Bair Argues for Non-Bank Resolution Fund

FDIC Chairwoman Sheila Bair affirmed her support for the creation of a non-bank resolution authority that would rely on a fund to pay for its winding down of failed financial institutions today. Speaking at the National Association for Business Economics Washington Policy Conference, she explained what we've learned from the crisis and what regulation needs to do to correct those problems. In doing so, she spent some time on the role of a resolution authority, which makes sense since the FDIC will likely have this duty. I'm a little unclear on whether Bair thinks this authority should consider options other than just winding down troubled institutions.

Here's an expert of what Bair said after stressing the importance of higher capital requirements:

But what we need most is a pre-funded resolution mechanism, similar to the FDIC's receivership authority for failed banks ... and a clear mandate to close large, systemically important firms when they get into trouble and to quickly sort out the claims against them so that key financial relationships can be preserved and the taxpayer and can be protected.

Let me be clear - this would not be another bailout mechanism.

Shareholders and creditors would bear the losses, not the public.

But, the process would be orderly and help prevent a catastrophic collapse of other firms.

If you've read much of my writings on financial regulation, then you know the creation resolution authority is a pet cause of mine. I also support the conception that the mechanism is pre-funded, as it doesn't make sense for the good guys to pay for those that failed after-the-fact.

But I also think that a resolution authority should keep troubled firms if possible by restructuring capital. I wrote about this a few weeks ago when explaining another article by some executives from Credit Suisse. The idea is that some troubled institutions could simply restructure capital, like swapping debt for equity in some manner, so to prevent failure. Under the current system, that would be very difficult to do quickly. But I believe if an institution's failure plan featured a way to restructure capital if the firm ran into problems, then the resolution authority could consider restructuring capital as the plan dictates first, before simply winding down the institution.

From this speech, it's a little unclear whether or not Bair has a more simplistic view, where a resolution authority would just close troubled firms. Right now, most banks are just wound down by the FDIC with failure looming. While that's one option, if the market could be saved from some additional losses associated with outright failure without taxpayers bearing the cost of keeping a firm going, then I don't see why regulators wouldn't want to include that option as well. This isn't currently an explicit alternative according to what I understand about the FDIC's bank resolution practices, but there are other options considered before just winding it down. Any new resolution authority should also have the power to consider alternatives, including capital reallocation to keep a firm afloat.