Bank Negotiators Battle Over ‘Too Big To Fail’

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MarketWatch

June 17, 2010 Thursday 5:09 PM EST

SECTION: NEWS & COMMENTARY; Economy and Politics

LENGTH: 1015 words

HEADLINE: Bank negotiators battle over ‘too big to fail’

BYLINE: Ronald D. Orol, MarketWatch mailto:rorol@marketwatch.com.

Ronald D. Orol is a MarketWatch reporter, based in Washington.

WASHINGTON (MarketWatch) — House and Senate lawmakers on a committee to work out differences in sweeping financial-regulatory bills on Thursday launched into a battle over each chamber’s vastly different approaches to the thorny issue of how to handle banks that are “too big to fail,” and what to do to make sure such failures don’t wreak havoc on the markets.

The bank-reform legislation, written in response to the financial panic of 2008, marks the most significant expansion of the regulations governing U.S. financial firms since the Great Depression.

So far, legislators have agreed to tough regulations for hedge funds, private-equity firms and new provisions that would allow for an ongoing audit of the Federal Reserve’s discount window, a lending facility through which banks borrow reserves.

On Thursday, Democrats and Republicans argued about whether to include a House provision that would require big banks to pay fees to create a $150 billion fund to be used to dismantle a failing megafirm so its collapse doesn’t cause collateral damage to the markets.

The Senate would rather use taxpayer funds to dismantle a failing big bank and then recoup those costs from financial institutions afterward. The Senate bill has a provision that would give bank regulators the authority to borrow taxpayer funds of up to 90% of the value of the assets of a failing megabank. In the event that a bank with $2 trillion in assets collapses, regulators could borrow from taxpayers as much as $1.8 trillion.

With both approaches, so-called solvent financial institutions that have contracts with the failing megabank would receive funds — from the bank fund or from taxpayers — to ensure that they don’t fail as well.

The $150 billion fund “will have to go,” said Senate Banking Committee Chairman Christopher Dodd. The Connecticut Democrat reached a deal with Sen. Richard Shelby (R., Ala), the banking committee’s ranking member, over eliminating a similar bank fund in Senate legislation.

Several House members backed the $150 billion fund, while Republicans contended that it would create moral hazard.

“We are proposing that the players pay for their cleanup,” said Rep. Gregory Meeks (D., N.Y.). “Funding after the fact promotes risk-taking. Those who are more prudent and survive the crisis are left holding the tab for the bank that causes the problems.”

Rep. Jeb Hensarling (R., Texas) and other Republicans maintain that if lawmakers agree to create a fund, it will encourage big banks to be overly risky knowing that they could receive funds in the event of a financial crisis.

“Under the bailout regime, whether you fund it in advance or after the fact, it’s a bailout and it creates moral hazard,” said Hensarling. “If you build it, they will come.”

Also, lawmakers on the panel are expected to battle over whether to include a House provision that would cap big firms’ borrowing, called leverage, at a ratio of 15 to 1. The Senate leaves it up to regulators to set leverage ratios.

House lawmakers also set the stage for a clash with the Senate after they voted to eliminate a section of the bill that would have allowed derivatives clearinghouses to be regulated by the Federal Reserve and given the institutions access to the central bank’s discount window, a government lending facility from which banks borrow reserves.

Supporters argue that access to the discount window would have made it easier for clearinghouses, which are intermediaries between buyers and sellers, to take dangerous risks and even become “too big to fail” themselves.

The Senate is expected to reject the House clearinghouse provision and will likely offer a compromise. Senate leaders are in discussions with the Treasury Department and the Commodity Futures Trading Commission over a possible compromise.

“Ready access to the Fed discount window increases moral hazard,” said Rep. Collin Peterson (D., Minn.), chairman of the House Agriculture Committee.

Capital required?

House lawmakers also set the stage for possible dispute with the Senate after they voted to back an amendment introduced by Rep. Rep. Dennis Moore (D., Ks.), which would allow banks to continue to count existing trust preferred securities, a form of hybrid debt capital, toward their capital standards.

The Moore amendment, if approved, will help many banks, particularly community banks. It seeks to modify a Senate measure, introduced by Sen. Susan Collins (R., Maine), that otherwise would prohibit banks from counting trust preferred securities toward their capital standards.

The measure is backed by community banks, hundreds of which issue preferred trusts. Chris Cole, council at the Independent Community Bankers of America, said that preferred trusts represent about $11 billion in capital for small banks and an immediate requirement to eliminate the hybrid capital from the standards would require them to raise billions in common equity in a difficult economy.

However, the Senate is expected to reject the Moore amendment and Cole contends that Senators are likely to respond to it with a provision that would grandfather smaller institutions, but prohibit larger banks from counting trust preferred securities toward their capital standards. The Senate provision, Cole added, would likely give larger institutions a period of time to phase out use of trust preferred securities.

FDIC guarantees

Backed by the White House, House lawmakers will be working to remove a provision in the Senate bill that would require congressional approval before the Federal Deposit Insurance Corp. can provide debt guarantees to big banks in the event of a future financial crisis.

Critics of the provision argue that FDIC guarantees is one of the best ways to calm markets without exposing taxpayers to losses. They contend that should Congress vote to prohibit the FDIC’s ability to provide guarantees it could quickly transform a small crisis into a bigger one while the agency seeks to borrow funds from the Treasury.

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