WASHINGTON — Banks are more inclined to plot their expansion than prepare for their demise, but with the Federal Deposit Insurance Corp. soliciting the industry's help to establish a new resolution unit, charting their own death is exactly what many large institutions will have to do.
In early conversations highlighted by last month's FDIC roundtable on the topic, executives appeared willing to help the agency devise the new wind-down system but also pressed the agency on their own concerns, including how flexible regulators will allow resolution plans to be, the level of certainty creditors will receive in a failure scenario and any potential for future resolution planning to hurt current profitability.
"Who is excited about planning their own death, especially organizations that in theory think they're going to be perpetual?" said Robert Litan, a senior fellow at the Brookings Institution and research chief at the Kauffman Foundation. "Unlike people, who already know they're going to die, companies think they're going to live forever. To plan the demise of a perpetual company is sort of like running against nature. But the reason they've got to do it is we know who comes to the rescue in case they fail."
At issue are new powers the FDIC gained under the Dodd-Frank law to clean up large bank holding companies and nonbanks that the government deems too systemically important to be unwound by the bankruptcy system. The lack of a resolution system in 2008 is blamed for much of the turmoil that came with the failures of giants like Bear Stearns and Lehman Brothers.
The agency is expected to unveil a rule implementing the new system soon. Along with the Federal Reserve Board, the FDIC also must set standards for a giant firm to complete its own "living will" — essentially a plan detailing how to unwind the firm's various business lines without causing a systemic problem.
"This resolution authority can work best if we have on the shelf a resolution plan that can be used in a very short time frame," FDIC Chairman Sheila Bair said at the meeting.
But so far at least, the FDIC does not want to just come up with rules of the road on its own. Instead, the agency is seeking industry input even as companies try to get an idea of what the new system will look like.
"Everybody quite legitimately is trying to grope toward a solution," said Gary Gorton, a Yale finance professor who participated in the agency's Aug. 31 roundtable.
He said the meeting showed that "firms were all interested in 'We don't want to have to do anything too complicated, and we don't know what we're supposed to do, please tell us.' The regulators were 'We don't know what to do, either, please tell us.' "
Executives at the meeting urged the FDIC to provide as much certainty as possible about what creditors of a failed bank holding company or systemically important nonbank firm will get from a receivership. That question is relatively well understood in the case of individual bank takeovers, in which insured depositors are covered but most other creditors are wiped out.
But the process is unclear for holding companies. Although the FDIC has said the process for nonbanks will be similar to the priority used in bankruptcy courts, executives said any uncertainty about the order of claims will have harmful effects.
"Providing a degree of certainty to the market around creditor rights is probably the single most important thing that you could do just in terms of the impact it will have on funding," Hamid Bigliari, a vice chairman at Citigroup Inc., said at the forum.
But while they want certainty for investors, bankers also urged regulators not to force them to draft living wills that are too rigid, and do not allow for differences for institutions during economic cycles.
"The diversity of the people around this table demonstrates that you've got to make sure the regs are flexible enough to allow you and your other colleagues … to be able to figure out how to craft the right living will [and] resolution [plan] on a firm-by-firm basis," said Barry Zubrow, the chief risk officer for JPMorgan Chase & Co.
John Wright, the chief regulatory counsel at Wells Fargo & Co., agreed. For example, he said, it would not make sense for all systemically important firms to have to incorporate international operations into their wind-down plans.
"We don't have a lot of international operations. We're pretty simple from an operational standpoint," Wright said. "In terms of principles, we agree with a lot that was said here, but when you come down to the actual requirements, if it could be more of a dialogue up front so that each organization is able to tell its story and not be expected to fall into a particular mold."
FDIC officials signaled that implementation of the resolution provisions could contain a mix of specificity — to provide certainty where needed — and a level of ambiguity. "Theoretically there could be a blend between regulations and some type of 'policies,' if you will. Regulations to provide clarity. Policies to provide the ability to adapt," said Michael Krimminger, Bair's deputy for policy, who moderated the roundtable.
He said the crafting of the rules will likely be "an iterative process" with the industry "because there's no way that we could define a resolution plan, and we think there's probably no way that the firms could define a resolution plan without talking to us.
"It's going to be very important to have good feedback loops with the marketplace," Krimminger said.
Other topics at the meeting included how much of a failed company the FDIC would potentially need to place in a bridge firm, which the agency would keep operating in the interest of preventing a systemic effect on other institutions, and then sell off down the road.
Some observers said if there is another crisis, the FDIC may need to move more into the bridge firm than less.
"It's not immediately clear what significant part of one of the firms wouldn't be moved. If it's, say, a clearing house, the whole thing's going to have to be moved," Gorton said at the meeting. He added later, "You want to distinguish between a resolution when we're not in a crisis from a resolution when we are in a crisis."
Bair countered that tighter regulations on companies resulting from the new law may make the failure of a systemically important institution in the future more of an isolated event, relieving some pressure on the FDIC about the risks facing other institutions.
"I am not so sure … we would have a systemic failure only when there's a broader crisis going on," Bair said. "History has said that there can be some very badly managed institutions when the overall system is not that bad off."
In a true crisis situation, Bair said, regulators now have tools at their disposal to prevent systemic fallout other than preserving individual institutions, including the Fed's so-called "13(3) authority" to provide support across the system, and the FDIC's ability to get Capitol Hill approval to guarantee the industry's debt in an emergency.
"I am operating under the theory that, yes, there will be another cycle and, yes, there will be another downturn," Bair said. "The kind of cataclysm we just faced, I don't think it's going to — I hope it's not going to — happen again."
But executives also sounded concern about the inconsistency between preparing one's company for a hypothetical resolution and aiming for higher profits.
One obstacle is "the very significant difference in priorities between sometimes what we think our shareholders want to protect shareholder value, and what we need to do to keep the banking system running in an efficient way and avoid systemic risks," said Art Certosimo, an executive vice president at Bank of New York Mellon Corp.
As a result of planning a living will, many firms may have to think about creating a simpler structure with clearer lines between entities underneath the holding company.
"I don't think we would suggest that everything needs to be brought down to the simplest level possible," Krimminger said. "Certainly the needs and the risks that are created by the interconnections and the complexity clearly have to be considered if you're going to have a credible plan. … It's a "healthy thing to look at: are there complexities or interconnections that may even impair business efficiency while also creating additional systemic risk?"
But participants at the FDIC meeting said that may be out of whack with a firm's goals in healthy times.
"Managing something that's easily broken apart just for planning for what happens in the case of a resolution is not necessarily good for business," said Phil Wertz, an associate general counsel at Bank of America Corp. "Having 20 legal-entity silos that don't talk to one another and can easily be broken apart … defeats the purpose of having the cross-selling and integration of a large financial firm. … Hopefully we're not going to be driven purely by resolution as driving everything during the good times, planning for it obviously, but not making business decisions that ultimately are contrary both to the company and to the system."
Several participants, including Wertz, emphasized the importance of remediation plans — another requirement of the law, which forces firms to plot how they would recover to health in a distressed climate — along with resolution plans.
Observers said planning for one's death is an easier exercise for a person to stomach than a financial institution. "It might sound nice in terms of an individual, where you're thinking about: 'Death is inevitable.' Therefore you want to make sure your heirs get assets," William Longbrake, the executive in residence at the University of Maryland's Smith School of Business and a former vice chairman at Washington Mutual Inc., said in an interview. "In the case of a corporation, that's not the way you think. You don't think about failing. You think about being successful."
