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Report to Congressional Committees:
United States Government Accountability Office:
GAO:
April 2010:
Federal Deposit Insurance Act:
Regulators' Use of Systemic Risk Exception Raises Moral Hazard
Concerns and Opportunities Exist to Clarify the Provision:
GAO-10-100:
GAO Highlights:
Highlights of GAO-10-100, a report to congressional committees.
Why GAO Did This Study:
In 2008 and 2009, the Federal Deposit Insurance Corporation (FDIC)
provided emergency assistance that required the Secretary of the
Department of the Treasury (Treasury) to make a determination of
systemic risk under the systemic risk exception of the Federal Deposit
Insurance Act (FDI Act). The FDI Act requires GAO to review each
determination made. For the three determinations made to date, this
report examines (1) steps taken by FDIC, the Board of Governors of the
Federal Reserve System (Federal Reserve), and Treasury to invoke the
exception; (2) the basis of the determination and the purpose of
resulting actions; and (3) the likely effects of the determination on
the incentives and conduct of insured depository institutions and
uninsured depositors. To do this work, GAO reviewed agency
documentation, relevant laws, and academic studies; and interviewed
regulators and market participants.
What GAO Found:
Treasury, FDIC, and the Federal Reserve collaborated before the
announcement of five potential emergency actions that would require a
systemic risk determination. In each case, FDIC and the Federal
Reserve recommended such actions to Treasury, but Treasury made a
determination on only three of the announced actions. Although two
recommendations have not resulted in FDIC actions to date, their
announcement alone could have created the intended effect of
increasing confidence in institutions, while similarly generating
negative effects such as moral hazard. However, because announcements
without a determination do not trigger FDI Act requirements for
documentation and communication, such as Treasury consultation with
the President and notification to Congress, such de facto
determinations heightened the risk that the decisions were made
without the level of transparency and accountability intended by
Congress. Further, uncertainties can arise because there is no
requirement for Treasury to communicate that it will not be invoking a
systemic risk determination for an announced action.
Two of Treasury’s systemic risk determinations—-for Wachovia and
Citigroup-—were made to avert the failure of an institution that
regulators determined could exacerbate liquidity strains in the
banking system. A third determination was made to address disruptions
to bank funding affecting all banks. Under this latter determination,
FDIC established the Temporary Liquidity Guarantee Program (TLGP),
which guaranteed certain debt issued through October 31, 2009, and
certain uninsured deposits of participating institutions through
December 31, 2010, to restore confidence and liquidity in the banking
system. While there is some support for the agencies’ position that
the statute authorizes systemic risk assistance of some type under
TLGP facts and that it permits assistance to the entities covered by
the program, there are questions about these interpretations, under
which FDIC created a broad-based program of direct assistance to
institutions that had never before received such relief—“healthy”
banks, bank holding companies, and other bank affiliates. Because
these issues are matters of significant public interest and
importance, the statutory requirements may require clarification.
Regulators’ use of the systemic risk exception may weaken market
participants’ incentives to properly manage risk if they come to
expect similar emergency actions in the future. The financial crisis
revealed limits in the current regulatory framework to restrict
excessive risk taking by financial institutions whose market
discipline is likely to have been weakened by the recent use of the
systemic risk exception. Congress and regulators are considering
reforms to the current regulatory structure. It is important that such
reforms subject systemically important financial institutions to
stricter regulatory oversight. Further, legislation has been proposed
for an orderly resolution of financial institutions not currently
covered by the FDI Act. A credible resolution regime could help impose
greater market discipline by forcing participants to face significant
costs from their decisions and preclude a too-big-to-fail dilemma.
What GAO Recommends:
To better ensure transparency and accountability, Congress should
consider amending the FDI Act to require Treasury to document reasons
for not making a determination for an announced action and to clarify
the requirements and exception. As Congress considers financial
regulatory reform, it should ensure greater regulatory oversight of
systemically important institutions to mitigate the effects of
weakened market discipline from use of the systemic risk exception.
The Federal Reserve and Treasury generally agreed with our findings.
View [hyperlink, http://www.gao.gov/products/GAO-10-100] or key
components. For more information, contact Orice Williams Brown, (202)
512-8678, williamso@gao.gov.
[End of section]
Contents:
Letter:
Background:
Documentation Evidences Interagency Collaboration, but Announcements
of FDIC Actions That Did Not Result in a Systemic Risk Determination
Create Accountability and Transparency Concerns:
Systemic Risk Determinations Authorized FDIC Guarantees That
Regulators Determined Were Needed to Avert Adverse Effects on
Financial and Economic Conditions:
Systemic Risk Determinations and Related Federal Assistance Raise
Concerns about Moral Hazard and Market Discipline That May Be
Addressed by Potential Regulatory Reforms:
Conclusions:
Matters for Congressional Consideration:
Agency Comments and Our Evaluation:
Appendix I: Objectives, Scope, and Methodology:
Appendix II: Analysis of Legal Authority for the Temporary Liquidity
Guarantee Program (TLGP):
Appendix III: Comments from the Board of Governors of the Federal
Reserve System:
Appendix IV: Comments from the Department of the Treasury:
Appendix V: GAO Contact and Staff Acknowledgments:
Table:
Table 1: TLGP Eligibility and Fee Requirements:
Figures:
Figure 1: Overview of Steps Regulators Must Take to Invoke Systemic
Risk Exception:
Figure 2: Three-Month LIBOR and 3-Month Treasury Bill Yield, as of
November 21, 2008:
Abbreviations:
AIG: American International Group, Inc.
ARM: adjustable-rate mortgage:
DGP: Debt Guarantee Program:
FDI Act: Federal Deposit Insurance Act:
FDIC: Federal Deposit Insurance Corporation:
FDICIA: Federal Deposit Insurance Corporation Improvement Act of 1991:
Federal Reserve: Board of Governors of the Federal Reserve System:
LLP: Legacy Loans Program:
OCC: Office of the Comptroller of the Currency:
PDCF: Primary Dealer Credit Facility:
PPIP: Public-Private Investment Program:
SIGTARP: Special Inspector General for the Troubled Asset Relief
Program:
TAGP: Transaction Account Guarantee Program:
TLGP: Temporary Liquidity Guarantee Program:
TARP: Troubled Asset Relief Program:
Treasury: Department of the Treasury:
[End of section]
United States Government Accountability Office:
Washington, DC 20548:
April 15, 2010:
The Honorable Christopher J. Dodd:
Chairman:
The Honorable Richard C. Shelby:
Ranking Member:
Committee on Banking, Housing, and Urban Affairs:
United States Senate:
The Honorable Barney Frank:
Chairman:
The Honorable Spencer Bachus:
Ranking Member:
Committee on Financial Services:
House of Representatives:
In late 2008, the federal government took unprecedented steps to
stabilize the financial services sector by committing trillions of
dollars of taxpayer funds to assist financial institutions and restore
order to credit markets. One of these steps was the use of the
"systemic risk" exception contained in the Federal Deposit Insurance
Act (FDI Act), which Congress enacted as part of the Federal Deposit
Insurance Corporation Improvement Act of 1991 (FDICIA).[Footnote 1]
Under the systemic risk exception, the Federal Deposit Insurance
Corporation (FDIC) can provide certain emergency assistance authorized
in the provision if the Secretary of the Department of the Treasury
(Treasury), in consultation with the President and upon written
recommendation of FDIC and the Board of Governors of the Federal
Reserve System (Federal Reserve), determines that compliance with
certain cost limitations would result in serious adverse effects on
economic conditions or financial stability and that such assistance
could mitigate these systemic effects. Such a determination exempts
FDIC from the FDI Act's least-cost rule, which requires FDIC to use
the least costly method when assisting an insured institution and
prohibits FDIC from increasing losses to the Deposit Insurance Fund by
protecting creditors and uninsured depositors of an insured
institution.
On September 29, 2008, the Secretary of the Treasury invoked the
systemic risk exception for the first time since the enactment of
FDICIA. This first determination authorized FDIC to provide assistance
to facilitate a sale of Wachovia Corporation's (Wachovia) banking
operations to Citigroup Inc. (Citigroup). At the time, Wachovia was
the fourth-largest banking organization in terms of assets in the
United States. On October 14, 2008, the Secretary of the Treasury
again invoked the systemic risk provision, in order to allow FDIC to
provide certain assistance to insured depository institutions, their
holding companies, and qualified affiliates under the Temporary
Liquidity Guarantee Program (TLGP). Under TLGP, FDIC has guaranteed
newly issued senior unsecured debt up to prescribed limits for insured
institutions, their holding companies, and qualified affiliates and
provided temporary unlimited coverage for certain non-interest-bearing
transaction accounts at insured institutions. TLGP's debt guarantee
program ceased issuing new guarantees on October 31, 2009, and TLGP's
transaction account guarantees remain in effect for insured
institutions participating in an extension expiring on December 31,
2010.[Footnote 2] A third systemic risk determination, on January 15,
2009, permitted FDIC to provide assistance to Citigroup, the third-
largest U.S. banking organization by asset size at the end of the
third quarter of 2008. FDIC and the Federal Reserve also made two
other recommendations to Treasury--to authorize FDIC to provide open
bank assistance to Bank of America Corporation (Bank of America) and
to support the Public-Private Investment Program's (PPIP) proposed
Legacy Loans Program (LLP)--neither of which had resulted in a
systemic risk determination as of this report's issuance date.
Treasury is no longer considering making a systemic risk determination
for the announced assistance to Bank of America as Treasury, FDIC, and
the Federal Reserve agreed with Bank of America to terminate the term
sheet with respect to this assistance. Under LLP, FDIC would provide
certain guarantees on the financing used by public-private investment
funds to purchase distressed loans and other troubled assets from
financial institutions to help restore their balance sheets.
The FDI Act requires GAO to review and report to Congress on each
systemic risk determination made by the Secretary of the Treasury.
[Footnote 3] For the three systemic risk determinations made as of
March 2010, this report examines (1) the steps taken by Treasury, the
Federal Reserve, and FDIC to invoke the systemic risk exception; (2)
the basis for each determination and the purpose of actions taken
pursuant to each determination; and (3) the likely effects of each
determination on the incentives and conduct of insured depository
institutions and uninsured depositors.
