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March 25, 2009
tg-70
Treasury Proposes Legislation for Resolution Authority
Treasury Secretary Timothy Geithner on Monday called for new legislation granting
additional tools to address systemically significant financial institutions that fall
outside of the existing resolution regime under the FDIC. A draft bill will be sent to
Congress this week and several key features are highlighted below.
The legislative proposal would fill a significant void in the current financial services
regulatory structure and is one piece of a comprehensive regulatory reform strategy
that will mitigate systemic risk, enhance consumer and investor protection, while
eliminating gaps in the regulatory structure.
Why We Need Resolution Authority:
The current financial crisis reveals the consequences of this regulatory gap.
Generally when a large, interconnected non-bank financial firm is in severe distress,
there are currently only two options:
1. Obtain outside capital or funding from the US government as in the case of
AIG
2. File for bankruptcy as we witnessed with Lehman Brothers
Those options do not provide the government with the necessary tools to manage
the resolution of the firm efficiently and effectively in a manner that limits the
systemic risk with the least cost to the taxpayer.
In the case of AIG, the government has provided financial assistance in
order to avert the risks to the global financial system of the rapid and
disorderly failure of such a large, complex entity in a fragile market
environment. Had the government possessed the authorities contained in
the proposed legislation, it could have resolved AIG in an orderly manner
that shared losses among equity and debt holders in a way that maintained
confidence in the institution's ability to fulfill its obligations to insurance
policyholders and other systemically important customers.
The Lehman Brothers bankruptcy illustrates the potential impact of the
bankruptcy of a large interconnected financial firm during a period of severe
financial stress. Several money market funds had significant exposure to
Lehman. Concern about the stability of money market funds caused
investors to withdraw funds, thus creating further instability in the financial
system. That instability ultimately obliged the Treasury Department to
establish the money market fund guarantee program.
What the Legislation Would Do:
Instead of subjecting a firm to bankruptcy or simply injecting taxpayers' funds with
no real control, the legislation would:
Grant the US government resolution authority, which would allow the
government to put the firm into conservatorship or receivership and then to
administer its effective, orderly reorganization or wind-down.
Enable the government to reduce the need for taxpayer funds. For example,
it would enable the federal agency acting as conservator or receiver to sell
or transfer the assets or liabilities of the institution in question, to renegotiate
or repudiate the institution's contracts (including with its employees), and to
address the derivatives portfolio, thus reducing the potential for further
disruption
More Details on the Proposed Legislation:
The legislation would authorize the US government, in appropriately limited
circumstances, to intervene at the appropriate time to avert the systemic
risks posed by the potential insolvency of a significant financial firm.

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Many aspects of the bill are modeled on the statutory framework that
governs the FDIC's exercise of emergency resolution and other authority
with respect to banks.
Key Features of the Proposed Legislation:
Covered institutions: It would cover financial institutions that have the
potential to pose systemic risks to our economy but that are not currently
subject to the resolution authority of the FDIC. This would include bank and
thrift holding companies and holding companies that control broker-dealers,
insurance companies, and futures commission merchants.
Prerequisites for the actions to be taken: Parallel to the current provisions of
law that apply to depository institutions, before any of the emergency
measures specified in the proposed legislation may be taken, the Secretary,
upon the positive recommendations of both the Federal Reserve Board and
the appropriate federal regulatory agency and in consultation with the
President, must make a triggering determination that -(1) the financial institution in question is in danger of
becoming insolvent;
(2) its insolvency would have serious adverse effects on
economic conditions or financial stability in the United States;
and
(3) taking emergency action as provided for in the law would
avoid or mitigate those adverse effects.
Selection of emergency measures: The decision whether to provide
financial assistance to the institution or to put it into
conservatorship/receivership will be made by the Secretary and the FDIC,
and will be informed by the recommendations of the Federal Reserve Board
and the appropriate federal regulatory agency (if different from the FDIC).
Financial assistance measures: The proposed legislation permits the US
government to utilize a number of different forms of financial assistance in
order to stabilize the institution in question. These include making loans to
the financial institution in question, purchasing its obligations or assets,
assuming or guaranteeing its liabilities, and purchasing an equity interest in
the institution. This authority is modeled on current law with respect to
banks. The Deposit Insurance Fund will not be used to fund such
assistance.
Conservatorship/receivership: This authority is modeled on the resolution
authority that the FDIC has under current law with respect to banks and that
the Federal Housing Finance Agency has with regard to the GSEs.
The objective of a conservatorship is to take actions that are
necessary and appropriate to restore the institution to a position of
solvency so that it can carry on its business; the objective of a
receivership is to provide for the orderly liquidation of the institution.
Here, the goal of the conservatorships or receiverships would be to
minimize the impact of the potential failure of the financial institution
on the financial system and consumers as a whole, rather than
simply addressing the rights of the institution's creditors as in
bankruptcy.
The trustee of the conservatorship or receivership would have broad
powers, including to sell or transfer the assets or liabilities of the
institution in question, to renegotiate or repudiate the institution's
contracts (including with its employees), and to deal with a
derivatives book. A conservator would also have the power to
fundamentally restructure the institution by, for example, replacing its
board of directors and its senior officers. None of these actions
would be subject to the approval of the institution's creditors or other
stakeholders.
Funding: The proposed legislation would create an appropriate mechanism
to fund the appropriately limited exercise of the resolution authorities it
confers. This could take the form of a mandatory appropriation to the FDIC
out of the general fund of the Treasury (subject to all the restrictions on the

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use of appropriated funds, including apportionments under the
Anti-Deficiency Act), and/or through a scheme of assessments, ex ante or ex
post, on the financial institutions covered by the legislation. The government
would also receive repayment from the redemption of any loans made to the
financial institution in question, and from the ultimate sale of any equity
interest taken by the government in the institution.
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REPORTS
Proposed Legislation

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Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102