FDIC to propose rules on financial firm breakups

By Reuters
Posted Oct. 8, 2010 at 10:11 a.m.

A top U.S. banking regulator is expected to propose rules as soon as Friday that set out how creditors will be treated under the government’s new authority to dismantle large financial firms that run into trouble.

The Federal Deposit Insurance Corp.’s proposed rule will make clear that all creditors of big, non-bank financial companies should expect losses in a failure, according to a source familiar with the rule.

It is also expected to say that, in some cases, certain short-term creditors could expect to get additional payments, the source said.

The FDIC’s work on the rule has caused concern among other regulators starting to implement the Wall Street reform law enacted in July in the wake of the 2007-2009 financial crisis that set off the worst U.S. downturn since the 1930s.

Banking and financial firms are closely watching how the FDIC will treat creditors under its new liquidation power.

Treasury Department officials are concerned the rule could give incentives to some creditors to pull out of financial firms when they hit hard times — creating a “run” — if they believe the FDIC will hit them harder than others during a liquidation, the Wall Street Journal reported.

The “resolution authority” was a main plank in the reform law and is designed to avoid massive government bailouts such as the one for giant insurer AIG and destructive bankruptcies like the one of investment bank Lehman Brothers.

The ad hoc nature of dealing with financial giants during the height of the crisis fueled the panic that almost froze global credit markets.

FDIC Chairman Sheila Bair said last week that how creditors are treated under the new resolution authority would closely match how they are treated under bankruptcy proceedings.

“The authority to differentiate among creditors will be used rarely and only where such additional payments are essential to the implementation of the receivership or any bridge financial company,” she said.

The reform law, the Dodd-Frank Act, allows the FDIC to move certain parts of failing institutions’ business into a separate entity so that they can be sold at a later date.

FDIC officials have said subordinated debt, long-term bondholders and shareholders would not be allowed to be moved into this entity under the rule.

The officials said the agency hoped this would clear up industry questions about the issue and eliminate the perception that some institutions are “too big to fail.”

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