He noted that stand-alone subsidiaries would be easier to manage and regulate and far less messy to resolve. The failure of one or more subsidiaries would result in an investment loss for the parent corporation, he noted, but would not necessarily result in the disorderly collapse of the financial institution. If the financial institution became insolvent, many subsidiaries could still operate relatively normally. Stand-alone subsidiaries could be sold or spun off without significant disruption to the financial firm or the financial system, even in a crisis, without damaging the franchise value of the subsidiaries.
According to Rep. Miller, stand-alone subsidiaries would also provide prudential regulators with an important ally, the financial market, in the oversight of systemically significant institutions: Each of the systemically significant institutions has hundreds if not thousands of subsidiaries. The financial institutions create subsidiaries for regulatory or tax purposes, noted Rep. Miller, but operate the firm as a single enterprise with consolidated management and a common pool of capital and liquidity. While the financial institution presents the subsidiaries to taxing authorities and regulators as separate entities, said Rep. Miller, the firm assures counterparties that all of the assets of the financial institution stand behind each subsidiary.
Practically speaking, the prudential regulators have no realistic way to assess the risk posed in thousands of subsidiaries engaged in all manner of businesses and neither do counterparties, warned Rep. Miller. Counterparties assume that the financial institutions are still too big to fail, so they will get paid one way or another. But if counterparties knew that they could only be paid from the assets of the specific subsidiary with which they did business, he reasoned, they would consider that subsidiary's assets and potential liabilities. The adequacy of capital would be far easier to judge if the capital was devoted to a specific subsidiary.
In his view, this restoration of market discipline would go a long way to solving the too big to fail problem. If subsidiaries engaged in other business lines were small enough to fail, prudential regulators could pay closer attention to the activities that create the greatest risk of economic disruption.
The congressman also urged the Fed and FDIC to exercise their authority under the living wills provision of the Dodd Frank Act with more energy, ambition and urgency. In the letter to the Fed and FDIC Chairs, he referenced recent concerns voiced by William Dudley, the president of the Federal Reserve Bank of New York, that the living wills submitted by systemically significant financial institutions this summer confirmed that we are a long way from the desired situation in which large complex firms could be allowed to go bankrupt without major disruptions to the financial system. Significant changes in structure and organization will ultimately be required for this to happen.
Rep. Miller agreed with Mr. Dudley that "ultimately" is an unacceptable deadline for structural changes required for credible resolution plans. The legislator warned that the uncertainties in the financial system may not allow for year after year of polite suggestions by regulators and modest tweaks by financial institutions.