The next time a big bank or financial firm fails, regulators hope to avoid a major blow to the economy by seizing the firm’s parent company while allowing its healthy subsidiaries to continue operations, the head of the Federal Deposit Insurance Corp. says.
FDIC Acting Chairman Martin Gruenberg outlined the agency’s strategy in a speech last Thursday. Under the 2010 financial overhaul law, the agency has the authority to seize and dismantle big financial firms that could collapse and threaten the broader system. The aim is to avoid another taxpayer bailout of Wall Street banks in another financial crisis. The FDIC’s power extends to financial firms other than banks, such as insurance companies.
Gruenberg said that under the strategy, the FDIC would take over a failing firm’s parent company but allow its healthy subsidiaries to continue operating. He said 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, Gruenberg said. That would “mitigate systemic consequences,” he said in the speech at a Federal Reserve conference in Chicago. That means it would reduce the chance that big financial firms closely connected to each other would fall like dominoes.
In shutting down a firm’s parent company, the FDIC would transfer its assets, especially holdings in its subsidiaries, to a new “bridge” company under the strategy. The firm’s shareholders would lose their investment. Its creditors would receive equity stakes in the “bridge” company.
Eventually, the bridge company would become a healthy company in private hands, Gruenberg said.
“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,” he said.
FDIC officials have cited the example of Lehman Brothers. Its collapse in September 2008 in the biggest bankruptcy in U.S. history precipitated the financial meltdown that plunged the economy into the Great Recession.
Despite Lehman’s extensive losses, there were substantial valuable assets in some of its subsidiaries, especially its European operation based in London, FDIC officials say. When Lehman failed, that operation had to be dissolved under British law. The FDIC strategy would permit such an operation to continue.
The American Bankers Association, the industry’s biggest lobbying group, said the FDIC’s strategy is an important step toward ending the doctrine of “too big to fail” and government bailouts of big financial institutions.
“In any failure, it’s the equity owners that should take losses,” Frank Keating, the group’s president and CEO, said in a statement. “This strategy assures that, but would continue the operations of the firm going forward to minimize market disruptions.”