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Fed Approves New Resolution Plans, But is it Enough?

by Chicago Agent

The Fed now has official policies in place for larger financial companies, but some critics say it still falls far short.

The Federal Reserve approved a new policy on Monday that aims to clarify how larger financial institutions would handle another systemic shock to the banking sector, though some critics still say the new policy falls short.

The plan, which was a cornerstone of the 2010 Dodd-Frank regulatory bill, requires banks with various amounts of assets to submit “resolution plans,” detailed explanations that explain how the institutions would wind down their operations if another Lehman-esque event were to occur. The ostensible goal is for banks to have a plan in place that would avoid any “too big to fail” scenarios, should they enter bankruptcy.

Under the plan, companies with $250 billion or more in non-bank assets must submit their resolution plans on or before July 1, 2012, while those with $100 billion or more in non-bank assets, but less than $250 billion, will have to submit their plans on or before July 1, 2013. Remaining companies will have to submit their outlines on or before Dec. 31, 2013.

“Each plan will describe the company’s strategy for rapid and orderly resolution in bankruptcy during times of financial distress,” reads a Fed press release on the policy. “A resolution plan must include a strategic analysis of the plan’s components, a description of the range of specific actions the company proposes to take in resolution, and a description of the company’s organizational structure, material entities, interconnections and interdependencies, and management information systems.”

The plan was co-written with the Federal Deposit Insurance Corp. (FDIC), and it does grant the government with same receivership powers that the FDIC utilizes when taking over failing banks.

Some commentators, though, particularly Simon Johnson, an MIT professor and former chief economist of the IMF who runs the popular Baseline Scenario blog, feel that the supposed powers in the plan fall far short of what the current financial system demands.

In an article on Bloomberg, Johnson said the receivership powers do little to address the international presence of the largest financial banks, preferring instead to refer to JPMorgan Chase, Citibank and Wells Fargo on purely domestic terms.

“This presents a major problem if large financial institutions, which typically have extensive international operations, need to be shut down in an orderly way,” Johnson said. “U.S. legislation can’t specify how assets and liabilities in other countries will be treated; this requires an intergovernmental agreement of some kind. But no international body – not the Group of -20, the Group of Eight or anyone else – shows any indication of taking this on, mostly because governments don’t wish to tie their own hands.”

And in the end, Johnson said, receivership or resolution plans will have no impact on institutions that are still far too large, and solution remains the same as it was in 2008 – break up the big banks.

“To make the FDIC resolution powers credible, large banks should have been made small enough and simple enough to fail. Of course, if we had really done that, we wouldn’t need a resolution authority,” Johnson said. “When CIT Group failed in the fall of 2009, it had a balance sheet of about $80 billion. There was no bailout, the firm’s debts were restructured, and today it is back in business – with an appropriately slimmer $48 billion in total assets at the end of the 2011 second quarter.”

There were no adverse systemic consequences for the financial system,” Johnson concluded. “I’ve talked to many analysts and people active in financial markets, and cannot find any measurable consequences from the CIT failure on the real economy, including on access to credit for their customers, which were small and medium-sized businesses.”

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