Just take control of the bank

[ProSense]

Here's a clue, every bank holding company has a bank that it holds. There is no need to seize the bank holding company, just the bank.
link

Wrong, as the update here states. Also, the issue is more complex than just taking control of a bank.

FDIC Chair Sheila Bair (PDF)

In the case of a bank holding company, the FDIC has the authority to take control of only the failing banking subsidiary, protecting the insured depositors. However, many of the essential services in other portions of the holding company are left outside of the FDIC’s control, making it difficult to operate the bank and impossible to continue funding the organization’s activities that are outside the bank. In such a situation, where the holding company structure includes many bank and non-bank subsidiaries, taking control of just the bank is not a practical solution.

If a bank holding company or non-bank financial holding company is forced into or chooses to enter bankruptcy for any reason, the following is likely to occur. In a Chapter 11 bankruptcy, there is an automatic stay on most creditor claims, with the exception of specified financial contracts (futures and options contracts and certain types of derivatives) that are subject to termination and netting provisions, creating illiquidity for the affected creditors. The consequences of a large financial firm filing for bankruptcy protection are aptly demonstrated by the Lehman Brothers experience. As a result, neither taking control of the banking subsidiary or a bankruptcy filing of the parent organization is currently a viable means of resolving a large, systemically important financial institution, such as a bank holding company. This has forced the government to improvise actions to address individual situations, making it difficult to address systemic problems in a coordinated manner and raising serious issues of fairness.

<...>

The current financial crisis demonstrates the need for changes in the supervision and resolution of financial institutions, especially those that are systemically important to the financial system. The choices facing Congress in this task are complex, made more so by the fact that we are trying to address problems while the whirlwind of economic problems continues to engulf us. While the need for some reforms is obvious, such as a legal framework for resolving systemically important institutions, others are less clear and we would encourage a thoughtful, deliberative approach. The FDIC stands ready to work with Congress to ensure that the appropriate steps are taken to strengthen our supervision and regulation of all financial institutions -- especially those that pose a systemic risk to the financial system.

March 31, 2009, 7:31 AM ET

Guest Contribution: The Real Geithner Plan, a ‘Nuclear Option’

By Guest Contributor

The Obama administration is seeking broad new resolution authority for banks, Peter Boone and Simon Johnso argue that the powers should be approved by Congress and used quickly and decisively. Boone is chairman of Effective Intervention, a U.K.-based charity, and a research associate at the Centre for Economic Performance, London School of Economics, and Johnson is a former IMF chief economist, and is currently a professor at MIT Sloan School of Management and a senior fellow at the Peterson Institute for International Economics. They run the economic crisis Web site http://BaselineScenario.com .


The Obama administration last week proposed draft legislation for a “resolution authority” that would effectively permit the government to liquidate or restructure large systemic financial institutions. If passed by Congress, these powers would allow the governments to treat nonbank financial institutions more like regulated deposit-taking banks. This authority offers a clear path to recapitalize institutions without using taxpayer money and therefore avoiding some dimensions of moral hazard but, if implemented poorly, the existence of this “nuclear option” can cause panic in financial markets and substantially delay recovery. This fear may be with us already — despite all of the material and moral support already on the table, the market is pricing in the highest ever risk of default for Citigroup senior debt, i.e., about a one in three chance over the next five years. (See the credit-default spreads for major banks.)

Imagine what happens when these powers are passed. The U.S. Treasury and FDIC would immediately have the tools need to walk into America’s largest financial institutions, such as Citibank or Bank of America, and liquidate them, or rewrite their contracts and capital structures. Such powers are clearly useful: if the banks are undercapitalized, and private money is not available, then the government could force creditors to swap claims into equity, thus instantly recapitalizing the banks while avoiding use of taxpayer funds. With such steps, the problem of moral hazard, where creditors to banks are bailed out by taxpayers, would at once be forgotten. Shareholders in banks would lose through dilution, some (unsecured?) creditors would lose with debt-equity swaps, while the nation would be better off having a well-capitalized banking system. The banks would remain private but now be controlled by (ex)creditors.

