Resolving Banks by Guaranteeing Short-Term Debt

Robert Pozen has an interesting idea:

In my view, the adverse repercussions of Lehman’ failure could have been substantially reduced if the federal regulators had made clear that they would protect all holders of Lehman’s commercial paper with a maturity of less than 60 days and guaranteed the completion of all trades with Lehman for that period.

James Kwak tries to flesh it out:

Once the government has determined which liabilities and exposures will have systemic ripple effects (he says short-term CP and outstanding trades), it could just announce a guarantee on those liabilities and exposures and let everything else go into bankruptcy. Now maybe they didn’t have time to make such a determination the weekend before Lehman failed (although arguably they had since March to figure it out), but by the time Citi and BAC and the last AIG bailout rolled around arguably they did. I’m not enough of a markets person to be sure this would work, but it seems like a viable proposal.

One has to be careful when using the term “bankruptcy” with respect to banks, because I think what we really want here is a massive debt-for-equity swap which keeps the bank viable in some form, rather than outright liquidation (which is what banks have to do if they file for bankruptcy). Given the fact that recovery rates for unsecured bank creditors in liquidation are very close to zero, few creditors would be likely to object to such a thing. Is such a thing possible under the government’s existing resolution authority? I’m unclear on that, but I’m definitely interested in the details of Pozen’s proposal.

One big problem here is that such a plan can’t really be institutionalized ex ante: the last thing we need is an incentive for too-big-to-fail banks to borrow short rather than long, because there’s a semi-explicit government guarantee on all of their funding less than 60 days. Or maybe the Fed could force all banks to have no more than x% of their unsecured debt in the form of commercial paper.

Comments

[Roger Knights:]

A bit OT: Here's my suggested reform for the banking system: Mandate that all investment banks be partnerships. That will force them to be smaller and to behave more prudently, since it would be their own money at risk, not the stockholders.

Sep 30 03:42 PM

[warriornasdaq:]

Imperial Capital Bank is way oversold they have not been in a rush to raise cash or dilute shareholders. IMPC is the cheapest bank out their toughing it out good banks with solid management and assets will come out for the best in the end.
The small regional banks starting to rip north buy impc imperial capital bank book value $19.50 chart moving north abva alliance bank book value $8.50 moving north.
Imperial Capital Bank is the most intriguing with $4.3 billion assets lots of ginnie mae govt guaranteed interest as california recovers impc will mirror this recovery. On the west coast impc looks best and on the east coast in virginia the #1 business state Alliance Bank looks awesome up 12% today.
i agree short term paper should've been granted use of the TLGP for the nearly 100 banks that failed already saving the taxpayers $Billions. The problem withe the FDIC is that it is run by an evil witch who is clueless on running the FDIC or how banking works Shelia Bair is a disgrace to America and the goverment she should be fired! As well she should lose her pension, perhaps charged with treason.
All the FDIC had to do was allow those banks that needed help to issue short term paper then they could goto the private capital route and raise matching cash. The govt deciding that a handful of banks should get cash and the others die is absurd its just the rich bailout out the rich. the rich get richer while the poor get poorer.
As well as the debacle at CIT to roll their paper over. Instead the braindead govt allowed small businesses to be left out in the cold, nearly 100 banks go under the life blood of community banks wiped out the trust fund. All of this could have been avoided as well it has hampered the economy as big banks hord cash no loans are made for autos homes or small business that needs cash to make payrolls.
The Fed and the Treasury have publicly fueded with Shelia Bair on policy its clear shes created a disaster and needs to be replaced. Its clear shes a failure her approach has failed and the treasury doesnt want to cut the FDIC a blank check to pay for this mess.
The banks left in business are held over the coals and essentially blackmailed for higher fees to cover the mess Bair has created.
Who is Sheila Bair to decide which banks are successful and which ones go under? She isnt GOD and looks like the devil to me a witch who needs to ride off on her broomstick and let competent person run the FDIC. Strong banks with good CFO's like Imperial Captial Bank IMPC.pk and Alliance Bank ABVA will weather this bs mess with or without the govt buy IMPC and ABVA eom

Oct 01 01:23 AM