To address our objectives, we reviewed and analyzed documentation of
Treasury's systemic risk determinations and the supporting
recommendations that FDIC and the Federal Reserve made. We also
reviewed FDI Act requirements for transparency and accountability with
respect to the use of the systemic risk exception and analyzed the
implications of announcements that are not followed by a Treasury
determination that would trigger these requirements. In addition, we
collected and analyzed various data to illustrate financial and
economic conditions at the time of each determination and the actions
taken pursuant to each determination. We reviewed and analyzed the
research reports of one credit rating agency and studies identifying
the likely effects of each determination and the actions taken on the
incentives and conduct of insured depository institutions and
uninsured depositors. We also reviewed prior GAO work on the financial
regulatory system. In addition we interviewed three economists, one
banking industry association, and a banking analyst as well as
officials from Treasury, FDIC, the Federal Reserve and the Office of
the Comptroller of the Currency (OCC) to gain an understanding of
their collaboration prior to making systemic risk determinations, the
basis and authority for each determination, and the purpose of the
actions taken under each determination. To perform our review of
whether the legal requirements for making determinations and providing
assistance under the systemic risk exception were met with respect to
TLGP, we reviewed applicable statutes, regulations, guidance, and
agency materials and obtained the legal views of agency officials,
practitioners, and academics.
The work upon which this report is based was conducted in accordance
with generally accepted government auditing standards. Those standards
require that we plan and perform the audit to obtain sufficient,
appropriate evidence to provide a reasonable basis for our findings
and conclusions based on our audit objectives. We believe that the
evidence obtained provides a reasonable basis for our findings and
conclusions based on our audit objectives. This work was conducted
between October 2008 and April 2010.
Background:
The dramatic decline in the U.S. housing market that began in 2006
precipitated a decline in the price of mortgage-related assets,
particularly mortgage assets based on subprime loans, in 2007. Some
institutions found themselves so exposed that they were threatened
with failure, and some failed because they were unable to raise
capital or obtain liquidity as the value of their portfolios declined.
Other institutions, ranging from government-sponsored enterprises such
as Fannie Mae and Freddie Mac to large securities firms, were left
holding "toxic" mortgages or mortgage-related assets that became
increasingly difficult to value, were illiquid, and potentially had
little worth. Moreover, investors not only stopped buying private-
label securities backed by mortgages but also became reluctant to buy
securities backed by other types of assets. Because of uncertainty
about the liquidity and solvency of financial entities, the prices
banks charged each other for funds rose dramatically, and interbank
lending conditions deteriorated sharply. The resulting liquidity and
credit crunch made the financing on which businesses and individuals
depend increasingly difficult to obtain. By late summer of 2008, the
ramifications of the financial crisis ranged from the continued
failure of financial institutions to increased losses of individual
savings and corporate investments and further tightening of credit
that would exacerbate the emerging global economic slowdown.
Treasury and federal financial regulators play a role in regulating
and monitoring the financial system. Historically, Treasury's mission
has been to act as steward of U.S. economic and financial systems.
Among its many activities, Treasury has taken a leading role in
addressing underlying issues such as those precipitating the recent
financial crisis. The key federal banking regulators include the
following:
* The Federal Reserve, an independent agency that is responsible for
conducting the nation's monetary policy by influencing the monetary
and credit conditions in the economy in pursuit of maximum employment,
stable prices, and moderate long-term interest rates; supervising and
regulating bank holding companies and state-chartered banks that are
members of the Federal Reserve System; and maintaining the stability
of the financial system and containing systemic risk that may arise in
financial markets through its role as lender of last resort;
* FDIC, an independent agency created to help maintain stability and
public confidence in the nation's financial system by insuring
deposits, examining and supervising insured state-chartered banks that
are not members of the Federal Reserve System, and resolving failed or
failing banks;
* OCC, which charters and supervises national banks; and the:
* Office of Thrift Supervision, which supervises savings associations
(thrifts) and savings and loan holding companies.
In 1991, Congress enacted FDICIA in response to the savings and loan
crisis. FDICIA enacted a number of reforms, including some designed to
address criticisms that federal regulators had not taken prompt and
forceful actions to minimize or prevent losses to the deposit
insurance funds caused by bank and thrift failures. Among other
things, FDICIA amended the FDI Act by establishing a rule requiring
FDIC to follow the least costly approach when resolving an insured
depository institution. Specifically, under the least cost rule, FDIC
must resolve a troubled insured depository institution using the
method expected to have the least cost to the deposit insurance fund
and cannot use the fund to protect uninsured depositors and creditors
who are not insured depositors if such protection would increase
losses to the fund.[Footnote 4] To make a least-cost determination,
FDIC must (1) consider and evaluate all possible resolution
alternatives by computing and comparing their costs on a present-value
basis, and (2) select the least costly alternative on the basis of the
evaluation. Under the least-cost requirements, FDIC generally has
resolved failed or failing banks using three basic methods, which do
not constitute open bank assistance. These are: (1) directly paying
depositors the insured amount of their deposits and disposing of the
failed bank's assets (deposit payoff and asset liquidation); (2)
selling only the bank's insured deposits and certain other
liabilities, and some of its assets, to an acquirer (insured deposit
transfer); and (3) selling some or all of the failed bank's deposits,
certain other liabilities, and some or all of its assets to an
acquirer (purchase and assumption). According to FDIC officials, they
have most commonly used purchase and assumption, as it is often the
least costly and disruptive alternative.[Footnote 5]
FDICIA also amended the FDI Act to create an exception to the least-
cost requirements, known as the systemic risk exception, that allows
FDIC assistance without complying with the least cost rule if
compliance would have "serious adverse effects on economic conditions
and financial stability"--that is, would cause systemic risk--and if
such assistance would "avoid or mitigate such adverse effects." FDIC
may act under the exception only under the process specified in the
statute. The FDIC Board of Directors and the Board of Governors of the
Federal Reserve System each must recommend use of the exception by a
vote of not less than two-thirds of their respective members and
deliver a written recommendation to the Secretary of the Treasury.
Based on a review of the FDIC and Federal Reserve recommendations, the
Secretary of the Treasury, in consultation with the President, may
make a systemic risk determination authorizing FDIC to take action or
provide assistance that does not meet the least-cost
requirements.[Footnote 6] For example, under a systemic risk
determination, FDIC is not bound to identify and follow the least-cost
resolution strategy and may provide assistance (such as debt or
deposit guarantees) that protects uninsured depositors and creditors,
who otherwise might suffer losses under a least-cost method such as a
purchase and assumption or depositor payoff. Until recently, the
systemic risk exception required FDIC to recover any resulting losses
to the insurance fund by levying one or more emergency special
assessments on insured depository institutions. Congress amended this
requirement in May 2009 to also authorize assessments on bank holding
companies, and savings and loan holding companies. Finally, the
systemic risk exception includes requirements that serve to ensure
accountability for regulators' use of this provision. The Secretary of
the Treasury must notify Congress in writing of any systemic risk
determination and must document each determination and retain the
documentation for GAO review, and GAO must report its findings to
Congress.
Documentation Evidences Interagency Collaboration, but Announcements
of FDIC Actions That Did Not Result in a Systemic Risk Determination
Create Accountability and Transparency Concerns:
On five occasions, collaboration among high-level officials at
Treasury, FDIC, and the Federal Reserve resulted in the announcement
of emergency actions that would require a systemic risk exception.
FDIC and the Federal Reserve provided written recommendations to the
Secretary of the Treasury for all five announced actions, but the
Secretary has made a determination on only three of these
announcements. Treasury made the first two determinations concurrent
with the initial announcements, and the third determination was made
nearly 2 months after the announcement of action. Treasury has not
made a determination on the remaining two announced actions which have
not been implemented to date. Such announcements can affect market
expectations and contribute to moral hazard, but the announcements
alone--absent a Treasury determination--do not trigger requirements
established by Congress for documentation and communication of the
agencies' use of the systemic risk exception. Such requirements serve
to ensure transparency and accountability related to the application
of the systemic risk exception.
Treasury, FDIC, and the Federal Reserve Collaborated before Announcing
Emergency Actions:
On five occasions between late 2008 and early 2009, regulators
announced potential emergency actions that would require a systemic
risk determination before they could be implemented. In each case, a
liquidity crisis--either at a single institution or across the banking
industry--triggered discussions among FDIC, Federal Reserve, and
Treasury officials about whether to invoke the systemic risk
exception.[Footnote 7] According to regulators, these discussions
generally occurred among high-level officials at the three agencies
over a period of a few days, through e-mail, memorandums, telephone
calls, and emergency meetings. The regulators shared and analyzed
information, such as data describing the liquidity pressures facing
financial institutions, to help them understand the financial
condition of the troubled institutions and the potential systemic
implications of complying with the least-cost resolution requirements.
In the second section of this report, we discuss in detail publicly
available information about the financial condition of the
institutions that received emergency assistance, the basis for each
decision to invoke the systemic risk exception, and the actions that
FDIC took under the provision.
Following these collaborations, FDIC and Federal Reserve staff
submitted documentation of their analyses and recommendations to
support invoking the systemic risk exception to their respective
Boards. In each of the five cases, FDIC's Board of Directors and
Federal Reserve Board members voted in favor of recommending a
systemic risk determination, and FDIC and the Federal Reserve provided
written recommendations to the Secretary of the Treasury (see fig. 1).
On each occasion, the regulators issued public statements announcing
planned FDIC actions that would require a systemic risk determination
for implementation. The Secretary of the Treasury made a determination
in response to three of the five recommendations (Wachovia, TLGP, and
Citigroup); therefore, we reviewed, as provided by the mandate,
documentation related to these three cases. Treasury documents that we
reviewed indicate that the Secretary of the Treasury signed and
approved the determinations (as required by the FDI Act) and
authorized FDIC to take planned action after having reviewed the FDIC
and the Federal Reserve's written recommendations and consulted with
the President. Also as required by the FDI Act, Treasury sent letters
to Congress to notify the relevant committees of all three
determinations.
Figure 1: Overview of Steps Regulators Must Take to Invoke Systemic
Risk Exception:
[Refer to PDF for image: illustration]
Trigger event and collaboration:
Crisis situation:
FDIC; Federal Reserve: Collaborate with Treasury on solutions and
agree to recommend the use of the systemic risk exception.
FDIC and Federal Reserve recommendations:
* Boards vote (2/3 vote to recommend exception):
Written recommendations to Treasury secretary, who consults with
President prior to making determination.
* Boards vote (2/3 vote to recommend exception):
Public announcement of emergency FDIC actions; Regulators may announce
planned FDIC actions requiring a Treasury determination prior to a
Treasury determination;
Will announced actions be implemented?
If no:
No Treasury determination = No FDI Act requirements for Treasury
documentation and no mandatory GAO review;
If yes:
Determination required to authorize implementation; to Treasury
secretary, who consults with President prior to making determination.
Treasury determination (Treasury determination = statutory
requirements for Treasury documentation and GAO review):
Formal systemic risk determination.
FDI Act accountability requirements:
FDIC: Auhorized to take actions under systemic risk exception.
Source: GAO.