However, today these powers don’t exist, and none of us know exactly how this authority would be used if it ever lands on Mr. Geithner’s desk. We’ll now have a healthy debate in Congress and then see revised versions passed and signed into law. But as this debate proceeds, creditors and shareholders in all such institutions will be nervous. We’ll be giving the Treasury a “nuclear option” and no one can be sure who is safe. A natural reaction by clients and investors of these banks will be to edge towards the exit immediately and to stay away until the dust has settled. It won’t matter whether institutions are solvent: Due to the uncertainty and risk of losses, investors and clients may run. We’ve seen repeated waves of such panics over the last year, and we can live through them, but each successive one hurts the institutions we are trying to save and delays recovery.

What should the administration do to prevent the panics that can ensue from this legislation? First, if they plan to use it soon, they need to pass this legislation quickly. There is good logic behind requiring creditors to bear part of the cost of restructuring, but we can’t afford to have this hanging over credit markets for months to come.

Second, once passed, the new authority should be used. There is no point in incurring the political and financial costs of passing this legislation now unless it is really needed.

Third, as in any major crisis, the aim should be to use this weapon once and decisively. If the government first hits one “weak” institution then another, and piecemeal restructures the sector, then investors and creditors will constantly “game” the system. This will drive down share and debt prices, forcing the government into action, gradually moving down the chain of institutions. We’ve seen this with successive panics at Bear Stearns, Lehman, AIG, Citigroup, etc. The most solvent institutions today could be made insolvent through higher credit costs brought on by the uncertainty, and the recession will be deeper.

more

[girl gone mad]

1. You do know that the author of your second piece, Simon Johnson,

has argued for nationalization from the beginning of this crisis and has also argued that the government has the authority to do so (if not the necessarily the perfect 'tools'), right?

Because it seems to me that you've been against nationalization all this time, and it's kind of odd to now see you quoting one of the biggest proponents of nationalization to make a point entirely unrelated to the topic of his piece.

It's even odder when you twist the meaning of his arguments around try and give the appearance that he's making a claim which he obviously would never make, seeing as how he has supported government receivership (precisely what William Black endorses) all along.

[ProSense]

2. You characterize Johnson as "one of the biggest proponents of nationalization"

and here he is saying that the government doesn't have the power to seize the complex financial institutions.

It's possible to be for nationalization and face facts at the same time.

[girl gone mad]

3. That's not what he's saying at all.

Either you don't understand the article or you are deliberately mischaracterizing Johnson's writing. Read it again, without the unnecessary and misplaced emphasis. Johnson and Boone are merely arguing that the powers Geithner was pressing for would make it easier for the government to quickly liquidate large financial institutions. Thus the "nuclear option" label.

As an aside, Johnson and Boone also pointed to the CDS spreads as an indication that banks' bondholders feared Geithner's push meant that just such a large scale action was likely. Since this article was published last week, the spread has narrowed considerably and the two events don't seem to have been closely related.

[ProSense]

5. Really? "However, today these powers don’t exist..."

What does that mean?

The Obama administration last week proposed draft legislation for a “resolution authority” that would effectively permit the government to liquidate or restructure large systemic financial institutions.

Imagine what happens when these powers are passed. The U.S. Treasury and FDIC would immediately have the tools need to walk into America’s largest financial institutions, such as Citibank or Bank of America, and liquidate them, or rewrite their contracts and capital structures.

However, today these powers don’t exist, and none of us know exactly how this authority would be used if it ever lands on Mr. Geithner’s desk.

He isn't saying anything about making it easier.

[girl gone mad]

6. This is laughable. Of course the powers Geithner is seeking don't exist yet.

Why would he be seeking them if they did?

Here's Simon Johnson a few weeks ago on NPR pushing for nationalization:

http://www.npr.org/templates/story/story.php?storyId=101360253

Why don't you listen to it and let us know why it is that he says very clearly in this interview that we can nationalize through the FDIC, but a few short weeks later you think Johnson has changed his mind completely now says we can't do it at all unless Geithner gets these specific resolution trust powers.

