Federal Reserve Must Disclose Bank Bailout Records

Posted on Mar 22, 2010 in Economic News

Source: Bloomberg

Federal Reserve Chairman Ben S. Bernanke said any mechanism to dismantle firms deemed too big to fail must avoid disruptions to the financial system while imposing costs on shareholders and creditors, not taxpayers.

“Market participants must be convinced that if one of these firms is unable to meet its obligations, its shareholders, creditors and counterparties will not be protected from losses by government action,” he said two days ago in a speech in Orlando, Florida. “We need an alternative for resolving failing firms that is neither a disorderly bankruptcy nor a bailout.”

Congress is considering a resolution mechanism for large, complex firms as part of the most sweeping overhaul of the financial regulatory system since the Great Depression. The changes are intended to prevent a repeat of the crisis that prompted bailouts such as the $182.3 billion rescue of insurer American International Group Inc., in which the Fed took part.

“If, in the end, funds must be injected to resolve a systemically critical institution safely, the ultimate cost must not fall on taxpayers or small financial institutions, but on those institutions that are the source of the too-big-to-fail problem,” Bernanke said in his speech to the Independent Community Bankers of America.

“It is unconscionable that the fate of the world economy should be so closely tied to the fortunes of a relatively small number of giant financial firms,” Bernanke said. “If we achieve nothing else in the wake of the crisis, we must ensure that we never again face such a situation.”

Capital, Liquidity

Bernanke said regulators must also impose requirements for capital, liquidity and risk management at the largest firms and improve clearing and settlement of derivatives contracts to protect the financial system in the event of a failure.

A plan by Senate Banking Committee Chairman Christopher Dodd, a Connecticut Democrat, would allow the Federal Deposit Insurance Corp. to liquidate a large firm after a panel of bankruptcy judges determines the company is insolvent and with approval of the Fed, FDIC and Treasury Department.

The Fed chairman has faced criticism from Congress for bailouts that he said were intended to prevent a possible depression. Lawmakers including Dodd have criticized the Fed’s purchase of $29 billion of securities in March 2008 to facilitate the merger of Bear Stearns Cos. with JPMorgan Chase & Co., and loans to keep New York-based insurer AIG from default.

Revamping Approach

The Fed is revamping its approach to supervision of large banks, using economists and quantitative analysts to help with horizontal reviews targeting risks across the financial system, Bernanke said.

“We at the Federal Reserve have been working with international colleagues to require that the most systemically critical firms increase their holdings of capital and liquidity and improve their risk management,” he said.

Dodd’s proposal includes a provision that requires large, complex companies to periodically submit “funeral plans” for their quick and orderly shutdown in the event of failure. Bernanke said the concept was “worth exploring.”

While the FDIC has the power to take over failing deposit- taking firms and wind down assets, no such authority exists for financial firms that aren’t classified as banks, such as AIG or a hedge fund with extensive links throughout the banking system.

The Fed chairman also defended the central bank’s structure, which includes 12 regional banks, as a useful decentralized network to monitor the financial system and economy. He said the oversight of small banks has been critical to the Fed in setting monetary policy.

‘Distorted Picture’

A supervisory agency that focused only on the largest banking institutions, without knowledge of community banks, would get a limited and potentially distorted picture,” he said.

Dodd proposes limiting the Fed’s authority to bank holding companies with more than $50 billion in assets, while the Federal Deposit Insurance Corp. and the Office of the Comptroller of the Currency would regulate other banks. A bill passed by the House of Representatives in December left the Fed’s current supervisory authority intact.

The Fed oversees about 5,000 bank holding companies and more than 800 state member banks. The Board of Governors in Washington delegates supervisory authority to the regional Fed banks which have examiners on staff.

John Bowman, acting director of the Office of Thrift Supervision, called for the creation of a federal agency to supervise community banks and thrifts.

“Whether a community bank holds a state charter, a national bank charter or a federal thrift charter, that institution should not be supervised by the same agency that oversees complex commercial banks,” Bowman said two days ago in a speech to the conference, according to an OTS release.

To contact the reporters on this story: Steve Matthews in St. Louis at smatthews@bloomberg.net; Phil Mattingly in Washington at pmattingly@bloomberg.net

Last Updated: March 22, 2010 00:00 EDT

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