[End of figure]
Announcements of Emergency Actions without a Systemic Risk
Determination Diminish the Level of Transparency and Accountability
Intended by Congress:
In all five cases, planned emergency actions were announced by
regulators, but Treasury did not make an immediate determination for
three of these announcements and still has not made a determination to
date in two of them. In two cases, Wachovia and TLGP, Treasury made a
determination before regulators finalized the terms of the assistance.
According to Treasury, FDIC, and Federal Reserve officials, they
publicly announced emergency assistance prior to a Treasury
determination in these cases to reassure the markets that the
government was committed to supporting financial market stability. In
the Citigroup case, the public announcement preceded Treasury's
determination by about 2 months. Specifically, on November 23, 2008,
Treasury, FDIC, and the Federal Reserve jointly announced an agreement-
in-principle to assist Citigroup. FDIC and the Federal Reserve
delivered written recommendations by early December 2008 and Treasury
signed the determination in January 2009 when the finalized agreement
was executed.
Since the Citigroup determination, Treasury has not made
determinations following two announcements of emergency actions and
those announced initiatives have not been implemented. On January 16,
2009, FDIC announced an agreement-in-principle with Bank of America to
share losses on a fixed pool of Bank of America assets. Although FDIC
and the Federal Reserve provided written recommendations in support of
a determination, according to Treasury and FDIC officials, the
Secretary of the Treasury did not make a determination at the time
because the terms of the agreement had not been finalized. In May
2009, Bank of America requested a termination of the term sheet for
the announced guarantee of up to $118 billion in assets by the U.S.
government and in September 2009, the parties to the agreement-in-
principle executed a termination agreement in which Bank of America
agreed to pay $425 million to Treasury, the Federal Reserve, and FDIC.
Similarly, on March 23, 2009, FDIC and Treasury announced the creation
of the PPIP's LLP, but Treasury has not yet made a determination.
According to a Treasury official with whom we spoke, Treasury has
delayed making a determination while regulators considered how to
structure the program.
While important to stabilizing markets, the public announcement of
planned actions can serve as a de facto determination by implying that
Treasury has made a systemic risk determination. An announcement alone
could have given rise to some of the benefits of a systemic risk
determination, while similarly generating the potential for negative
incentives such as moral hazard. For example, although FDIC did not
provide assistance to Bank of America, the announcement of the planned
Bank of America guarantees signaled regulators' willingness to provide
such assistance and may have achieved to some degree the intended
effect of increasing market confidence in Bank of America. The
agreement requiring Bank of America to pay a $425 million termination
fee recognized that although the parties never entered into a
definitive documentation of the transaction, Bank of America received
value from the announced term sheet, including benefits in terms of
market confidence in the institution.
Although the effects of announcements and determinations can be
similar, determinations must be conducted under procedural and
documentation requirements that do not apply to announcements. Under
the determination process, Treasury must consider recommendations from
FDIC and the Federal Reserve, consult with the President before making
a determination, and document its reasons for making a determination
and retain the documentation for later review.[Footnote 8] Treasury
must also notify Congress in writing of each systemic risk
determination. None of these requirements applies when a determination
is not made.
We acknowledge that Treasury is not required to make a determination
within a set period and recognize the need for some flexibility during
crisis situations. However, absent a determination, the agency is not
required to follow the formal process put in place by Congress to
ensure transparency and accountability in the application of the
systemic risk exception. Therefore, when a determination is not made
along with the announced actions, Congress cannot be assured that
Treasury's reasoning would be open to the same scrutiny required in
connection with a formal systemic risk determination because Treasury
does not have to act upon the FDI Act's documentation and
accountability measures. For instance, Congress cannot be assured that
the documentation required to support a determination will be or has
been generated, even when the announcement by the agencies can have
some of the same effects a systemic risk determination would have.
Furthermore, uncertainty in de facto determination situations can
arise because Treasury is not required to communicate that it will not
make a systemic risk determination for an announced action. For
example, since the announcement proposing the creation of the PPIP's
LLP in March 2009, it has not been clear whether Treasury intends to
make a systemic risk determination, raising questions about whether
Treasury will make a determination to authorize the program.
Systemic Risk Determinations Authorized FDIC Guarantees That
Regulators Determined Were Needed to Avert Adverse Effects on
Financial and Economic Conditions:
The Secretary of the Treasury's three systemic risk determinations
authorized FDIC guarantees that FDIC, the Federal Reserve, and
Treasury determined were needed to avoid or mitigate further serious
adverse effects on already deteriorating financial and economic
conditions. Treasury invoked the exception so that FDIC could provide
assistance to Wachovia and its insured institution subsidiaries, the
banking industry as a whole (through TLGP), and Citigroup and its
insured institution subsidiaries.
FDIC Protection against Large Losses on Wachovia Assets Was Intended
to Facilitate an Orderly Sale to Citigroup and Avert a Resolution with
Potentially Systemic Consequences:
In describing the basis for the first systemic risk determination in
September 2008, Treasury, FDIC, and the Federal Reserve noted that
mounting problems at Wachovia could have led to a failure of the firm,
which in turn could have exacerbated the disruption in the financial
markets. At the time, the failures and near-failures of several large
institutions had increased stress in key funding markets. As noted
earlier, by late summer 2008, the potential ramifications of the
financial crisis included the continued failure of financial
institutions and further tightening of credit that would exacerbate
the emerging global economic slowdown that was beginning to take
shape. In this environment, many financial institutions, including
Wachovia, were facing difficulties in raising capital and meeting
their funding obligations. In its recommendation, FDIC said that the
rapidly deteriorating financial condition of Wachovia Bank, N.A.--
Wachovia's largest bank subsidiary--was due largely to its portfolio
of payment-option adjustable-rate mortgage (ARM) products, commercial
real-estate portfolio, and weakened liquidity position.[Footnote 9]
Over the first half of 2008, Wachovia had suffered more than $9
billion in losses due in part to mortgage-related asset losses and
investors increasingly had become concerned about the firm's
prospects, given the worsening outlook for home prices and mortgage
credit quality. In addition, during the week preceding Treasury's
determination, Wachovia's stock price declined precipitously and the
spreads on credit default swaps that provide protection against losses
on Wachovia's debt widened, indicating that investors considered a
Wachovia default increasingly likely.[Footnote 10] FDIC consulted with
Treasury and the Federal Reserve in conducting an analysis of
Wachovia's liquidity and determined that Wachovia would soon be unable
to meet its funding obligations as a result of strains on its
liquidity, particularly from projected outflows of deposits and retail
brokerage accounts.
Treasury, FDIC, and the Federal Reserve Determined a Least-Cost
Resolution of Wachovia Would Likely Exacerbate Market Strains:
In considering actions to avert a Wachovia failure, Treasury
determined that a least-cost resolution of Wachovia's bank and thrift
subsidiaries, without protecting creditors and uninsured depositors,
could--in light of conditions in the financial markets and the economy
at the time--weaken confidence and exacerbate liquidity strains in the
banking system.[Footnote 11] FDIC could have effected a least-cost
resolution of Wachovia Bank, N.A. through a depositor payoff or
purchase and assumption transaction following appointment of FDIC as
the receiver of the bank's assets. FDIC and the Federal Reserve
projected that either of these least-cost resolution options would
have resulted in no cost to the deposit insurance fund, but that
either option likely would have imposed significant losses on
subordinated debtholders and possibly senior note holders.[Footnote
12] In addition, Treasury, the Federal Reserve, and FDIC expected
these resolution options to impose losses on foreign depositors, a
significant funding source for several large U.S. institutions. Their
concerns over the possible significant losses to creditors holding
Wachovia subordinated debt and senior debt were reinforced by the
recent failure of Washington Mutual, a large thrift holding company.
According to Treasury's determination, under the least-cost resolution
of Washington Mutual, senior and subordinated debtholders of the
holding company and its insured depository subsidiaries suffered large
losses. Treasury, FDIC, and the Federal Reserve expressed concern that
imposing similarly large losses on Wachovia's creditors and foreign
depositors could intensify liquidity pressures on other U.S. banks,
which were vulnerable to a loss of confidence by creditors and
uninsured depositors (including foreign depositors), given the
stresses already present in the financial markets at that time.
According to FDIC and Federal Reserve documents, Wachovia's sudden
failure would have led to investor concern about direct exposures of
other financial institutions to Wachovia. Furthermore, a Wachovia
failure also could have led investors and other market participants to
doubt the financial strength of other institutions that might be seen
as similarly situated. In particular, the agencies noted that a
Wachovia failure could intensify pressures on other large banking
organizations that, like Wachovia, reported they were well capitalized
but continued to face investor concerns about deteriorating asset
quality. At the time of the Wachovia determination, the Emergency
Economic Stabilization Act had not yet been passed and, thus, the
authorities under that law to create the Troubled Asset Relief Program
(TARP) were not available to help mitigate these effects.[Footnote 13]
Furthermore, a least-cost resolution of Wachovia, N.A. could have
negatively affected the broader economy, because with banks
experiencing reduced liquidity and increased funding costs, they would
be less willing to lend to businesses and households.
In recommending a systemic risk determination, the Federal Reserve and
FDIC described the extent of Wachovia's interdependencies and the
potential for disruptions to markets in which it played a significant
role. The Federal Reserve listed the top financial entities exposed to
Wachovia, noting that mutual funds were prominent among these
counterparties. In addition, FDIC expressed concern that a Wachovia
failure could result in losses for mutual funds holding its commercial
paper, accelerating runs on those and other mutual funds.[Footnote 14]
The Federal Reserve also noted that Wachovia was a major participant
in the full range of major domestic and international clearing and
settlement systems and that a least-cost resolution would likely have
raised some payment and settlement concerns.
Treasury, FDIC, and the Federal Reserve concluded that FDIC assistance
under the systemic risk exception could avert the potential systemic
consequences of a least-cost resolution of Wachovia's bank and thrift
subsidiaries. In particular, they determined that authorizing FDIC
guarantees to protect against losses to Wachovia's uninsured creditors
would avoid or mitigate the potential for serious adverse effects on
the financial system and the economy by facilitating the acquisition
of Wachovia's banking operations by Citigroup.