[ProSense]

7. If the power doesn't exist

what authority does he have to do this:

The Obama administration last week proposed draft legislation for a “resolution authority” that would effectively permit the government to liquidate or restructure large systemic financial institutions.

People keep throwing up the FDIC's authority, and the OP makes clear the limits of that authority.

The power doesn't exits.

[girl gone mad]

8. The government doesn't have to create a resolution trust corp. to nationalize.

Do you not understand that?

Asset management could be outsourced to private managers.

Geithner is supposedly seeking power to simplify the process.

What you are arguing is that by labeling itself a "bank holding company" rather than a "bank" and institution can effectively subvert the law.

Okay, if the banks want to play that stupid game, give them an option: orderly wind down through the FDIC or disorderly wind down in bankruptcy court. I'm guessing they'll start calling themselves banks again very quickly.

[ProSense]

9. Do you not understand

the differences in company structures?

Johnson does, you obviously refuse to accept reality, preferring instead to try to spin his opinion stating very clearly that the power doesn't exist to mean making it "easier."

[girl gone mad]

10. If he thought it couldn't be done, then why was he pushing for it?

You haven't answered that question.

Banks can and do re-structure themselves into bank holding companies all the time. Are you trying to say this process can't be reversed? Make a case.

[Emit]

11. I read a piece over at Baseline that spoke directly to this, although I do not think it was written

by Johnson. Essentially, it spoke to the fact that Baseline Scenario was supportive of nationalization but that the problem was it might not be constitutional. I'll try to find the link.

[girl gone mad]

12. here.

http://baselinescenario.com/2009/03/25/constitutional-obstacles-to-nationalization/

ETA: the constitutionality issue this author is referring to would apply to nationalization with or without with or without the government powers Geithner is seeking. Within the article is this http://baselinescenario.com/2009/03/09/nationalization-for-beginners/">link, which points to another Baseline Scenario article detailing Simon Johnson's support for FDIC receivership.

[girl gone mad]

13. Yes, I "obviously refuse to accept reality"..

especially when that reality is actually you trying to put words into another person's mouth, metaphorically speaking.

Here is Johnson, in his own words, debating nationalization (from 03/09/09):

Steve Weisman:

Simon, what is meant by bank nationalization?

Simon Johnson:
.
Well, I think, Steve, different people use that term to mean very different things. The issue to my mind in the United States right now is whether you should have an FDIC-type takeover or bankruptcy procedure, if you like, managed by the FDIC for major US banks. Obviously, the FDIC does this for smaller banks on a routine basis. Now, this kind of FDIC takeover is, I think, what people are referring to in many contexts as nationalization. And some people think it’s a bad idea. Some people think the FDIC would not be able to handle this and there are other ways to proceed with regard to any big banks that may be technically or otherwise deemed insolvent.

Steve Weisman:

Just to clarify: When you say “takeover,” does that mean that the government purchases the shares, whatever they’re worth, or seizes them in some place, and takes them over? What’s the procedure in which that happens?

Simon Johnson:

Well, the determination by the regulator—which sometimes is the FDIC, sometimes the FDIC working with, for example, the state regular or one of the federal regulators—that certain banks don’t have enough capital on a forward- looking basis in order to stay in business, and the regulator has the right to, at that point, declare that you’re no longer in business. So, you’re taken over and managed by the FDIC. Ordinarily, at least for smaller banks, the FDIC tries to sell off parts of the bank’s operations. For example, the deposits of the bank, the retail deposits that are insured by the FDIC, are often sold off to another bank, perhaps immediately. So, the FDIC tries to not actually run a bank. At least that’s the traditional model. But they manage the winding down of the bank. They’re the official receiver, if you want to use a slightly technical term.

Steve Weisman:

In your judgment, the federal government—whether the FDIC or regulators or other entities—should move more assertively in taking over banks at present. Let’s talk about the context. There are 8,000 banks in the United States. But the federal government has its eye on the 19 biggest banks, on which they are now conducting “stress tests,” as they put it. In your judgment, roughly how many of these banks are candidates for being taken over, without mentioning any names?

