that, but would continue the operations of the firm going forward to minimize market disruptions.
It will be interesting to see how the FDIC’s new strategy works. At first look, it seems to make sense. Hopefully, it will prove to be a good thing both for big business, their investors and the American people generally.
Source: Insurance Journal
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