FDIC Loss-Sharing Agreement Intended to Avert Likely Additional Market
Strains from a Least-Cost Resolution:
On September 29, 2008, pursuant to Treasury's systemic risk
determination, FDIC announced that it had agreed to provide protection
against large losses on a fixed pool of Wachovia assets to facilitate
the orderly sale of Wachovia's banking operations to Citigroup and
avert an imminent failure that might exacerbate the serious strains
then affecting the financial markets, financial institutions, and the
economy. On September 28, 2008, Citigroup and Wells Fargo both
submitted bids to FDIC to acquire Wachovia's banking operations with
FDIC open bank assistance in the form of loss sharing on Wachovia
assets. The Citigroup and Wells Fargo bids differed in terms of the
amount of losses each proposed to absorb and the result of the bidding
process held by FDIC was the acceptance of Citigroup's bid.[Footnote
15] After agreeing with FDIC to a loss-sharing agreement on selected
Wachovia assets, Citigroup announced that it would acquire Wachovia's
banking operations for $2.2 billion and assume the related
liabilities, including senior and subordinated debt obligations and
all of Wachovia's uninsured deposits.[Footnote 16] Under the
agreement, Citigroup agreed to absorb the first $42 billion of losses
on a $312 billion pool of loans and FDIC agreed to assume losses
beyond that. To compensate FDIC for its assumption of this risk,
Citigroup agreed to grant FDIC $12 billion in preferred stock and
warrants. A few days after the announcement of the proposed Citigroup
acquisition, Wachovia announced that it would instead merge with Wells
Fargo in a transaction that would include all of Wachovia's operations
and, in contrast to the bids submitted days earlier by Citigroup and
Wells Fargo, require no FDIC assistance. As a result, the FDIC loss-
sharing agreement on Wachovia assets was not implemented and no
assistance was provided under the systemic risk exception.
Although the loss-sharing agreement never took effect, the
announcement of the Citigroup acquisition and loss-sharing agreement
may have helped to avert a Wachovia failure with potential systemic
consequences. While acknowledging that isolating the impact of FDIC's
assistance from other factors is difficult, Treasury and FDIC
officials with whom we spoke said that one measure of the success of
the loss-sharing agreement was that Wachovia was able to remain open
and meet its funding obligations on Monday, September 29, 2008. In
particular, the determination and the announcement of Citigroup's
assumption of debt and deposit liabilities of Wachovia and its insured
bank and thrift subsidiaries may have helped to allay the concerns of
creditors and depositors that might otherwise have withdrawn liquidity
support. As Wachovia did not fail, the extent to which a Wachovia
failure would have had adverse effects on financial stability is not
known.
TLGP Determination Was Intended to Help Restore Confidence and
Liquidity to the Banking System, but Highlights Need for Clarification
of the Systemic Risk Exception:
In describing the basis for the second systemic risk determination,
which authorized TLGP, Treasury, FDIC, and the Federal Reserve said
that disruptions in credit markets posed a threat to the ability of
many institutions to fund themselves and lend to consumers and
businesses. In a memorandum provided to Treasury, FDIC noted that the
reluctance of banks and investment managers to lend to other banks and
their holding companies made finding replacement funding at a
reasonable cost difficult for these financial institutions. The TED
spread--a key indicator of credit risk that gauges the willingness of
banks to lend to other banks--peaked at more than 400 basis points in
October 2008, likely indicating an increase in both perceived risk and
in risk aversion among investors (see fig. 2).[Footnote 17] In
addition to disruptions in interbank lending, financial institutions
also faced difficulties raising funds through commercial paper and
asset-backed securitization markets.[Footnote 18] The resulting credit
crunch made the financing on which businesses and individuals depend
increasingly difficult to obtain. In addition, FDIC was concerned that
large outflows of uninsured deposits could strain many banks'
liquidity. According to FDIC officials with whom we spoke, they were
not tracking outflows of these deposits, but relied on anecdotal
reports from institutions and the regulators serving as their primary
supervisors.
Figure 2: Three-Month LIBOR and 3-Month Treasury Bill Yield, as of
November 21, 2008:
[Refer to PDF for image: multiple line graph]
Initial rates for each year:
Year: 1982;
LIBOR: 13.75%;
3-month treasury: 12.08%;
TED spread: 1.67%.
Year: 1984;
LIBOR: 9.94%;
3-month treasury: 9.3%;
TED spread: 0.64%.
Year: 1986;
LIBOR: 8.06%;
3-month treasury: 7.27%;
TED spread: 0.79%.
Year: 1988;
LIBOR: 7.67%;
3-month treasury: 5.93%;
TED spread: 1.73%.
Year: 1990;
LIBOR: 8.38%;
3-month treasury: 7.84%;
TED spread: 0.54%.
Year: 1992;
LIBOR: 4.22%;
3-month treasury: 3.96%;
TED spread: 0.26%.
Year: 1994;
LIBOR: 3.38%;
3-month treasury: 3.13%;
TED spread: 0.25%.
Year: 1996;
LIBOR: 5.62%;
3-month treasury: 5.2%;
TED spread: 0.42%.
Year: 1998;
LIBOR: 5.84%;
3-month treasury: 5.4%;
TED spread: 0.44%.
Year: 2000;
LIBOR: 6.03%;
3-month treasury: 5.43%;
TED spread: 0.60%.
Year: 2002;
LIBOR: 1.87%;
3-month treasury: 1.73%;
TED spread: 0.14%.
Year: 2004;
LIBOR: 1.15%;
3-month treasury: 0.93%;
TED spread: 0.22%.
Year: 2006;
LIBOR: 4.55%;
3-month treasury: 4.19%;
TED spread: 0.35%.
Year: 2008;
LIBOR: 4.66%;
3-month treasury: 3.27%;
TED spread: 1.39%.
Source: Global Insight and Federal Reserve Bank of St. Louis.
[End of figure]
Treasury, FDIC, and the Federal Reserve Determined That Resolving
Institutions on a Bank-by-Bank Basis Could Result in Adverse Impacts:
In light of the liquidity strains many institutions faced, Treasury,
FDIC, and the Federal Reserve determined that resolving institutions
on a bank-by-bank basis in compliance with least-cost requirements
would result in adverse impacts on financial stability and the broader
economy. In its recommendation letter, FDIC concluded that the threat
to the market for bank debt was a systemic problem that threatened the
stability of a significant number of institutions, thereby increasing
the potential for failures of these institutions and losses to the
Deposit Insurance Fund. The Federal Reserve reasoned, among other
things, that the failures and least-cost resolutions of a number of
institutions could impose unexpected losses on investors and further
undermine confidence in the banking system, which already was under
extreme stress. Treasury concurred with FDIC and the Federal Reserve
in determining that relying on the least-cost resolution process would
not sufficiently address the systemic threat to bank funding and the
broader economy.
Treasury concluded that FDIC actions under a systemic risk exception
would avoid or mitigate adverse effects that would have resulted if
assistance were provided subject to the least cost rules.
Specifically, Treasury, FDIC, and the Federal Reserve advised that
certain FDIC debt and deposit guarantees--otherwise subject to the
prohibition against use of the Deposit Insurance Fund to protect
uninsured depositors and creditors who are not insured depositors--
could address risk aversion among institutions and investors that had
become reluctant to provide liquidity to financial institutions and
their holding companies. In a memorandum describing the basis for TLGP
determination, Treasury explained the need for emergency actions in
the context of a recent agreement among the United States and its G7
colleagues to implement a comprehensive action plan to provide
liquidity to markets and prevent the failure of any systemically
important institution, among other objectives.[Footnote 19] To
implement the G7 plan, several countries had already announced
programs to guarantee retail deposits and new debt issued by financial
institutions. Treasury noted that if the United States did not take
similar actions, global market participants might turn to institutions
and markets in countries where the perceived protections were the
greatest.
TLGP Determination Highlights the Need for Clarification of
Requirements and Authorized Assistance under the Systemic Risk
Exception:
Some have noted that under a possible reading of the exception, the
statute may authorize assistance only to particular institutions,
based on those institutions' specific problems, not, as was done in
creating TLGP, systemic risk assistance based on problems affecting
the banking industry as a whole. Treasury, FDIC, and the Federal
Reserve considered this and other legal issues in recommending and
making TLGP determination. The agencies believe the statute could have
been drafted more clearly and that it can be interpreted in different
ways. They concluded, however, that under a permissible
interpretation, assistance may be based on industry-wide concerns.
They also concluded that a systemic risk determination waives all of
the normal statutory restrictions on FDIC assistance and then creates
new authority to provide assistance, both as to the types of aid that
may be provided and the entities that may receive it. Under this
reading, the agencies believe the statutory criteria were met in the
case of TLGP and that the assistance was authorized.
We examined these issues as part of our review of the basis of the
systemic risk determinations made to date. As detailed in appendix II,
the recent financial crisis is the first time the agencies have relied
on the systemic risk exception since its enactment in 1991, and no
court to date has ruled on when or how it may be used. We found there
is some support for the agencies' position that the exception
authorizes assistance of some type under TLGP facts, as well as for
their position that the exception permits assistance to the entities
covered by this program. There are a number of questions concerning
these interpretations, however. In the agencies' view, for example,
some of the statutory provisions are ambiguous. What is clear,
however, that the systemic risk exception overrides important
statutory restrictions designed to minimize costs to the Deposit
Insurance Fund, and in the case of TLGP, that the agencies used it to
create a broad-based program of direct FDIC assistance to institutions
that had never before received such relief--"healthy" banks, bank
holding companies, and other bank affiliates. Because application of
the systemic risk exception raises novel legal and policy issues of
significant public interest and importance, and because of the need
for clear direction to the agencies in a time of financial crisis, the
requirements and the assistance authorized under the systemic risk
exception may require clarification by Congress.
FDIC Established TLGP to Promote Confidence and Liquidity in the
Banking System:
In October 2008, FDIC created TLGP to complement the TARP Capital
Purchase Program and the Federal Reserve's Commercial Paper Funding
Facility and other liquidity facilities in restoring confidence in
financial institutions and repairing their capacity to meet the credit
needs of American households and businesses.[Footnote 20] TLGP's Debt
Guarantee Program (DGP) was designed to improve liquidity in term-
funding markets by guaranteeing certain newly issued senior unsecured
debt of financial institutions and their holding companies. According
to FDIC officials, by guaranteeing payment of these debt obligations,
DGP was intended to address the difficulty that creditworthy
institutions were facing in replacing maturing debt because of risk
aversion in the markets. TLGP's Transaction Account Guarantee Program
(TAGP) also was created to stabilize an important source of liquidity
for many financial institutions. TAGP temporarily extended an
unlimited deposit guarantee to certain non-interest-bearing
transaction accounts to assure holders of the safety of these deposits
and limit further outflows. By facilitating access to borrowed funds
at lower rates, Treasury, FDIC, and the Federal Reserve expected TLGP
to free up funding for banks to make loans to creditworthy businesses
and consumers. Furthermore, by promoting stable funding sources for
financial institutions, they intended TLGP to help avert bank and
thrift failures that would impose costs on the insurance fund and
taxpayers and potentially contribute to a worsening of the crisis.
TLGP Requirements Were Structured to Prevent Costs to the Insurance
Fund:
FDIC structured TLGP requirements to provide needed assistance to
insured banks while avoiding costs to the deposit insurance fund.