Simon Johnson:

Federal and state government has its eye on all banks all the time. The banks are very carefully scrutinized and I think everyone feels they’ve done a good job on small and medium-sized banks in terms of determining when they’ve run out of capital, when they’re going to run out of capital, and when they’re unable to replenish their capital sufficiently and rapidly through the usual private-sector means. So, the issue is the management or the oversight of the largest banks. There the government has the right approach in setting up a stress test in which they would ascertain which banks need more capital and presumably would be given the option of raising that amount of capital privately.

My issue is just that the stress test seems to be too mild, particularly in the “stress” scenario that’s been announced. We know the general microeconomic parameter is pretty optimistic, in my view, given what’s happening around the world. But I think the stress test, when you do it for all the banks, you do it quickly and you make a pretty tough determination and then you give the banks the chance to raise capital privately, again, moving quite quickly, moving over a one- or two-month horizon. If they can’t raise it privately, then the government steps in with the recapitalization program. That would involve, obviously, government ownership of a substantial fraction of common equity.

Steve Weisman:

But you don’t think that will happen. I mean, you think that there are a number, and maybe even some of the big banks, that would have to go through this nationalization process, right?

Simon Johnson:

No. That’s not my position. My position, Steve, is I just don’t know. I want a process to be put into place through which this information will be discovered. And I would stress, this is very important, that the information that is revealed be as public and as transparent as possible. Now, there may be some things that you can’t reveal to the public. Then I would advocate, I am advocating, closed-door hearings on Capitol Hill just like you have for intelligence briefings, where you can show key senators who are skeptical of this point exactly why, for example, all the banks have sufficient capital. And if you can persuade them, just like what happens with secret intelligence briefings, then you’re a long way down the road toward persuading the public.

I want a process, and I think the process should include a sensible intervention point and, if you like it, it’s going back to the original point: It’s a form of bankruptcy if you don’t have enough capital. You’re taken over by the FDIC, and in that takeover it is typically the case that shareholders lose substantially. But by the way, most of the shareholder value in these banks has already been destroyed, not by actions of the government, but by the actions of incompetent management and boards of directors who, as far as anyone can see, have not exercised the kind of supervisory role that they’re supposed to perform.

[Emit]

14. girl gone mad, I think you may be missing the point of this post

Simon Johnson is supportive of nationalization, and he and Boone also support the Obama's administration's legislative proposal that would allow the governments to treat nonbank financial institutions (AIG) more like regulated deposit-taking banks.

It appears that the point of the post is that Black's criticism of Obama, Geithner, et al is that they did not do a receivership under the Prompt Corrective Action law. But, as the OPer is trying to point out, the Prompt Corrective Action law applies to FDIC banks not bank holding companies. As the Johnson/Boone piece quoted in the OP, Geithner's legislative proposal is asking for the ability to do to bank holding companies what the FDIC can do with banks. In other words, Geithner is trying to position the government to be able to do a receivership if necessary for these large holding companies. It would appear that the Obama administration is not against this receivership, and, on the contrary, recognizes the need for it. Does that make sense?

[girl gone mad]

15. Black's point was that all of this should have been done first..

before indiscriminately handing over hundreds of billions of taxpayer dollars to failed financial institutions while leaving in place corrupt, incompetent management.

The argument about banks vs. bank holding companies doesn't hold water. It's political cover. The bankers had their backs against the wall and if our officials had been following the spirit of the law, they would have made the banks an offer they couldn't refuse rather than handing over the reigns of our Treasury dept. to them.

Black is a legal scholar and a regulatory expert and he was dead right.

[On the Road]

4. Oh My Goodness!

if the banks are undercapitalized, and private money is not available, then the government could force creditors to swap claims into equity, thus instantly recapitalizing the banks while avoiding use of taxpayer funds.

That is a pretty astonishing proposal -- like a forced-convertible bond. Could cause some reluctance to lend to banks, but on the other hand if the government is committed to keeping banks out of insolvency and bankruptcy, there can be a benefit to bondholders.