Wednesday, May 05, 2010

Dodd-Shelby Amendment Ends Liquidation Fund and Allows Regulators to Impose Industry Bans on Culpable Executives at Failed Firms

Senate Banking Committee Chair Chris Dodd and Ranking Member Richard Shelby have reached an agreement on various issues in the financial reform legislation, S 3217, allowing the measure to move forward. The Dodd-Shelby Amendment kills the $50 billion liquidation fund which was to have been used in the resolution and liquidation of failed financial firms. Creditors will be required to pay back the government any amounts they received above what they would have gotten in liquidation. Those who directly benefited from the orderly liquidation will be the first to pay back the government at a premium rate. Also, under the Amendment, Congress must approve the use of debt guarantees. Also, the Federal Reserve can only use its 13(3) emergency lending authority to help solvent companies. The accord allows regulators to ban culpable management and directors of failed firms from working in the financial sector.

The elimination of the liquidation fund sets up a conflict with the House, which provided for a $150 billion dissolution fund administered by the FDIC to facilitate and provide for the orderly and complete dissolution of any failed financial company posing a systemic threat to the financial markets or economy. The conflict will have to be resolved in the upcoming House-Senate conference.

The Amendment requires post resolution reviews to determine whether regulators did all that they were supposed to do to prevent the failure of a systemically significant institution. In Senator Shelby’s view, such a review is essential to hold regulators accountable for their actions or inaction as the case may be. The Amendment significantly tightens up language in the bill dealing with the Fed’s ability to provide liquidity to the financial system in times of severe market distress. It requires the approval of the Treasury Secretary before the Fed can undertake any emergency lending and establishes strict solvency and collateral requirements for any emergency lending, all under strict accountability standards.

According to Senator Dodd, the vast bulk of the legislation remains unchanged. Thus, there will still be an orderly liquidation mechanism for FDIC to unwind failing systemically significant financial companies. And shareholders and unsecured creditors will still bear losses and management will be removed.

Regulators will still have the authority to break up a company if it poses a grave threat to the financial stability of the United States, said the Chair, an large bank holding companies that have received TARP funds will still not be able to avoid Federal Reserve supervision by simply dropping their banks. Most large financial companies are still expected to be resolved through the bankruptcy process.