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Busted Banks: TBTF and the Single Point of Entry

posted by Jay Lawrence Westbrook

Shutterstock_95970961A Single Point of Entry (SPOE) sounds like the route of a returning astronaut or perhaps a building’s security plan or even a sex guide, but actually it is the FDIC’s proposal for saving the financial system when a giant financial institution strikes out on the derivatives market or discovers it has a school of London Whales. SPOE is important because the FDIC and the Bank of England have agreed on it as the best approach to a global resolution of a failing SIFI, the polite term for a TBTF bank. That agreement is crucial, because the largest banks can only be resolved on a global basis.

SPOE is a method of resolution of a SIFI in financial distress without having to choose between a government bailout or the collapse of the global financial system. By contrast, legislation passed by the House would privatize the SPOE process and likely result in future bailouts. The legislation is being marketed under the term SPOE, but bears little relationship to the FDIC proposal. The three key aspects of the FDIC plan are that a) the resolution process will be controlled by the regulator; b) there will be no bailout of the SIFI’s owners and management; and c) the creditors of the parent holding company will be tossed overboard, returning the bank group to solvency by erasing debt and lessening the need for government money to make the process work. This post discusses the first two points, control and no bailout, while a second post will talk about the debt dump. 

The FDIC model of SPOE is derived from its well-known treatment of banks in the United States: arrive at the failing bank on a Friday, work on a makeover all weekend, and open a new bank in one form or another Monday morning. The civilians barely notice the change and all is well. That’s why we don’t have those terrible runs on the banks that became routine disasters during the Great Depression. But that power has been limited to the actual bank subsidiary in a bank group, not the holding company at the top that controls it all. Title II of Dodd-Frank gave the FDIC that same sort of resolution power over the bank holding company and thus the whole bank group (see Adam Levitin's post). The result would not be a bail out because the old management and shareholders, and for the most part the parent’s creditors, would be jettisoned. The group’s assets, in the form of the bank itself and the other subsidiaries, would be stabilized and then presumably sold.

Some in Congress are now seeking to repeal Title II in favor of new bankruptcy legislation (H.R. 5421) that would essentially privatize the resolution process, while pretending no government money would be needed. The great majority of bankruptcy experts don’t believe a SIFI could be resolved in bankruptcy with private money. The inevitable result is that the privately nominated trustee would tell the government “So sorry, but we need a government bailout to avoid the end of civilization.”  The government would then do what it had to do, with nothing in place to impose the pain on those responsible or to put strings on the bailout—Son of TARP without admitting it in advance.

Aside from pickpocketing the taxpayers, there is no chance a privatized regime without government support and control would be accepted by the foreign financial regulators who must be our key partners in a SIFI crisis. (See my discussion here.) Only government control can provide the rock-solid market confidence that is essential to stem panic and ensure global coordination.

The third component of SPOE--the debt dump--will be discussed in a second post.

Graph image from Shutterstock


The attempt to repeal Title II shows the problem of bank reform that is contingent on extraordinary circumstances. The economic arguments linking TBTF to systemic crises tend to be highly stylized, and most models rely upon rather peculiar monetary reaction functions. In many cases, the functions are implicitly modelled. However, there are very robust arguments about regulatory capture, and excessive TBTF influence in government. If regulation is focused upon systemic events, like SPOE, then it misses the more mundane, creeping issues of TBTF.

If you look at the latest versions of HR 5421, you can see that it is trying to address every concern except two: funding and international regulatory cooperation.

HR 5421 has to be unyielding on the funding issue, because of the odd conservatarian definition of "bailout", which damns low-risk senior public bridge funding every bit as much as it does high-risk public equity funding.

However, I think that HR5421's insistence on a full-bore bankruptcy framework could be finessed. Effective cross-border cooperation does require regulatory governance. But it doesn't require regulatory governance through the entire process. The regulators are needed only in the first few weeks, to create confidence. A bankruptcy court can do just fine in the next stage--allocating new equity to the dumped debt. Judge Peck, after all, thought he did a great job with Lehman--and he's right, if you ignore the first chaotic two weeks.

Question? How does a forest get too dangerous to burn (TDTB)?

Answer: By the suppression of smaller, COOLER, natural fires that tend to keep the forest cleared of excessive flammable material without destroying it (the forest).

In a similar way, the suppression* of bank runs allows the creation of Too Big To [be allowed to] Fail banks.

Bank should be 100% private with 100% voluntary depositors. If that were the case, then why should we care if a few gamblers lose? Since most of us would be in a Postal Savings Service that makes no loans and thus carries no risk? Or at least know our money was at risk in a bank and exercise due diligence?

*via various unethical, philosophically inconsistent government privileges for the so-called private banks such as government deposit insurance, a fiat lender of last resort, borrowing by the monetary sovereign, etc.

HR 5421 died with the last Congress. But it did not propose to repeal Title II of Dodd-Frank, but the provide a bankruptcy alternative. On the other hand, the similar Senate chapter 14 bill did propose to repeal Title II.

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