The Wonk Room

Banking Industry Pans Resolution Authority: It Makes Business ‘Unnecessarily More Expensive’

Rep. Barney Frank (D-MA), after consulting with the Treasury Department, plans to introduce legislation this week that would create a resolution authority for liquidating large, complex financial firms. It’s widely acknowledged (though not universally) that one of the problems facing the government during the economic crisis was that it had no authority to unwind the likes of AIG or Citigroup. Thus, propping them up was the only alternative to the widespread economic pain that would have been caused by their collapse.

As federal Reserve Chairman Ben Bernanke said, taking AIG into some sort of receivership “would have been far preferable” to the recurring AIG bailout. To that end, resolution authority will legalize a systematic process “for the government to seize control of troubled financial institutions, throw out management, wipe out the shareholders and change the terms of existing loans held by the institution.”

According to the New York Times, the bill will also require corporations to set up “the equivalent of living wills” — their own procedure for being disentangled — which the administration says “ought to be made public in advance.” But like so many of the recent regulatory reform efforts, the banking industry is coming out hard against resolution authority, this time without even seeing the bill:

Even before Mr. Frank unveils his latest proposals, industry executives and lawyers say its approach could make it unnecessarily more expensive for them to do business during less turbulent times. “Of course you want to set up a system where an institution dreads the day it happens because management gets whacked, shareholders get whacked and the board gets whacked,” said Edward L. Yingling, president of the American Bankers Association. “But you don’t want to create a system that raises great uncertainty and changes what institutions, risk management executives and lawyers are used to.”

For the record, as Shahien Nasiripour pointed out, Yingling has been spectacularly wrong about, well, everything, when it comes to the effects of regulations. And it’s really not surprising that the banking industry wants to enshrine “too big to fail,” as the alternative is unappealing from a business point of view.

But resolution authority is arguably the most important part of regulatory reform, as it should seriously mitigate the “too big to fail” problem. If there is a mechanism for taking apart a firm, no matter how large, an implicit government guarantee goes by the wayside. Bernanke is even advocating some sort of assessment on financial institutions, to build up a fund that will be used when resolution authority is invoked, moving the taxpayer a step further away from funding an institution’s failure.

Of course, problems could still occur if regulators — for whatever reason — are hesitant to pull the trigger and take a firm into receivership. That’s why even the most robust resolution authority needs to be pared with much stronger capital requirements and leverage limits for the banks, which will disincentivize and discourage excessive size or risk-taking. That way, a bank failure will really constitute a management failure, as it occurred despite all the safeguards.

And as for “unnecessary” expenditures, I’d like to ask Yingling what he thinks of the $700 billion spent to pull the banking system back from the brink. I bet he thinks that was a very necessary expense.