FDIC Chair Calls for New Way to Unwind Ailing Big Banks

The chairman of the FDIC in a speech today proposed a new way to resolve large financial institutions that have been deemed by some "too big to fail."

Speaking in New York City before the prestigious Economic Club, Sheila Bair said her agency's power to resolve insolvent, FDIC-insured banks does not work for complex financial holding companies because many units of these companies do not fall under the authority of the FDIC. 

As a result, the overall state of such financial holding companies remains weak, leaving them in constant need of governmental support and taxpayer-funded financial aid. That's a scenario that has played out repeatedly during the current recession.

"The lack of an effective resolution mechanism for large financial organizations is driving many of our policy choices," Bair said.

"Bankruptcy doesn't meet these objectives. We need an effective resolution mechanism, not a get-out-of-jail free card. Taxpayers should not be called on to foot the bill to support non-viable institutions because there is no orderly process for resolving them."

The new resolution authority would be funded in part by assessments on larger firms to create a reserve. The assessments would be based on the differential in the cost of capital between these large firms and smaller banks.

"Risk-based surcharges should be imposed on higher risk behavior," Bair said. "This might include certain derivatives, market making or proprietary trading, and rapid growth. We now have such a risk-based system for the insurance premiums we charge for deposit insurance, and it's working very well."

 Bair said the FDIC should be home to the new resolution authority. "In the longer term," she said, "a legal mechanism to resolve systemically important firms would result in a more efficient alignment of capital with better managed institutions."