The Big Fail

Despite the reach of Dodd-Frank, the "too-big-to-fail" dilemma lives on.

You Say You Want a Resolution

After the demise of Lehman Brothers, letting the operating entities of big banks declare the kind of Chapter 11 in which they enter a turnaround situation or are acquired without government assistance seems unwise. And it is nearly impossible in the current regulatory framework, say restructuring experts. Allowing an insured bank to fail naturally shifts substantial risk back to the Feds. “What happens if someone takes those deposits guaranteed by the government and uses them up?” asks Jacen Dinoff, a principal at KCP Advisory Group. “You’re not going to see a bank file Chapter 11 and sit in bankruptcy winding down its assets while depositors petition as creditors to get percentage recoveries on life savings.”

The Dodd-Frank Wall Street Reform and Consumer Protection Act does limit how far regulators will go in propping up a large bank. The law grants the FDIC powers to dismantle the largest financial firms when they falter; the FDIC becomes a receiver for a bank if its failing presents a systemic risk to the financial markets. To help regulators devise plans to wind down huge banks, the biggest U.S. institutions — those with $50 billion in assets or greater — have to write “living wills.” The FDIC and the Federal Reserve were given 18 months to write a joint rule governing the drafting of living wills, so the rule could be unveiled later this year.

These bank-resolution blueprints might limit the amount the federal government would have to spend on bailouts, and they would also, to a degree, allow “market forces to creatively destruct an institution,” says Michael Hagedorn, CFO of UMB Financial, a $12 billion regional bank holding company. But the disposition of assets would need to be orderly, he says. For example, some of the largest banks in the United States perform securities processing for banks like UMB. “That couldn’t go away tomorrow and not have a big impact on the U.S. economy,” he says. “But you can sell that business to someone else, a much-better-run bank.”

But in the last financial crisis, Wall Street banks didn’t want to sell prized assets. “If they didn’t get a bailout, their next alternative would have been to sell off their good assets, but they didn’t want to do that, because they wanted the future revenue,” says Hagedorn. “If you let the free market function the way it is supposed to, it would dictate that they find a willing buyer and get the best price. When the government gets involved, it distorts this and lets a failed management team survive while allowing institutions with taxpayer-backed capital to actually grow their bank.”

Liquidation raises the specter of shotgun asset sales at a steep discount. Critics also contend that the speed with which the FDIC closes a community bank couldn’t be brought to bear at a larger institution. “I don’t think [resolution schemes] will work — because of the human factor, the panic that would set in,” says Sandy Brown, a partner at Bracewell & Giuliani LLP who served in the Office of the Comptroller of the Currency in the 1980s.

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