According to FDIC officials, in designing TLGP, FDIC sought to achieve
broad participation to avoid the perception that only weak
institutions participated and to help ensure collection of fees needed
to cover potential losses. Initially, all eligible institutions, which
included insured depository institutions, their holding companies, and
qualified affiliates, were enrolled in TLGP for 30 days at no cost and
only those that participated in DGP or TAGP (or both) after the opt-
out date became subject to fee assessments. Table 1 provides
additional details related to TLGP features and requirements. As of
March 31, 2009, among depository institutions with assets over $10
billion, 92 percent and 94 percent had opted into DGP and TAGP,
respectively. According to one regulatory official, this high
participation rate indicated that many large institutions judged the
benefits of the program to outweigh fee and other costs. However,
while seeking to encourage broad participation, TLGP was not intended
to prop up nonviable institutions, according to FDIC officials. The
TLGP rule allowed FDIC to prospectively cancel eligibility for DGP if
an institution had weak supervisory ratings.[Footnote 21] According to
FDIC officials, some financial institutions were privately notified by
their regulatory supervisors that they were not eligible to issue TLGP-
guaranteed debt. In addition, FDIC required all parts of a holding
company to make the same decision about TLGP participation to prevent
an entity from issuing guaranteed debt through its weakest subsidiary.
Table 1: TLGP Eligibility and Fee Requirements:
Program: TLGP (both programs);
Initial eligibility and coverage rules: All eligible institutions were
automatically enrolled at no cost for 1 month starting Oct. 14, 2008;
Eligible institutions include FDIC insured depository institutions
(IDIs); U.S. bank and financial holding companies and certain savings
and loan holding companies; and affiliates of IDIs upon application;
Fees and surcharges: Eligible institutions that remained in one or
both programs after the opt-out date (Dec. 5, 2008) became subject to
fees assessments as of Nov. 13, 2008;
Extensions: Mar. 17, 2009: FDIC announcement of DGP extension;
Aug. 26, 2009: FDIC announcement of first TAGP extension to June 30,
2010; Apr. 13, 2010: FDIC announcement of second TAGP extension by
interim rule to December 31, 2010, and potentially to the end of 2011.
Program: DGP;
Initial eligibility and coverage rules: Guarantee on newly issued
senior unsecured debt issued on Oct. 14, 2008, through June 30, 2009;
Covered debt included, but was not limited to;
* federal funds;
* promissory notes;
* commercial paper, and;
* unsubordinated unsecured notes;
Guarantees generally limited to 125 percent of senior unsecured debt
outstanding on Sept. 30, 2008, scheduled to mature before June 30,
2009. All eligible new debt issued up to this limit was required to
carry the FDIC guarantee.[A];
Fees and surcharges: Fees assessed on each TLGP-guaranteed debt
issuance by IDIs based on time to maturity (basis points per annum):
31-180 days: 50 181-364 days: 75 >=365 days: 100;
Extensions: Terms of DGP extension:
- Ability to issue guaranteed debt extended from June 30, 2009, to
Oct. 31, 2009;
- Guarantee expiration extended from June 30, 2012 to Dec. 31, 2012
for new debt;
Surcharges starting 4/1/09[B] (basis points per annum = bps);
10 bps if issued (20 bps for other participating entities) before June
30, 2009, and maturing in 1 year or more;
25 bps if issued (50 bps for other participating entities) under
extension (after June 30, 2009, or maturing after June 30, 2012).
Program: TAGP;
Initial eligibility and coverage rules: Extended deposit insurance to
non-interest-bearing transaction accounts until Dec. 31, 2009, for
amounts exceeding deposit insurance limit of $250,000;
Fees and surcharges: 10 basis points on quarter end balance of
eligible deposits over $250,000;
Extensions: Terms of first TAGP extension:
Extended coverage until June 30, 2010, if IDI did not opt out by Nov.
2, 2009;
Risk-based fees;
Starting on Jan. 1, 2010, risk-based assessment of 15, 20, or 25 basis
points.
Source: GAO analysis of TLGP regulations.
[A] FDIC has allowed institutions participating in DGP to issue
nonguaranteed debt under certain conditions.
[B] Surcharges collected under DGP extension are added to the deposit
insurance fund. Non-insured depository institutions have been required
to pay twice the surcharges shown for IDIs (that is, 20 basis points
or 50 basis points).
[End of table]
As of December 31, 2009, FDIC had collected $11.0 billion in TLGP fees
and surcharges and incurred claims of $6.6 billion on TLGP guarantees.
All of the claims to date, except for one $2 million claim under DGP,
have come from TAGP, under which FDIC has collected $639 million in
fees. Since the creation of TLGP, bank failures have been concentrated
among small banks (assets under $10 billion), which as a group have
not been significant participants in DGP. Although the high number of
small bank failures has resulted in higher-than-expected costs under
TAGP, FDIC officials still expect total TLGP fees collected to exceed
the costs of the program.[Footnote 22] At the end of the program, FDIC
will be permitted to account for any excess TLGP fees as income to the
deposit insurance fund.[Footnote 23] If a supportable and documented
analysis demonstrates that TLGP assets exceed projected losses, FDIC
may recognize income to the deposit insurance fund prior to the end of
the program. As noted earlier, in the event that TLGP results in
losses to the deposit insurance fund, FDIC would be required to
recover these losses through one or more special assessments.
FDIC Guarantees Lowered Certain Funding Costs and Some Indicators
Suggest Improvements in the Credit Markets:
Although isolating the impacts of TLGP on credit markets is difficult,
FDIC officials and some market participants have attributed positive
developments to the program. While being credited with helping to
improve market confidence in participating banks and other beneficial
effects, several factors complicate efforts to measure the impact of
this program on credit markets. For example, any changes in market
conditions attributed to TLGP could be changes that (1) would have
occurred without the program; (2) could be attributed to other policy
interventions, such as the actions of Treasury, the Federal Reserve,
or other financial regulators; or (3) have been enhanced or
counteracted by other market forces, such as the correction in housing
markets and revaluation of mortgage-related assets. Certain credit
market indicators, although imperfect, suggest general improvements in
credit market conditions since TLGP was launched in mid-October 2008.
For example, from October 13, 2008, to September 30, 2009, the cost of
interbank credit (LIBOR) declined by 446 basis points, and the TED
spread declined by 443 basis points. While these changes cannot be
attributed exclusively to TLGP, FDIC officials and other market
observers have attributed some benefits specifically to the debt and
deposit guarantees provided under TLGP. In March 2009, the FDIC
Chairman said that TLGP had been effective in improving short-term and
intermediate-term funding markets.[Footnote 24] In addition, FDIC
officials with whom we spoke said that although they do not track
outflows of deposits of transaction accounts covered under TAGP,
several institutions have told them that TAGP was helpful in stemming
such outflows.
[Side bar:
TLGP Extensions:
Since TLGP was created in October 2008, FDIC has extended both
components of the program. In March 2009, FDIC extended the final date
for new debt issuance under DGP from June 30, 2009, to October 31,
2009, and in August 2009, extended the TAGP for 6 months, through June
30, 2010. FDIC officials with whom we spoke said they consulted with
other regulators in determining that a separate systemic risk
determination was not required for these extensions. These officials
noted that economic conditions had improved at the time of the
extensions, but had not yet returned to precrisis conditions. FDIC
noted the need to ensure an orderly phase-out of TLGP assistance and
outlined certain higher fee requirements for institutions choosing to
continue participation past the original end dates. As part of the DGP
extension, FDIC established new surcharges beginning on April 1, 2009,
for certain debt issued prior to the original June 2009 deadline and
for all debt issued under the extension. In extending TAGP, FDIC
announced that eligible institutions not opting out of the 6-month
extension would be subject to higher fees based on the institution’s
risk category as determined by regulator assessments.
DGP concluded on October 31, 2009, for most entities participating in
the program. To further ensure an orderly phase-out of the program,
FDIC established a limited emergency guarantee facility through which
eligible entities (upon application and FDIC approval) could issue
guaranteed debt through April 30, 2010, subject to a minimum
annualized assessment of 300 basis points. In April 2010, FDIC’s Board
of Directors approved an interim rule to extend the TAGP until
December 31, 2010, and give the Board discretion to extend the program
to the end of 2011, if necessary.
End of side bar]
Moreover, some market observers have commented that FDIC's assumption
of risk through the debt guarantees enabled many institutions to
obtain needed funding at significantly lower costs. Eligible financial
institutions and their holding companies raised more than $600 billion
under DGP, which concluded on October 31, 2009, for most participating
entities. Notably, several large financial holding companies each
issued tens of billions of dollars of TLGP-guaranteed debt and most
did not issue senior unsecured debt outside DGP before April 2009.
[Footnote 25] Although determining the extent to which FDIC guarantees
lowered debt costs is difficult, a U.S. government guarantee
significantly reduces the risk of loss and accordingly, and would be
expected to substantially reduce the interest rate lenders charge for
TLGP-guaranteed funds. By comparing yields on TLGP-guaranteed debt to
yields on similar debt issued without FDIC guarantees, some market
observers have estimated that FDIC guarantees lowered the cost of
certain debt issues by more than 140 basis points. To the extent that
TLGP helped banking organizations to raise funds during a very
difficult period and to do so at substantially lower cost than would
otherwise be available, it may have helped improve confidence in
institutions and their ability to lend. However, some market observers
have expressed concern that the large volume of issuance under TLGP
could create difficulties associated with rolling over this debt in a
few years when much of this debt matures in a short time frame.
According to one financial analyst with whom we spoke, potential
difficulties associated with rolling over this debt could be mitigated
by any improvements in other funding markets, such as asset-backed
securitization markets.
