Dear Clients,
Congress is now well on its way to finalizing an untested “orderly-liquidation” framework with a hair-trigger implementation date. Thus, should your institution be feeling faint, we strongly recommend failure in June. That way, regulators could still ease you and your counterparties out of this world. Upon enactment, it’s the guillotine.
Seriously, this is a major problem that could create systemic risks all on its own. The new legislation of course comes at a time of profound global financial-market fragility. Facing the no-bail-out, no-time no-way new bill, prudent large institutions must look over the edge and do what they can now to protect themselves from the painful world soon to come. The EU, of course, has provided a massive bail-out package that buttresses all of its banks. U.S. financial institutions had better hope it holds.
That this sudden shift in resolution requirements comes at a tricky time is painfully obvious. Just as Congress gets ready to wreak the vengeance on big banks current politics demands, global financial markets are back on the brink. At a Thursday hearing, the Fed provided what comfort it could on the systemic risk brewing in the EU. However, in a critical – and little noticed — difference from crises past, Fed Governor Dan Tarullo conceded that the EU imbroglio isn’t just a liquidity one. Serious solvency problems lie behind short-term disruption, he rightly said under questioning from a GOP Member.
At the least, this means that the next few weeks will be rough. At the same time, Congress will finalize the new resolution regime that will make it virtually impossible for the FRB to provide non-liquidity support to anyone, as well as to offer any type of backstop to an individual financial institution. The FDIC’s hands will also be tied, with sharply limited powers going forward to come up with creative solutions like the 2008
Temporary Liquidity Guarantee Program. We’ll see what the final resolution regime looks like out of conference, but our guess is that it will largely track the Senate approach, not the more flexible one enacted late last year by the House. So, no “open-bank” assistance, no support to creditors, no succor for senior management and so forth.
We will need to read the Senate bill with care and contemplate how it fits with the House one to anticipate the new, final bell that will toll for systemic-risk resolutions in the U.S. At the least, it will be a one-sided affair while the EU talks about cross-border resolutions in Basel as it bails out all of its banks. At the most, though, the pending legislation is yet another risk factor that big financial institutions need now to consider carefully as they survey their counterparty exposures and whatever capital, collateral or guarantees they hope lie behind them.