July 9, 2020

DealBook: Regulator: Wall Street Not Too Big to Fail

3:22 p.m. | Updated

Michael H. Krimminger, the Federal Deposit Insurance Corporation's general counsel.Daniel Barry/Bloomberg NewsMichael H. Krimminger, the Federal Deposit Insurance Corporation’s general counsel.

Bailouts are no longer an option for Wall Street, a top Federal Deposit Insurance Corporation official told Congress on Tuesday.

Michael H. Krimminger, the F.D.I.C.’s general counsel, said in testimony before a House Financial Services Committee panel that regulators now have “the tools to end too big to fail.”

His position is a sharp turnaround from 2008, when the nation’s economy teetered on the brink of collapse. At the time, Washington enacted a $700 billion bailout for banks, the automotive industry and the giant insurer American International Group. Policymakers argued that they had no choice but to rescue the firms because they were so large and interconnected that their collapse would have caused the nation’s economic downfall.

“Such a presumption reduced market discipline and encouraged excessive risk-taking by firms,” Michael S. Barr, a former assistant Treasury Department secretary who is now a law professor at the University of Michigan, told the committee.

In the aftermath of the financial crisis, Mr. Barr was a leading architect of the Dodd-Frank Act, which aimed to rein in derivatives trading, mortgage securities and other risky Wall Street businesses.

The law, according to Mr. Krimminger, ended the era of bailouts, too.

“There is no statutory authority in the Dodd-Frank Act for us to bail out a failed financial institution.” he told lawmakers.

Instead, Dodd-Frank created the Financial Stability Oversight Council, a panel of regulators who will keep an eye on the nation’s biggest and riskiest companies. The council will designate specific financial firms — including mutual funds, insurance companies and hedge funds — that pose a systemic risk to the financial system. These firms, and banks like Goldman Sachs that have more than $50 billion in assets, will face tougher federal oversight and higher capital requirements.

The so-called systemically important financial institutions, or SIFIs, must also create a “living will” that spells out how the firms could be unwound through bankruptcy if they fall on hard times. And if the F.D.I.C. or Federal Reserve concludes that a firm’s plan is insufficient, the regulators may force the company to shed some of its riskier assets or operations, according to Mr. Krimminger.

The plan, regulators say, will prevent a repeat of the chaotic Lehman Brothers bankruptcy.

“Resolution plans are essential to ending too big to fail,” Mr. Krimminger said. “These plans will provide the analysis, information and advanced planning that was lacking in 2008.”

But some Republicans and financial industry executives say that labeling a company as “systemically important” only reinforces the too-big-to-fail problem. Others note that when complicated and huge institutions file for bankruptcy, as in the case of Lehman, markets can panic.

Dodd-Frank does offer an alternative: “orderly liquidation authority.” Under the law, the F.D.I.C. has receivership power over firms that are on the brink collapse, similar to the agency’s role when a local bank fails.

Critics contend that the process would give the government the arbitrary authority to decide when a firm lives and dies. Some also say it will force a fire sale of a failing firm’s assets.

But Mr. Krimminger reassured lawmakers that the failed firm’s shareholders and creditors would bear the brunt of the losses, protecting taxpayers from another massive bailout. The government would remove the firm’s executives, and claw back some of their compensation.

“This would be critical to avoid a future financial meltdown,” he said.

Article source: http://feeds.nytimes.com/click.phdo?i=cc7dfc3cd1c812c1b0df6a64624419d5