US Is Still Facing Hurdles In Regulating Financial Giants

For all the federal government’s intervention into the world of business and markets, there’s one thing it still can’t do to stop the bleeding in the financial system—even though a lot of experts would like it to.

Under current law, no regulator has the authority to essentially take over a troubled bank holding company—conglomerates with a wide range of financial operations—the way the government routinely does with smaller, commercial banks.


Both FDIC Chairman Sheila Bair and Fed Chairman Ben Bernanke have made that crystal clear in recent days that even as the government injects more taxpayer capital into giant financial institutions such as Citigroup it can't actually shut them down even if officials saw fit and wanted to.

"You simply need a way of calling 'time out,' ” says former Treasury official Robert Glauber, who served during the savings and loan crisis. “They lack that and they know it. I believe you do need this.”

The regulatory framework shared by several different regulators is complicated. But experts and some in Congress even say the loophole of sorts may help explain the incremental approach of both the Bush and Obama administrations in dealing with the financial crisis, regardless of their ideological positions on nationalization.

"It's an incredible gap in our authority," Sen. Bob Corker. (R-Tenn.) told Thursday. "There's no federal authority to go through an unwinding in a way that makes any sense. You have to wonder if that influences your policy somewhat."

Corker, a member of the Senate Finance Committee, was among those who was somehwat stunned when Bernanke said that at a hearing a week ago. The Fed Chairman said as much again to another Congressional panel today.

Regulatory reform is on the agenda for the Obama administration and the new Congress, but it’s still stuck in the back seat of the crisis. There’s been talk of a super-regulator, probably in the form of the Fed, but it's unclear if the bank holding company issue is on the agenda.

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Still, with such high profile players as Bernanke and Bair talking about the shortcomings of authority, many in Washington are becoming more aware of the obstacle.

Under current law, the FDIC has so-called “bridge bank authority” to take over a troubled institution with government insured depositions. The FDIC essentially keeps the bank open for a short period of time before a pre-arranged buyer—meaning another bank—assumes control and operation.

The FDIC, however, does not control bank holding companies, the parent companies of the commercial banks. That is the responsibility of the Fed, but the central bank is only legally allowed to make the company take so-called prompt corrective, action, to deal with such things a capital requirements.

There is no temporary status for that company if it is in trouble. Like any other corporation, its fate is settled through the bankruptcy court system,

“When you have that high degree of integration, the idea of taking over the bank and letting the bank holding company collapse doesn't really work that well,” says independent bank analyst Bert Ely. “When a holding company is stripped of key asset, the company often files for Chapter 7 or Chapter 11."

That means liquidation or protection from creditors towards a hoped for restructuring.

Bernanke: What's Missing In Dealing With Problem

“I think what is missing is a comprehensive dissolution authority to address systemically critical firms,” Bernanke told the Senate Finance Committee recently under tough questioning. "The existing rules don’t cover a Citigroup because it is a bank holding company with many parts.”

Both Citibank and the holding company, Citigroup, are enormously large yet separate institutions with assets of more than a billion dollars. But unlike the bank, whose core business is deposits and lending, the holding company’s activities involve a diverse group of financial activities, from investment to insurance, most of which aren't regulated or insured by the government.


The world of finance and the structure of financial institutions have changed in recent decades, but while the government was undertaking sweeping deregulation it failed to make the necessary changes to provide proper supervision, says experts.

In addition, the management and balance sheets of the two institutions have become irrevocably intertwined.

“The Fed and bank regulators were not prepared to deal with big bank holding companies,” says economist George Kaufman, a banking expert at Loyola University who also does consulting work for the Federal Reserve Bank of Chicago.

Experts say there were numerous opportunities to address the issue, particularly with the passage of the Gramm-Leach-Bliley legislation of 1999, which repealed part of the Depression-era Glass-Steagall Actof 1933 and allowed banks, insurers and investment firms to essentially compete with each other for consumer’s dollars.

Experts say AIG, because it is regulated by many individual state authoriities and also has a thrift, or lending, unit, regulated by the federal Office of Thrift Supervision, presents the same holding company quandry for officials.

The situation has become further complicated because of the proliferation of exotic financial instruments, namely derivatives, and a high level of risky investments, many of which now fall into the toxic asset category.

“There's plenty of blame to go around but there's no question, the Fed has not done a very good job of regulating the holding companies," says Lawrence White, a former S&L regulator and White House economist, now with NYU's Stern School of Business.

Kaufman is among those who would like government officials “to have the authority to treat the holding company like they treat the bank—put them through a regulatory process, not a bankruptcy.”

“The problem is the liabilities," says Glauber. "What do you do with the uninsured liabilities? Are you going to protect senior debt, secured debt?”

Such liabilities involve so-called counter parties, the people on the other end of the business transaction. Unlike bank depositors, their interests and rights can’t be settled simply, quickly or fairly.

The perils of that scenario became apparent after Lehman Brothers—unlike Bear Stearns—failed to attract a last-minute buyer or a government lifeline.

"The Chapter 11 process is not amenable to quick resolution and improvisational solutions,” says Rob Johnson, a consultant and former chief economist for the Senate Banking Committee during the heyday of deregulation. “It’s a bit of tragedy that we didn’t think of this,”

Though no one is urging nationalization, some takeover authority, says White, has to be part of the “resolution solution”, as the government tries to cut its losses.

"What do you do with Bank of America," says White. "It can't sell Merrill Lynch. There's no market out there."

In something of an ironic twist, theTreasury under Henry Paulson was moving toward addressing the outdated regulatory structure in early 2008 when the financial crisis kicked in. Its regulatory blueprint effort was essentially overtaken by events, including the then earth-shattering collapse of Bear.

That is, in part, why the Obama administration is moving ahead on financial reforms, though it's unclear whether that will include giving regulators more authority over holding companies.

"I get the feeling this is an issue that’s being discussed quietly,' said Corker, who added he plans to push Senate Finance Committee chairman Christopher Dodd (D-Conn.) and others to focus on the issue.

"We have to either temporarily or in a more thoughtful way on a permanent basis move to give the the Fed or some other entity the ability to unwind one of these things in an orderly fashion," says Corker.

As with other govenment initiatives in tackling the financial crisis, that may involve some tough choices.

“They simply don't want to face up to the question about what you protect and what you don't protect,” says Glauber.