Banks--Bad Investments And Bad Customers

The FDIC has begun the process of the creation of a road map
to show how massive financial firms should be put to death
if they become threats to the global credit system. Presumably
if such a system had been in place in 2008, AIG (NYSE: AIG), and perhaps
Citigroup (NYSE: C), would have been euthanized. That may
actually have been the best case given what the AIG rescue
has cost taxpayers

The agency will propose that equity holders and long-term
debt holders go down with the ship if a bank is dissolved.
This should not come as a surprise to investors who held
stock in banks which included Bear Stearns and Lehman Bros.
It will be a shock to those companies that have major debt
arrangements with banks

The only group of companies that have financial relationships
with banks that get payment in a wind down would be short-term
creditors whose services are needed to keep a bank open
long enough to be shuttered.

In the words of the agency, The Notice of Proposed Rulemaking
that covers the issues of bank closings says  it  “proposes
to clarify that all creditors, must expect to absorb losses in
any liquidation. Under the NPR, no creditor can receive any additional
payment unless the FDIC Board of Directors has determined, by recorded
vote, that the payments meet the statutory standards.
“To the extent that any portion of the claim is unsecured, it will
absorb losses along with other unsecured creditors. Secured obligations
collateralized with US government securities will be valued at par.”

The program, if it becomes a full-fledged regulation, will have a chilling
effect on many  future financial relationships between banks
and other intuitions. It will almost certainly make it harder for banks
which have less than pristine balance sheets to have easy access to the
capital markets.

The plan also does not adequately enable troubled banks to to tap the public markets if they need capital to tide them over what may be temporary problems. No sane investor would aid a bank, even if it appeared that the cause of the troubles would soon be over. The rule, in effect, takes banks that might have concerns which are only short-term, and puts them out of business.
Douglas A. McIntyre