This story appeared in Bank Digest.
Speaking at the George Washington University Law School conference on Financial Stability After Dodd-Frank: Have We Ended Too Big To Fail in Washington, D.C., Federal Deposit Insurance Corporation Vice Chairman Thomas M. Hoenig said that the U.S. and global financial systems are the definition of concentrated risk. Composed of systemically important financial institutions that are highly leveraged, heavily reliant on wholesale funding, and unduly interconnected, when even one of these institutions fails, its impact on world economies can be devastating.
According to Hoenig, the Dodd-Frank Act designates bankruptcy—not Title II Orderly Liquidation—as the chosen resolution method for the largest U.S. financial institutions and requires that the firms show themselves capable of going through bankruptcy without bringing down the economy. For bankruptcy plans to be credible, Hoenig said, firms must be far more realistic in their assumptions and approaches regarding capital, liquidity, structure, and cross-border impediments to an orderly bankruptcy.
Dealing with these issues as they arise is not a solution, said Hoenig. Potential obstacles to bankruptcy must be identified and dealt with well before a financial firm fails and turns what might have been an idiosyncratic failure into a global crisis. Management must anticipate challenges and assure that in a failure their firms' structures can be managed, disassembled, and reorganized to assure an orderly bankruptcy. If it is determined that a firm cannot feasibly be put through bankruptcy due to its structure and operations, then the law requires changes within the firm.