Friday, October 23, 2009

FDIC Asks For Bridge Bank Powers To End Too Big To Fail

The FDIC tells Congress that the way to allow the orderly closing of too big and too interconnected to fail institutions is to grant powers to the FDIC to allow the transfer of the bank's assets to a "bridge bank."
We [FDIC] have recommended that a special resolution process for systemically significant financial firms include an option to create a bridge financial institution. This tool, which is available as well in bank receiverships, allows the receiver to transfer assets and contracts from the failed firm to the bridge institution in order to retain franchise value and to avoid dumping financial contracts on the markets. Under the proposed resolution process, financial market contracts could be transferred to the bridge institution run by the governmental receiver without triggering netting and liquidation rights. This could prove vital to avoid a market melt-down. The bridge financial institution also can maintain other systemically significant functions such as payments processing, securities lending, and the settlement of ongoing government securities or other transactions. Most critically, the bridge financial institution allows time to avoid a sudden loss of critical services and promotes market confidence.

The bridge financial institution option, and the continuity it can provide, requires access to liquidity for ongoing operations. To achieve this, the proposed special resolution process includes ready access to liquidity for the bridge financial institution from a resolution fund provided from assessments paid by the industry. In contrast, under the Bankruptcy Code, a Chapter 11 debtor who will incur post-petition expenses to maintain operations must often borrow from lenders, usually at unfavorable rates. Debtor in possession financing can be particularly costly, or unavailable, for large financial firms in bankruptcy since their assets are so dependent on market liquidity and confidence and the bankruptcy filing itself greatly reduces their asset value. The result is that there may be less funding to preserve valuable ongoing operations for sale. According to some commentators, the lack of debtor in possession financing following the Lehman bankruptcy filing led to many possible Chapter 11 reorganizations becoming Chapter 7 liquidations. Under the proposed resolution system for systemically significant financial firms, the bridge option with its access to liquidity will provide continuity, while better preserving the value of financial assets for the benefit of creditors.

The FDIC's current authority for insured banks and thrifts to act as receiver and to establish a bridge bank to maintain key functions and sell assets offers a good model. A temporary bridge bank allows the FDIC to transfer needed contracts to the bridge bank and preserve key banking operations, which can be crucial to stemming contagion. At the same time, by closing the bank and placing it into receivership, the FDIC assesses the losses against shareholders and market participants who should appropriately bear the risk. By preserving the going concern value of the financial assets, it also encourages interest by other firms in purchasing the operations and assets of the firm, which can reduce losses to the receivership.
The above is from an October 22, 2009, Statement of Michael Krimminger, Special Advisor for Policy, Federal Deposit Insurance Corporation on Too Big to Fail: The Role of Bankruptcy and Antitrust Law in Financial Regulation Reform before the Committee on the Judiciary; Subcommittee on Commercial and Administrative Law; U.S. House of Representatives.

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