FDIC Protection against Large Losses on Citigroup Assets Was Part of a
Package of Government Assistance Intended to Forestall a Resolution
with Potential Systemic Consequences:
In describing the basis for the third systemic risk determination,
Treasury, FDIC, and the Federal Reserve cited concerns similar to
those discussed in connection with the Wachovia determination. During
November 2008, severe economic conditions persisted despite new
Federal Reserve liquidity programs and the announcements of the
Treasury's Capital Purchase Program and FDIC's TLGP. Similar to
Wachovia, Citigroup had suffered substantial losses on mortgage-
related assets and faced increasing pressures on its liquidity as
investor confidence in the firm's prospects and the outlook for the
economy declined. On Friday, November 21, 2008, Citigroup's stock
price fell below $4, down from over $14 earlier that month. In their
memoranda supporting their recommendations for a systemic risk
determination, FDIC and the Federal Reserve expressed concern that
Citigroup soon would be unable to meet its funding obligations and
expected deposit outflows. FDIC concluded that the government funding
support otherwise available to Citigroup through the Federal Reserve's
lending programs such as the Commercial Paper Funding Facility and the
Primary Dealer Credit Facility and TLGP provided the firm with short-
term funding relief but would not be sufficient to help Citigroup
withstand the large deposit outflows regulators expected if confidence
in the firm continued to deteriorate.[Footnote 26]
Treasury, FDIC, and the Federal Reserve Concluded That a Least-Cost
Resolution of Citigroup's Insured Depository Institution Subsidiaries
Would Likely Exacerbate Market Strains:
As was the case with Wachovia, Treasury, FDIC, and the Federal Reserve
were concerned that the failure of a firm of Citigroup's size and
interconnectedness would have systemic implications. They determined
that resolving the company's insured institutions under the least-cost
requirements likely would have imposed significant losses on
Citigroup's creditors and on uninsured depositors, thus threatening to
further undermine confidence in the banking system. According to
Treasury, a least-cost resolution would have led to investor concern
about the direct exposures of other financial firms to Citigroup and
the willingness of U.S. policymakers to support systemically important
institutions, despite Treasury's recent investments in Citigroup and
other major U.S. banking institutions. In its recommendation to
Treasury, the Federal Reserve listed the banking organizations with
the largest direct exposures to Citigroup and estimated that the most
exposed institution could suffer a loss equal to about 2.6 percent of
its Tier 1 regulatory capital.[Footnote 27] Furthermore, Treasury,
FDIC, and the Federal Reserve were concerned that a failure of
Citigroup, which reported that it was well-capitalized (as did
Wachovia at the time of the first systemic risk determination), could
lead investors to reassess the riskiness of U.S. commercial banks more
broadly. In comparison to Wachovia, Citigroup had a much larger
international presence, including more than $500 billion of foreign
deposits--compared to approximately $30 billion for Wachovia. Given
Citigroup's substantial international presence, imposing losses on
uninsured foreign depositors under a least-cost framework could have
intensified global liquidity pressures and increased funding pressures
on other institutions with significant amounts of foreign deposits.
For example, this could have caused investors to raise sharply their
assessment of risks of investing in U.S. banking organizations, making
raising capital and other funding more difficult.
In addition to the potential serious adverse effects on credit
markets, Treasury, FDIC, and the Federal Reserve expressed concern
that a Citigroup failure could disrupt other markets in which
Citigroup was a major participant. Citigroup participated in a large
number of payment, settlement, and counterparty arrangements within
and outside the United States. The Federal Reserve expressed concern
that Citigroup's inability to fulfill its obligations in these markets
and systems could lead to widespread disruptions in payment and
settlement systems worldwide, with important spillover effects back to
U.S. institutions and other markets. Citigroup was a major player in a
wide range of derivatives markets, both as a counterparty for over-the-
counter trades and as a broker and clearing firm for trades on
exchanges. If Citigroup had failed, many of the firm's counterparties
might have faced difficulties replacing existing contracts with
Citigroup, particularly given concerns about counterparty credit risk
at the time.
Treasury, FDIC, and the Federal Reserve determined that FDIC
assistance under the systemic risk exception, which would complement
other U.S. federal assistance and TARP programs, would promote
confidence in Citigroup. Specifically, they determined that if the
systemic risk exception were invoked, FDIC could provide guarantees
that would help protect Citigroup from outsize losses on certain
assets and thus reduce investor uncertainty regarding the potential
for additional losses to weaken Citigroup. In addition, such actions
could help to reassure depositors and investors that the U.S.
government would take necessary actions to stabilize systemically
important U.S. banking institutions.
Assistance to Citigroup Included a Loss-Sharing Agreement and Capital
Infusion Intended to Restore Confidence and Promote Financial
Stability:
On November 23, 2008, Treasury, FDIC, and the Federal Reserve
announced a package of assistance to Citigroup, including a loss-
sharing agreement on a fixed pool of Citigroup's assets, to help
restore confidence in the firm and maintain financial stability.
[Footnote 28] By providing protection against large losses on these
assets, regulators hoped to promote confidence among creditors and
depositors providing liquidity to the firm to avert a least-cost
resolution with potential systemic risk consequences. In particular,
the loss-sharing agreement limited the potential losses Citigroup
might suffer on a fixed pool of approximately $300 billion of loans
and securities backed by residential and commercial real estate and
other such assets. Under the final agreement executed on January 15,
2009, Citigroup agreed to absorb the first $39.5 billion in losses
plus 10 percent of any remaining losses incurred. Ninety percent of
covered asset losses exceeding $39.5 billion would be borne by
Treasury and FDIC, with maximum guarantee payments capped at $5
billion and $10 billion, respectively. In addition, if all of these
loss protections were exhausted, the Federal Reserve Bank of New York
committed to allow Citigroup to obtain a nonrecourse loan equal to the
aggregate value of the remaining covered asset pool, subject to a
continuing 10 percent loss-sharing obligation of Citigroup. Citigroup
issued FDIC and Treasury approximately $3 billion and $4 billion of
preferred stock, respectively, for bearing the risk associated with
the guarantees.[Footnote 29] The Federal Reserve loan, if extended,
would have borne interest at the overnight index swap rate plus 300
basis points. Citigroup also received a $20 billion capital infusion
from the TARP's Targeted Investment Program, in addition to the
initial $25 billion capital infusion received from TARP's Capital
Purchase Program in October 2008. In addition, the agreement subjected
Citigroup to specific limitations on executive compensation and
dividends during the loss share period.[Footnote 30]
FDIC Assistance May Have Helped to Ensure Continued Access to Funding
for Citigroup:
Isolating the impact of FDIC assistance to Citigroup is difficult, but
according to Treasury and FDIC, the package of assistance provided by
regulators may have helped to allow Citigroup to continue operating by
encouraging private sector sources to continue to provide liquidity to
Citigroup during the crisis. According to one FDIC official, one
measure of success was that Citigroup could do business in Asia the
business day following the announcement. With the package of
assistance, regulators hoped to improve the confidence of creditors
and certain depositors, facilitating Citigroup's funding. Changes in
the market's pricing of Citigroup's stock and its default risk, as
measured by credit default swap spreads, indicate that the November
23, 2008, announcement boosted market confidence in the firm, at least
temporarily. From a closing price of $3.77 on Friday, November 21,
2008, Citigroup's common stock price rose 58 percent on Monday,
November 24 and more than doubled by the end of the week. However,
market confidence in Citigroup fell sharply again in early 2009 before
the company's stock price recovered and stabilized in spring 2009.
On December 23, 2009, Citigroup announced that it had reached an
agreement with FDIC, the Federal Reserve Bank of New York, and
Treasury to terminate the loss-sharing and residual financing
agreement.[Footnote 31] As part of the termination agreement,
Citigroup agreed to pay a $50 million termination fee to the Federal
Reserve. As of September 30, 2009, Citigroup reported that it had
recognized $5.3 billion of losses on the pool of assets covered by the
loss-sharing agreement. These losses did not reach the thresholds that
would trigger payments by Treasury or FDIC. In July 2009, the Special
Inspector General for the Troubled Asset Relief Program (SIGTARP)
announced plans to audit the asset guarantees provided to Citigroup.
According to SIGTARP, this audit is to examine why the guarantees were
provided, how the guaranteed assets were structured, and whether
Citigroup's risk controls were adequate to prevent government losses.
At the close of this review, the SIGTARP review was ongoing.
Systemic Risk Determinations and Related Federal Assistance Raise
Concerns about Moral Hazard and Market Discipline That May Be
Addressed by Potential Regulatory Reforms:
While the systemic risk determinations and associated federal
assistance may have helped to contain the crisis by mitigating
potential systemic adverse effects, they may have induced moral hazard--
encouraging market participants to expect similar emergency actions in
future crises, thereby weakening their incentives to properly manage
risks and also creating the perception that some firms are too big to
fail. Federal assistance required for large and important
institutions, such as non-bank holding companies, whose activities
could affect the financial system, also highlighted gaps in the
current regulatory regime, including inconsistent supervision and
regulatory standards and lack of resolution authority for these
institutions. Regulators, the Administration and Congress currently
are considering financial regulatory reform proposals that could help
address these concerns. Reforms that would enhance the supervision of
financial institutions--particularly large financial holding
companies--whose market discipline is likely to have been weakened by
the recent exercises of the systemic risk exceptions are essential.
Federal Assistance Could Exacerbate Moral Hazard and Reduce Potential
for Market Discipline Particularly for the Largest U.S. Financial
Institutions:
While the federal assistance authorized by the systemic risk
determinations may have helped to contain the financial crisis by
mitigating potential adverse systemic effects that would have resulted
from traditional FDIC assistance, they may have exacerbated moral
hazard, particularly for large financial institutions. According to
regulators and some economists, the expansion of deposit insurance
under TAGP, in which most insured depository institutions of all sizes
participated, could weaken incentives for newly protected, larger
depositors to monitor their banks, and in turn banks may be more able
to engage in riskier activities. According to some economists, the
higher the deposit insurance guarantee, the greater the risk of moral
hazard. In principle, deposit insurance helps prevent bank runs by
small depositors, while lack of insurance encourages (presumably
better informed) large depositors to protect their deposits by
exerting discipline on risk taking by banks.
Unlike the broad participation in TAGP, the majority of institutions
that participate in DGP are large financial institutions. In addition,
according to FDIC data, most of the senior unsecured debt under DGP
has been issued by the largest U.S. financial institutions. Market
observers with whom we spoke said that small banks did not participate
in DGP as generally they primarily rely on deposits for funding. The
bank debt guarantees, according to some economists, allow large
financial institutions to issue debt without regard for differences in
their risk profiles and can weaken the incentives for creditors to
monitor bank performance and exert discipline against excessive risk
taking for these institutions. In general, some economists said that
to help mitigate moral hazard, it is important to specify when the
extra deposit insurance and debt guarantee programs will end. Further,
while recognizing that uncertainty about the duration of the crisis
makes it difficult to specify timetables for phasing out guarantees,
some economists said it is important to provide a credible "exit
strategy" to prevent further disruption in the financial markets when
withdrawing government guarantees. In addition, some economists noted
that while government guarantees can be withdrawn once the crisis
abates, a general perception may persist that a government guarantee
always will be made available during a crisis--thus perpetuating the
risk for moral hazard.
Similarly, while the assistance to open banks authorized by the
systemic risk determinations may have helped to contain the crisis by
stabilizing the large and other financial institutions and mitigating
potential systemic adverse effects, it also may have exacerbated moral
hazard. According to regulators and market observers, assistance to
open banks may weaken the incentives of large uninsured depositors,
creditors, and investors to discipline large complex financial
institutions deemed too big to fail. Federal Reserve Chairman Bernanke
stated in March 2009 to the Council on Foreign Relations that the
belief of market participants that a particular institution is
considered too big to fail has many undesirable effects. He explained
such perceptions reduce market discipline, encourage excessive risk
taking by the firm, and provide artificial incentives for firms to
grow. He also noted these beliefs can create an unlevel playing field,
in which smaller firms may not be regarded as having implicit
government support. Similarly, others have noted how such perceptions
may encourage risk taking--for example, that large financial
institutions are given access to the credit markets at favorable terms
without consideration of the institutions' risk profile because
creditors and investors believe their credit exposure is reduced since
they believe the government will not allow these firms to fail.
