Outgoing FDIC Chairwoman Pushes Back Against ‘Too Big to Fail’ Critics

Financial entities designated as systemically risky will not be considered "too big to fail," Federal Deposit Insurance Corp. Chairwoman Sheila Bair said. Instead, under Dodd-Frank, such entities could be liquidated if they fail, she said.

New plans and institutions are designed to avoid situations that led to the financial crisis points of 2008 and federal bailouts, Bair said in a speech before a conference sponsored by the Federal Reserve Bank of Chicago. Dodd-Frank will allow officials to implement a new resolution framework for companies designated as systemically important financial institutions, she said at the May 5 event.

"The dilemma policymakers faced in the failure of large, complex financial institutions resembles a classic hostage drama, where the imperative of saving lives in the short run comes at the expense of encouraging more hostage-taking in the future. And so it is with the largest U.S. banks and other financial companies, which have every incentive to render themselves so large, so complex, and so opaque that no policymaker would dare risk letting them fail in a crisis," she said.

The new Financial Stability Oversight Council is establishing criteria to be used in determining when institutions, potentially including insurance companies, should be designated as SIFIs. Those designated will be subject to heightened supervision and required to maintain detailed resolution plans to show they would be able to resolve themselves through bankruptcy if their fortunes spiral down. A new Orderly Liquidation Authority would allow federal intervention if a SIFI fails in order to protect creditors and avert total collapse, Bair said, drawing a distinction between bailouts and OLA actions, which she compared to failed-bank receiverships.

Bair pushed back against Dodd-Frank foes who have criticized the new authority as bailouts by another name that could foster new problems by designating certain institutions as too big to fail (BestWire, April 10, 2011).

"The reality is that SIFIs will be subject to heightened supervision and higher capital requirements," she said. "It might be far better to fall just short of SIFI status in terms of size, complexity, and interconnectedness. In that case, your institution would be spared all of the additional regulatory burdens, but policymakers could still face significant challenges in effecting an orderly resolution in a crisis. That's why it is important that the FSOC move forward and develop some hard metrics to guide the SIFI designation process."

Wind-down procedures that avoid "too big to fail" are important to avoid competitive inequalities, said Dylan Jones, director of federal affairs for the National Association of Mutual Insurance Companies. But the FSOC should recognize that property/casualty insurers do not meet SIFI criteria and that size must not be the determining factor, he said in a statement.

"Chairwoman Bair notes the importance of 'resolvability' when declaring an institution systemically risky. Property/casualty insurers are subject to rigorous state guaranty funds to protect against insolvability. All property/casualty insurers are currently required to contribute to these guaranty funds that ensure that, in the unlikely event of a company failure, the economic impact is minimal," Jones said.

In January, the Dodd-Frank-created Financial Stability Oversight Council identified six criteria for assessing a nonbank financial entity's systemic importance: size, lack of substitutes for the financial services and products the company provides, interconnectedness with other financial firms, leverage, liquidity risk and maturity mismatch and existing regulatory scrutiny. The draft rule now being deliberated also leaves the council flexibility to "consider any other risk-related factors that the council deems appropriate, whether by regulation or on a case-by-case basis."

On May 9, Bair announced her intention to leave office July 8, at the conclusion of her five-year term.

(By Sean P. Carr, Washington Bureau Manager: sean.carr@ambest.com)