Taking On Too Big To Fail

CNBC is reporting that Congressional Dems and President Obama are going to make public their new bank failure resolution legislation in the next day or two. A preview:

The key changes in what is known as resolution authority affect compensation of creditors, shareholders and management, as well as the role of the Federal Reserve in handling such too-big-to-fail cases, according to a senior Congressional stiffer.

“This will be a significant shift," said the staffer.

In particular, the government would have more latitude in what compensation creditors and shareholders get in out-of-court settlements, similar to what happened to bondholders in the General Motors and Chrysler Chapter 11 cases.

The Fed would play less a role in handling firms that pose a systemic risk to the economy, giving more authority to a council composed of several regulatory agencies.

“The council is being beefed up to be a policy making [entity}, explained the source, and would define such issues as what constitutes a systemic institution and how it is going to be wound down.

In other words, the new laws say that the government can settle out the banks the way they did GM and Chrysler, forcing banks to agree to terms rather than dictating them to the regulatory agencies. It's a vitally needed step.

The other key change in the bill is meant to give the government enough control that it could essentially dictate and impose terms on creditors, such as defining the return on their investment.

It “could get them to take cuts.” said an industry executive. "It's a cram down, if you will, for bondholders. It's a paradigm shift."

Shareholders, meanwhile, would probably lose virtually everything, as is usually the case in bankruptcy court, and management would be removed.

Sources say the changes are intended to provide greater protection for taxpayers, amid a growing outcry over the costs of bailing out private companies. They also reflect widespread criticism of the Fed’s handling of the financial crisis and its revised role in the new regulatory framework being developed.

Good. It's a start. A long way to go and this stuff needs to be written into law before the next megabank fails, but it's a start.