Michael H. Krimminger, a partner in the Washington office of Cleary Gottlieb Steen & Hamilton, was general counsel of the Federal Deposit Insurance Corporation.
In a recent column for DealBook, Harvey R. Miller and Maurice Horwitz faulted the Dodd-Frank Act's resolution authority, and the “single receivership†resolution approach proposed by the Federal Deposit Insurance Corporation, because they purportedly fail to deal with cross-border issues raised by the failure of a global financial institution. Fortunately, their criticisms are not well-founded.
There is no question that any so-called systemically important financial institution, or SIFI, would have a complex structure and many subsidiaries in foreign jurisdictions. Their column states that the F.D.I.C.'s single receivership approach works only for domestic insolvencies because initiation of insolvency proceedings for the holding company will “precipitate the commencement of foreign insolvency proc eedings for all foreign operating subsidiaries, as occurred with Lehman.†This reflects the bankruptcy experience in the case of Lehman Brothers, but fails to recognize some important differences between that insolvency and the proposed approach under Dodd-Frank.
First, what is the F.D.I.C.'s proposal? The agency proposes, if it is appointed and where possible, to close the financial holding company, but keep the viable subsidiaries operating. Subsidiaries that are not viable would be closed and gradually wound down to prevent a sudden collapse, as occurred in the case of Lehman. The holding company would be restructured into a bridge entity that can continue to provide financing to viable subsidiaries.
Access to funding is critical to continued operations. Dodd-Frank provides for this financing from an “orderly liquidation fund,†and it must be paid back from the sale of the subsidiaries or from assessments from the industry. This addresses a fundamental p roblem with the bankruptcy model â€" it lacks any source of capital to allow a gradual, orderly wind-down.
It is important to emphasize, however, that this is no bailout. The shareholders and creditors of the holding company â€" which owned the subsidiaries â€" bear the losses for the failure. No losses can be borne by taxpayers.
As a result, this approach should help prevent the virtual liquidation that occurred in Lehman, where - as confirmed by the bankruptcy examiner - tens of billions of dollars were lost through the unnecessary disposal of valuable contracts. With the financing available from the orderly liquidation fund and the stabilization of the holding company through the transfer to the bridge company, the valuable subsidiaries should be able to continue in normal operation. This should avert a Lehman-style cascade of insolvencies and minimize the spread of financial dislocation to the real economy. Creditors of the holding company should benefit fro m the better value obtained through the sale or spinoff of operating subsidiaries.
Second, Dodd-Frank is a domestic law, but it provides a framework for international planning and cooperation. Contrary to the view expressed in the Miller-Horwitz column, foreign law does not automatically require closure of subsidiaries if the parent is placed into F.D.I.C. receivership.
Before I stepped down as the agency's general counsel in May, I confirmed this fact with regulators in all of the major jurisdictions. If, however, foreign subsidiaries are cut off from financing and operational support, they will be closed.
The F.D.I.C.'s single receivership approach should allow normal operations to continue, which would virtually eliminate the incentive for foreign regulators to close subsidiaries. In fact, foreign regulators will have positive incentives to cooperate since local â€" as well as American â€" interests would be better served by operating subsidiaries compar ed with separate insolvency proceedings.
The column seemed to prefer the European Union's admonition toward cooperation over the F.D.I.C.'s more detailed approach under Dodd-Frank. Like the European Union directive, however, Dodd-Frank also requires the F.D.I.C. to coordinate “to the maximum extent possible†with foreign authorities. In fact, the Dodd-Frank resolution powers are the international standard â€" they were effectively incorporated into the Financial Stability Board's “Key Attributes of Effective Resolution Regimes for Financial Institutions†and approved by the Group of 20 nations. The European Union directive draws directly from work done by the F.S.B. and the United States.
As F.D.I.C. general counsel, I worked closely with American and international colleagues on detailed resolution planning. This was not a conceptual effort. It was focused on specific SIFI's. It also built on the work of the Financial Stability Board, which has required regulators to set up institution-specific crisis management groups to conduct detailed recovery and resolution planning.
Today, the single receivership approach offers a better way to avoid an uncoordinated and destabilizing series of insolvencies for systemically important financial institutions. While a treaty mandating cooperation would be preferable, it is unlikely in the foreseeable future. The European Union's difficulties in deciding on burden-sharing illustrate the obstacles. Given that condition, we are better advised to apply the tools we now have to improve coordination and reduce the incentives for separate action.
More work must be done, but we must take these confidence-building steps if we are ever to achieve a future treaty on international resolutions. The alternative is a more Balkanized financial system that is less resilient. That is an outcome we cannot afford.
