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FDIC Rebuts Inaccurate Op-ed
The FDIC rebuts inaccuracies in the April 7 Wall Street Journal op-ed, "The Dodd Bill: Bailouts Forever," by Peter Wallison and David Skeel.
Op-ed assertion: The FDIC has no experience with large institutions.
The facts:
- FDIC insures trillions of dollars in deposits at the largest banks. The FDIC has back-up examination authority for those banks and has examiners assigned to them. In addition, the FDIC assesses deposit insurance premiums and evaluates the riskiness of the largest banks.
- The FDIC's debt-guarantee program provided liquidity protection for banks of all sizes – including the largest.
- The FDIC managed the receivership and sale of Washington Mutual Bank – a $299 billion institution with derivatives, covered bonds and other investment portfolios in addition to its core mortgage lending and depository operations. This resolution resulted in no costs to the Deposit Insurance Fund.
- The FDIC provided resolutions for three other large institutions with assets exceeding $3 trillion, which had to be bailouts because the FDIC did not have the statutory authority to reach the holding companies. There were no complaints at the time about the FDIC's big-bank experience.
- Continental Illinois – Assets $40 billion. Adjusted for growth in the total assets of federally-insured banks and thrifts that would be the equivalent of $158 billion in 2009 dollars. The industry has roughly quadrupled in size since 1983. Continental was the nation's 7th-largest banking organization at year-end 1983. At year-end 2009, the 7th-largest organization was PNC with total consolidated assets of $260.3 billion.
- FDIC provided expert support to FHFA in the initiation of the conservatorships for Fannie and Freddie
Op-ed assertion: Bankruptcy courts do have the experience and expertise to handle a large-scale financial failure. This was demonstrated most recently by the Lehman Brothers bankruptcy.
The facts:
- Bankruptcy has been rarely used for large firms.
- Lehman Brothers was the largest bankruptcy filing in U.S. history. Second to Lehman was Worldcom at $103 billion -- $500 billion less than Lehman, and $200 billion less than WaMu. Third, was Enron with $63.4 billion; fourth, Conseco with $61.4 billion; and fifth, was Texaco with $35.9 billion in 1987.
- In 22 years, the bankruptcy courts have only resolved five major corporate entities -- one of which was a financial company.
- The Lehman failure would have been much more destructive had the Federal Reserve Bank of New York not lent into the illiquid Lehman broker dealer after the failure of Lehman Holdings – in effect providing liquidity so that trades could settle outside of bankruptcy.
- The bankruptcy process did not respond rapidly to ongoing transactions. For example, about 100 hedge funds used Lehman as their prime broker and relied largely on the firm for financing. Despite the availability of collateral, those positions were not transferred to other parties and the prime broker positions were frozen.
- The bankruptcy process has shown that it creates:
- Significant market disruptions;
- Huge fees and expenses. As of January 2010, fees paid to debtor's counsel and experts in the Lehman bankruptcy exceeded $588 million without a plan of reorganization having been proposed by that date;
- Drawn out resolution (WAMU was resolved in 24 hours on a Thursday). Lehman has offered a "blueprint" for its reorganization 18 months after filing Chapter 11.
Op-ed assertion: AIG had more than $1 trillion in assets when it was kept from failing by the Federal Reserve.
The facts:
- The absence of a viable resolution process for non-bank financial firms led Treasury/FRB to provide a bail-out to AIG. With the consequences of the Lehman bankruptcy filing, and the absence of any resolution tools for AIG, a bail-out was used. We must avoid that result by creating a viable process.
Op-ed assertion: The assets of a large, nonbank financial institution are also different. Neither Lehman nor AIG had insured depositors—or depositors of any kind—and their complex assets and liabilities did not look anything like the simple small loans and residential and commercial mortgages the FDIC deals with.
The facts:
- Banks dominate the U.S. derivatives market. 975 commercial banks in the U.S. are engaged in derivative products, with NY money-center banks forming the predominate share of dealer institutions.
- The notional value of derivatives held by U.S. commercial banks increased $1.8 trillion in the second quarter 2008, or 1 percent, to $182.1 trillion. Derivative contracts remain concentrated in interest-rate products, which comprise 80 percent of total derivative notional values. The notional value of credit derivative contracts decreased by 6 percent during the quarter to $15.5 trillion, in part due to industry efforts to eliminate offsetting trades. Credit default swaps comprise 99 percent of credit derivatives. (OCC Quarterly Report 2008). 4th Quarter 2009 reports show notional value held by banks has increased to $212 trillion.