Limitations in Financial Regulatory Framework Restrict Regulators'
Ability to Mitigate Impact of Weakened Incentives but Some Reform
Proposals May Help Address These Concerns:
Although regulators' use of the systemic risk exception may weaken
incentives of institutions to properly manage risk, the financial
regulatory framework could serve an important role in restricting the
extent to which they engage in excessive risk-taking activities as a
result of weakened market discipline. Responding to the recent
financial crisis, recent actions by the Federal Reserve as well as
proposed regulatory reform and new FDIC resolution authority could
help address concerns raised about the potential conduct ( to monitor
and control risks) of institutions receiving federal assistance or
subject to the systemic risk determinations.
Enhanced Supervision of Systemically Important Institutions:
In an effort to mitigate moral hazard and weakened market discipline
for large complex financial institutions including those that received
federal assistance, regulators, the administration, and Congress are
considering regulatory reforms to enhance supervision of these
institutions. These institutions not only include large banks but also
nonbank institutions. In the recent crisis, according to a testimony
by FDIC Chairman Bair, bank holding companies and large nonbank
affiliates have come to depend on the banks within their organizations
as a source of funding.[Footnote 32] Bank holding companies must,
under Federal Reserve regulations, serve as the source of strength for
their insured institution subsidiaries. Subject to the limits of
sections 23A and 23B of the Federal Reserve Act, however, bank holding
companies and their nonbank affiliates may rely on the depository
institution for funding. Also, according to regulators, institutions
that were not bank holding companies (such as large thrift holding
companies, investment banks, and insurance organizations) were
responsible for a disproportionate share of the financial stress in
the markets in the past 2 years and the lack of a consistent and
coherent regulatory regime for these institutions helped mask problems
until they were systemic and gaps in the regulatory regime constrained
the government's ability to deal with them once they emerged.
Legislation has been proposed to create enhanced supervision and
regulation for any systemically important financial institution,
regardless of whether the institution owns an insured depository
institution. The proposals would establish a council chaired by the
Secretary of the Treasury with voting members comprising the chairs of
the federal financial regulators which would oversee systemic risk and
help identify systemically important companies. An institution could
be designated "systemically important" if material financial distress
at the firm could threaten financial stability or the economy.
Systemically important institutions would be regulated by the Federal
Reserve under enhanced supervisory and regulatory standards and
stricter prudential standards.[Footnote 33]
Regulators and market observers generally agree that these
systemically important financial institutions should be subject to
progressively tougher regulatory standards to hold adequate capital
and liquidity buffers to reflect the heightened risk they pose to the
financial system. They also generally agree that systemically
important firms should face additional capital charges based both on
their size and complexity.[Footnote 34] Such capital charges (and
perhaps also restrictions on leverage and the imposition of risk-based
insurance premiums on systemically important or weak insured
depository institutions and risky activities) could help ensure that
institutions bear the costs of growth and complexity that raise
systemic concerns. Regulators and market observers believe that
imposing systemic risk regulation and its associated safeguards will
strengthen the ability of these firms to operate in stressed
environments while the associated costs can provide incentives to
firms to voluntarily take actions to reduce the risks they pose to the
financial system. Under legislative proposals, these institutions also
would be subject to a prompt corrective action regime that would
require the firm or its supervisors to take corrective actions as the
institutions' regulatory capital level or other measures of financial
strength declined, similar to the existing prompt corrective action
regime for insured depository institutions under the FDI Act.
Regulators also are considering regulatory reforms to improve the
overall risk management practices of systemically important
institutions. The Federal Reserve has proposed standards for
compensation practices across all banking organizations it supervises
to encourage prudent risk taking by creating incentives focusing on
long-term rather than short-term performance.[Footnote 35] Regulators
noted that compensation practices that create incentives for short-
term gains may overwhelm the checks and balances meant to mitigate
excessive risk taking.[Footnote 36] In its proposal for financial
regulatory reform, Treasury recommended that systemically important
financial institutions be expected to put in place risk management
practices commensurate with the risk, complexity, and scope of their
operations and be able to identify firmwide risk concentrations (such
as credit, business lines, liquidity) and establish appropriate limits
and controls around these concentrations. Also, under Treasury's
proposal, to measure and monitor risk concentrations, these
institutions would be expected to be able to identify and report
aggregate exposures quickly on a firmwide basis.
Regulators also have indicated the need for measures to improve their
oversight of risk management practices by these institutions. In our
prior work on regulatory oversight of risk management at selected
large institutions, we found that oversight of institutions' risk
management systems before the crisis illustrated some limitations of
the current regulatory system.[Footnote 37] For example, regulators
were not looking across groups of institutions to effectively identify
risks to overall financial stability. In addition, primary,
functional, and holding company regulators faced challenges
aggregating certain risk exposures within large, complex financial
institutions. According to testimony by a Federal Reserve official,
the recent crisis highlighted the need for a more comprehensive and
integrated assessment of activities throughout bank holding companies--
a departure from the customary premise of functional regulation that
risks within a diversified organization can be managed properly
through supervision focused on individual subsidiaries within the
firm.[Footnote 38] Accordingly, the bank supervisors, led by the
Federal Reserve, recently completed the Supervisory Capital Assessment
Program, which reflects some of the anticipated changes in the Federal
Reserve's approach to supervising the largest banking organizations.
The Supervisory Capital Assessment Program involved aggregate analyses
of the 19 largest bank holding companies, which according to Federal
Reserve testimony, accounted for a majority of the assets and loans
within the financial system.[Footnote 39] Bank supervisors evaluated
on a consistent basis the expected performance of these firms under
baseline and more-adverse-than-expected scenarios, drawing on
individual firm information and using independently estimated
outcomes.[Footnote 40] In addition, according to the agency's
officials, the Federal Reserve is creating an enhanced quantitative
surveillance program for the largest and most complex firms, that will
use supervisory information, firm-specific data analysis, and market-
based indicators to identify emerging systemic risks as well as risks
to specific firms.
Some economists argue that a formal designation of systemically
important institutions would have significant, negative competitive
consequences for other firms and could encourage designated firms to
take excessive risk because they would be perceived to be too big to
fail. Instead some argue that a market stability regulator should be
authorized to oversee all types of financial markets and all financial
services firms, whether otherwise regulated or unregulated. Market
observers also point out factors that complicate such determinations
and make maintaining an accurate list of such institutions difficult.
Aside from asset size and degree of leverage, they include degree of
interconnectivity to other financial institutions, risks of activities
in which they engage, nature of compensation practices, and degree of
concentration of financial assets and activities. Moreover,
maintaining a list would require regular monitoring in order to ensure
the list was kept up to date, and some risky institutions would likely
go unidentified, at least for a time. Such designation also would
likely depend on factors outside the firm, such as economic and
financial conditions. However, supervisors would presumably be doing
much of the monitoring activity regardless of the existence of a
public list, and they would have to establish standards, including
assumptions regarding the economic and financial circumstances assumed
when making such designations. It is important for Congress and
regulators to subject systemically important institutions to stricter
regulatory requirements and oversight in order to restrict excessive
risk-taking activities as a result of weakened market discipline
particularly after the use of federal assistance during the crisis to
stabilize such institutions.
Resolution Authority for Systemically Important Institutions:
The recent crisis also highlighted how a lack of a resolution
authority for failing bank holding companies including those subject
to the systemic risk determinations as well as nonbank financial firms
such as Bear Stearns, Lehman Brothers, and American International
Group, Inc. (AIG), complicated federal government responses. For
example, regulators invoked the systemic risk exception to assist bank
holding companies and savings and loan holding companies to prevent
systemic disruptions in the financial markets and provided emergency
funding to AIG, and in doing so potentially contributed to a weakening
of incentives at these institutions and similarly situated large
financial institutions to properly manage risks.[Footnote 41]
According to regulators, the lack of a resolution authority for
systemically important institutions also contributes to a belief by
market participants that the government will not allow these
institutions to fail and thereby weakens market discipline. Proposals
for consideration by Congress include providing federal resolution
authority for large financial holding companies deemed systemically
important. One purpose of this authority would be to encourage greater
market discipline and limit moral hazard by forcing market
participants to realize the full costs of their decisions. In order to
achieve its intended purpose, the use of a new resolution authority
must be perceived by the market to be credible. The authority would
need to provide for a regime to resolve systemically important
institutions in an orderly manner when the stability of the financial
system is threatened. As noted in our prior work, a regulatory system
should have adequate safeguards that allow financial institution
failures to occur while limiting taxpayers' exposure to financial risk
while minimizing moral hazard.[Footnote 42]
Regulators and market observers generally agree that a credible
resolution authority to resolve a distressed systemically important
institution in an orderly manner would help to ensure that no bank or
financial firm would be too big to fail. Such authority would
encourage market discipline if it were to provide for the orderly
allocation of losses to risk takers such as shareholders and unsecured
creditors, and allow for the replacement of senior management. It also
should help to maintain the liquidity and key activities of the
organization so that the entity could be resolved in an orderly
fashion without disrupting the functioning of the financial system.
Unlike the statutory powers that exist for resolving insured
depository institutions, the current bankruptcy framework available to
resolve large complex nonbank financial entities and financial holding
companies was not designed to protect the stability of the financial
system. Without a mechanism to allow for an orderly resolution for a
failure of a systemically important institution, failures of such
firms could lead to a wider panic as indicated by the problems
experienced after the failure of such large financial companies as
Lehman Brothers, and near failures of Bear Stearns and AIG.
