Experts question the Federal Deposit Insurance Corp.’s ability to liquidate large, systemically important financial institutions because of the complexity of the firms involved and challenges relating to international coordination.
The Dodd-Frank Act created an Orderly Liquidation Authority, or OLA, for resolving failed, systemically important financial companies. Since then, regulators developed rules to implement this authority and avoid disorderly resolutions that create substantial losses for the financial system.
The largest bank holding companies were required to submit resolution plans, or "living wills," by July 1.
A new report by the Government Accountability Office recognizes that in the bankruptcy process, the liquidation of large, complex, internationally active financial firms involves challenges such as identifying funding sources and dealing with complex corporate structures across international jurisdictions.
But financial and legal experts note that resolution plans might not be as helpful as hoped during times of financial distress because of the need for current information. Much of a company’ contracts, assets and liabilities can change dramatically from day to day.
Dodd-Frank requires financial companies to stress test their portfolios under multiple scenarios to identify the financial firm’s risks. However, the scenarios may not anticipate the type of financial crisis that could eventually lead to a firm’s insolvency.
“Because of these challenges and the reported burden associated with developing the plans, some industry and academic experts have questioned the merits of the plans,” the GAO states in the report. “FDIC noted their expectation that the plans, when complete, would provide important information for its advance planning to facilitate any necessary liquidation of a firm, irrespective of the cause of the firm’s failure.”
The FDIC is working to further clarify its authority under OLA, but experts are raising concerns about its ability to effectively initiate a resolution without causing broader market disruption.
FDIC issued an analysis of how it would have handled the failure of Lehman Brothers under OLA. Some criticized the analysis for its assumptions about Barclays Capital's ability to obtain regulatory approval to purchase Lehman’s distressed assets at a time of widespread weakness in the financial markets.
According to Lehman’s bankruptcy examiner, Barclays' was interested in acquiring Lehman prior to its bankruptcy and purchased certain assets of Lehman’s following the bankruptcy. According to FDIC, its willingness to absorb the first $40 billion in Lehman’s losses would have addressed concerns of Barclays’ U.K. regulators. The FDIC told GAO officials it has sufficient powers to resolve such firms in order to limit further market disruption.
The GAO’s report reveals that academics are also noting the FDIC’s lack of experience in liquidating financial companies as complex as Lehman's with multiple international subsidiaries. An official from the Securities Investor Protection Corp., which protects investors in certain securities from financial harm if a brokerage firm fails, told the GAO that Lehman collapsed within 24 hours — a much shorter planning period than the FDIC is accustomed to when resolving failed banks.
In response, FDIC officials said they likely would have reviewed a firm’s resolution plan and been kept abreast of actions taken by the firm’s supervisor. The FDIC notes in a paper on the hypothetical liquidation of Lehman under OLA that it would have been engaged for months prior to the failure of the firm.
“There have been few large-scale bankruptcies of complex, internationally active financial firms,” the FDIC said.
However, others have noted that today’s largest financial companies have structures and asset sizes that dwarf those of Lehman, which remains the largest Chapter 11 debtor in U.S. history.
The FDIC also could be limited in its ability to manage the failure of an internationally active financial institution because it would be responsible for resolving the domestic subsidiaries of a failed company. Certain subsidiaries, assets and creditors are subject to separate insolvency regimes in various countries.