- In addition, the assertion misunderstands the liability structure of insurers and broker-dealers – both have protected classes of creditors consisting of "customers" under SIPA and "policyholders" under state insurance law.
Op-ed assertion: The agency is used to operating in secret, over a weekend
The facts:
- FDIC is subject to lawsuits by any creditor.
- FDIC is subject to close oversight by Office of Inspector General, GAO, and provides testimony and responds to questions from Congress.
- FDIC is subject to FOIA requests about its operations.
- FDIC publishes detailed information on its web site about resolution transactions.
- Bankruptcy courts are not subject to this level of oversight.
- Creditors' legitimate interests are protected by clear statutory priorities and rights to go to court. Priorities are not subject to creditor negotiation as they are in bankruptcy.
- Creditors are guaranteed by law that they will get no less than the value of their claim in a liquidation.
Op-ed assertion: The FDIC's strategy is always to find a buyer. When applied in the case of a large, failing nonbank financial institution, this means that some other large, "too big to fail" institution will only become that much larger.
The facts:
- The FDIC has the ability to create a bridge entity allowing for the sale of certain business lines to multiple buyers, while at the same time not disrupting essential market services and destroying public confidence.
- The FDIC has demonstrated an ability to act quickly through a transparent and competitive resolution process.
- This process allows sales of different business lines to separate acquirers. This can help prevent additional concentration.
Op-ed assertion: The firm's principal assets—its broker-dealer, investment-management and underwriting businesses—were all sold off to four different buyers within weeks of the filing of its petition.
The facts:
- This was a noncompetitive process and the businesses were sold arguably at fire sale prices. The sale to Barclays is still being litigated.
Op-ed assertion: In the course of Lehman's resolution, its creditors, shareholders and management all took severe losses.
The facts:
- In an FDIC resolution process unsecured creditors and shareholders are almost always wiped out.
- The FDIC is required to maximize recoveries from creditors and must comply with a strict priority system.
Op-ed assertion: At the time of its failure, the firm had more than 900,000 derivatives contracts, more than 700,000 of which were canceled and the rest either enforced or settled, if its creditors agreed, in the blueprint for the firm's reorganization.
The facts:
- The FDIC has the ability to terminate derivatives contracts or transfer them to a bridge firm if that will maximize recoveries.
- In Lehman, thousands of derivatives contracts were left unresolved because of the uncertainty created by the bankruptcy process for months. This unsettled the market by disrupting expectations.
- After Lehman's bankruptcy, the market virtually collapsed. The CDR Counterparty Risk Index (which averages the market CDS spreads of 15 major credit derivatives dealers) reached a new all-time high of 389.33bps – over 130 bps higher than the previous record.
- As of November 13, 2008, the Lehman Debtors estimated that they were party to approximately 930,000 Derivative Contracts and that over 190,000 of these contracts had not been terminated by their counterparties and remained outstanding.
- Prior to LBHI's filing, as of September 12, 2008, the Lehman Debtors had 6,120 outstanding ISDA Masters, in which they calculated that they were owed $23.8 billion, and that they owed $13 billion. As of January 2, 2009, 2,667 remained unresolved.
- There are over 140,000 failed LB International trades globally. Of the 140,000 failed trades approximately 82,500 are in Europe, approximately 12,500 in Americas and approximately 45,000 in Asia. Many of these trades were reliant on LBHI.
Op-ed assertion: The FDIC has no significant experience with broker dealers, investment management, securities underwriting, derivatives contracts, complex collateral arrangements for repos, or the vast number of creditors that had to be included in the Lehman settlement.
The facts:
- The FDIC has had a significant role in reviewing the derivatives activities, including credit facilities, trading operations, and back-office operations of major U.S. banking firms. As noted above, those banks dominate the U.S. derivatives market.
- The assets of Lehman were mostly trading assets, client accounts, and related operations. In many ways, those are simpler than the combined operations of one of the big dealer banks which combine the trading desk, lending, credit facilities for trading partners and customers, market operations around the globe, and others.
Op-ed assertion: The Dodd bill provides for a $50 billion fund, collected in advance from large financial firms that will be used for the resolution process. In other words, the creditors of any company that is resolved under the Dodd bill have a chance to be bailed out.
The facts:
- An ex ante resolution fund, funded by industry participants based upon their risk levels is not akin to a bailout.
- This is demonstrated by the Deposit Insurance Fund – which is an ex ante fund and does not bail out creditors.
- The proposed resolution fund will not protect any class of creditors, but is designed solely to provide liquidity to maximize the value of the failed firm's assets and allowing an orderly liquidation of the institution. Creditors will bear losses.
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