The Senate Plan's Resolution Authority

Given my strong dedication to the idea that we need a non-bank resolution authority, I couldn't resist addressing this aspect of the Senate's new systemic risk regulatory proposal (.pdf). It's a lot like the House's version, but there are some nice additional details it includes and a few important differences.

The Authority

As with the House plan, the Federal Deposit Insurance Corporation (FDIC) will be in the driver's seat when it comes to resolving financial institutions. As I said with the House version, this makes complete sense, given the FDIC's experience and success in this role with failed depository institutions.

Who Decides

The decision makers aren't identical, however. For the Senate version, in most cases either the Treasury, the proposed Agency for Systemic Risk (ASR) or the Financial Institutions Regulatory Administration (FIRA -- the proposed bank regulator) can recommend that an institution should be resolved. Then two-thirds of the FDIC's and FIRA's respective boards must vote to resolve the institution. At that point, the Treasury Secretary (in consultation with the President) has veto power over that resolution.

In the House version it was essentially just the Federal Reserve's decision (its systemic risk regulator) to resolve an institution, so long as the Treasury Secretary and President agree.

The Senate's plan also has a separate procedure for brokers/dealers. But the main difference there is that the Securities and Exchange Commission (SEC) plays the part of the FDIC in the resolution decision process.

I lean towards the Senate plan's decision-making procedure but am not entirely convinced. I kind of like that the Senate has more parties involved in the decision, but I also worry that too high a barrier for ordering a troubled firm's resolution could endanger financial stability.

Paying For Resolution

As in the House plan, the Senate tries to keep taxpayers from bearing the cost of resolution in the event that a firm's assets don't entirely cover it. They also both call for financial industry assessments, but how they do so is a little different.

The House version was quite vague on how these assessments would take place, but it appears that the plan wants financial companies, broadly, to pay for excess resolution costs after-the-fact. I objected that firms who are playing by the rules could end up paying for those who took excess risk.

In the Senate's plan, more care is taken with how these assessments will be charged. Bigger firms who pose greater systemic risk will be on the hook to pay more into a resolution fund. Interestingly, it says a firm's assessment fee will also be based on:

the extent to which the financial company has benefitted, or likely would benefit, from the resolution of a financial company under this title.

I think that's utterly sensible. It also says that these assessments will be countercyclical, meaning the FDIC won't assess firms as much at times of economic hardship, but replenish the fund once the economy has improved. I think this is important too, because you don't want a situation where a battered banking industry is forced to use some of its precious capital to replenish the fund.

From reading the document, two things were still unclear about these assessments. First, I couldn't figure out if the fund is built up for a rainy day based on pre-resolution assessments, or if the Treasury sets aside money at first, but then firms replenish the fund through assessments at some point after a resolution event has taken place. Second, I'm not entirely clear on whether only firms who the ASR places on the heightened regulatory oversight list are assessed or if the greater financial industry must bear the cost.

I have requested clarity from the Senate Banking Committee on these issues, but haven't heard back -- not sure they work on Veteran's Day. I will post an update once I hear, because I think these are important considerations.

But from what I do understand, I think both plans have mostly adequate resolution authority provisions. I like the detail in the Senate plan better, and if it turns out that its resolution fund is created by assessing firms before resolution, then I'd strongly prefer this version.