Proposed new authority for resolution of a systemically important
failing institution would provide for a receiver to resolve the
institution in an orderly way. Government assistance such as loans,
guarantees, or asset purchases would be available only if the
institution is in government receivership. The receiver would have
authority to operate the institution, enforce or repudiate its
contracts, and pay its claims as well as remove senior management. In
addition, shareholders and creditors to the firm would absorb first
losses in the resolution. However, imposing losses on unsecured debt
investors of large, interconnected, and systemically important firms
might be inconsistent with maintaining financial stability during a
crisis. In particular, faced with the potential failures of Wachovia
and Citigroup, Treasury, FDIC, and the Federal Reserve concluded that
the exercise of authority under the systemic risk exception was
necessary because the failure of these firms would have imposed large
losses on creditors and threatened to undermine confidence in the
banking system. An effective resolution authority must properly
balance the need to encourage market discipline with the need to
maintain financial stability, in particular in a crisis scenario. One
market observer argued that no such losses would be taken immediately
by creditors because the objective of the resolution authority is to
prevent a disorderly failure in which such creditors suffer immediate
losses. Therefore an appropriate degree of flexibility would mean that
some of an institution's creditors might be protected, at least to
some extent, against losses where doing so would be necessary to
protect the stability of the financial system. Other features of the
resolution authority would continue to promote market discipline even
if some credit obligations were honored, because shareholders and
senior management would still suffer losses. A regulatory official
stated that the intertwining of functions among an institution's
affiliates can present significant issues when winding down the
institution and recommended requirements that mandate greater
functional autonomy of holding company affiliates.[Footnote 43] In
addition, some economists and market observers also have recommended
that regulators break up large institutions in resolution to limit a
continuation of too-big-to-fail problems. That is, when a regulator
assumes control of a troubled important financial institution, it
should make reasonable efforts to break up the institution before
returning it to private hands or to avoid selling it to another
institution when the result would create a new systemically important
institution. It is important for Congress and regulators to establish
a credible resolution process to allow for an orderly resolution of a
failed systemically important institution thereby helping to ensure
that no bank or financial firm would be too big to fail.
Conclusions:
The recent financial crisis underscored how quickly liquidity can
deteriorate at a financial institution. As a result, regulators'
deliberations about whether to invoke the systemic risk exception
often occurred under severe time constraints. Treasury, FDIC, and the
Federal Reserve collaborated prior to making announcements intended to
reassure the markets, but the lack of a determination after two of
these announcements of planned FDIC assistance under the systemic risk
exception heightened the risk that such actions will be undertaken
without appropriate transparency and accountability. Specifically,
such an announcement signals regulators' willingness to provide
assistance and may give rise to moral hazard. However, in cases where
Treasury does not make a determination, FDI Act requirements for
communication and documentation do not apply. Therefore, when a
determination is not made along with the announced actions, Congress
cannot be assured that Treasury's reasoning would be open to the same
scrutiny required in connection with a formal systemic risk
determination. Furthermore, uncertainty in these situations can arise
because there is no requirement for Treasury to communicate that it
will not make a systemic risk determination for an announced action.
Our review of Treasury's systemic risk determinations highlights that
the announced FDIC actions were made to reduce strains on the
deteriorating markets and to promote confidence and stability in the
banking system. Regarding the systemic risk determinations, the
regulators concluded that resolving the depository institutions at
issue under the traditional least-cost approach would have worsened
adverse conditions in the economy and in the financial system. While
it is difficult to isolate the impact of those actions from other
government assistance, the actions seem to have reassured investors
and depositors at the particular banks and encouraged them to continue
to provide liquidity, thereby allowing the banks to keep operating. In
the case of TLGP, some regulators and market observers have attributed
short-term benefits to FDIC guarantees on certain debt obligations,
citing improved cost and availability of credit for many institutions.
However, with respect to TLGP determination, some have noted that
under a possible reading of the systemic risk exception, the statute
may authorize assistance only to particular institutions based on
those institutions' specific problems, not systemic risk assistance
based on problems affecting the banking industry as a whole. Treasury,
FDIC, and the Federal Reserve considered this and other legal issues
in recommending and making TLGP determination. The agencies believe
the statute could have been drafted more clearly and that it can be
interpreted in different ways. They concluded, however, that under a
permissible interpretation, assistance may be based on industry-wide
concerns. They also concluded that a systemic risk determination
waives all of the normal statutory restrictions on FDIC assistance and
then creates new authority to provide assistance, both as to the types
of aid that may be provided and the entities that may receive it.
Under this reading, the agencies believe the statutory criteria were
met in the case of TLGP and that the assistance was authorized. We
examined these issues as part of our review of the basis of the
systemic risk determinations made to date. We found there is some
support for the agencies' position that the exception authorized
systemic risk assistance of some type under TLGP facts, as well as for
their position that the exception permits assistance to the entities
covered by this program. There are a number of questions concerning
these interpretations, however. For example, the agencies agree that
some of the statutory provisions are ambiguous. Because application of
the systemic risk exception raises novel legal and policy issues of
significant public interest and importance, and because of the need
for clear direction to the agencies in a time of financial crisis, the
requirements and assistance authorized under the systemic risk
exception may require clarification by Congress.
Systemic risk assistance also raises long-term concerns about moral
hazard and weakened market discipline, particularly for large complex
financial institutions. This involves a trade-off between the short-
term benefits to markets, the economy, and business and households of
federal action and the long-term effects of any federal action on
market discipline. While the financial regulatory framework can serve
an important role in restricting excessive risk-taking activities as a
result of weakened market discipline, the financial crisis revealed
limitations in this framework. In particular, these limitations
include inconsistent oversight of large financial holding companies
(bank versus nonbank). Another limitation was a weakness in the risk
management practices of these companies. Legislators and regulators
currently are considering regulatory proposals to subject systemically
important institutions, including those whose market discipline is
likely to have been weakened by the recent exercises of the systemic
risk exception, to stricter regulatory standards such as higher
capital and stronger liquidity and risk management requirements.
Furthermore, according to regulators, the lack of resolution authority
for systemically important institutions contributes to a belief by
market participants that the government will not allow these
institutions to fail and thereby weakens incentives for market
participants to monitor the risks posed by these institutions.
Legislation has been proposed to expand resolution authority to large
financial holding companies deemed systemically important that is
intended to impose greater market discipline and limit moral hazard by
forcing market participants to face significant costs from their risk-
taking decisions. It is important for the use of a new resolution
authority to be perceived by the market to be credible for it to help
achieve the intended effects.
Matters for Congressional Consideration:
To help ensure transparency and accountability in situations where
FDIC, the Federal Reserve, and Treasury publicly announce intended
emergency actions but Treasury does not make a systemic risk
determination required to implement them, Congress should consider
requiring Treasury to document and communicate to Congress the
reasoning behind delaying or not making a determination.
Recent application of the systemic risk exception raises novel legal
and policy issues, including whether the exception may be invoked
based only on the problems of particular institutions or also based on
problems of the banking industry as a whole, and whether and under
what circumstances assistance can be provided to "healthy"
institutions, bank holding companies, and other bank affiliates.
Because these issues are of significant public interest and
importance, as Congress debates the modernization and reform of the
financial regulatory system, Congress should consider enacting
legislation clarifying the requirements and assistance authorized
under the systemic risk exception. Enacting more explicit legislation
would provide legal clarity to the banking industry and financial
community at large, as well as helping to ensure ultimate
accountability to taxpayers.
As Congress contemplates reforming the financial regulatory system,
Congress should ensure that systemically important institutions
receive greater regulatory oversight. This could include such things
as more consistent and enhanced supervision of systemically important
institutions and other regulatory measures, such as higher capital
requirements and stronger liquidity and risk management requirements
and a resolution authority for systemically important institutions to
mitigate risks to financial stability.
Agency Comments and Our Evaluation:
We provided a draft of this report to the Federal Reserve, FDIC and
Treasury for their review and comment. The Federal Reserve and
Treasury provided us with written comments. These comments are
summarized below and reprinted in appendixes III and IV, respectively.
FDIC did not provide written comments. We also received technical
comments from the Federal Reserve, FDIC, and Treasury that we have
incorporated in the report where appropriate.
In its comments, the Federal Reserve agreed with our findings that
while the agencies' actions taken under the systemic risk exception
were important components of the response by the government to the
financial crisis, these actions have the potential to increase moral
hazard and reinforce perceptions that some firms are too big to fail.
In order to mitigate too big to fail and risks to financial stability,
the Federal Reserve stated that it agrees with our matter for
Congressional consideration that all systemically important financial
institutions be subject to stronger regulatory and supervisory
oversight and that a resolution system be put in place that would
allow the government to manage the failure of these firms in an
orderly manner.
Treasury also commented that it agreed with our findings and our
matter for Congressional consideration for greater regulatory
oversight of the largest, most interconnected financial firms and
resolution authority to wind down failing nonbank financial firms in a
manner that mitigates the risks that their failure would pose to
financial stability and the economy.
We are sending copies of this report to the Chairman of the Board of
Governors of the Federal Reserve System; the Chairman of FDIC; the
Secretary of the Treasury; and other interested parties. In addition,
the report will be available at no charge on GAO's Web site at
[hyperlink, http://www.gao.gov].
If you or your staff have any questions regarding this report, please
contact me at (202) 512-8678 or williamso@gao.gov. Contact points for
our Offices of Congressional Relations and Public Affairs may be found
on the last page of this report. GAO staff who made major
contributions to this report are listed in appendix V.
Signed by:
Orice Williams Brown:
Director, Financial Markets and Community Investment:
[End of section]
Appendix I: Objectives, Scope, and Methodology:
To describe the steps taken by the Federal Deposit Insurance
Corporation (FDIC) and the Board of Governors of the Federal Reserve
System (Federal Reserve) to make the recommendations and the
Department of the Treasury (Treasury) to make determinations in some
cases, we reviewed documentation of recommendations that FDIC and the
Federal Reserve made for Wachovia, the Temporary Liquidity Guarantee
Program (TLGP), Citigroup, Bank of America, and the Public-Private
Investment Programs proposed Legacy Loans Program (LLP) as well as
documentation of Treasury's determination for Wachovia, TLGP, and
Citigroup. We also reviewed press releases by the agencies announcing
the respective intended actions. In addition, to gain an understanding
of how the agencies collaborated prior to the announcements of
emergency actions, we interviewed officials from Treasury, FDIC, and
the Federal Reserve. We also spoke with these officials about the
status of emergency actions that were announced, but did not result in
a systemic risk determination by Treasury. Finally, we reviewed the
Federal Deposit Insurance Act (FDI Act) requirements for transparency
and accountability with respect to the use of the systemic risk
provision and analyzed the implications of announcements that are not
followed by a Treasury determination that would trigger these
requirements.
To describe the basis for each determination and the purpose of
actions taken pursuant to each determination we reviewed and analyzed
documentation of Treasury's systemic risk determinations and the
supporting recommendations that FDIC and the Federal Reserve made for
Wachovia, TLGP, and Citigroup. We interviewed officials from Treasury,
FDIC, the Federal Reserve, and the Office of the Comptroller of the
Currency (OCC) to gain an understanding of the basis and authority for
each determination and the purpose of the actions taken under each
determination. We also interviewed three economists, one banking
industry association, and a banking analyst. In addition, we collected
and analyzed various data to illustrate financial and economic
conditions at the time of each determination and the actions taken
pursuant to each determination.
We examined whether the legal requirements for making the systemic
risk determination with respect to TLGP were met and whether the
assistance provided under that program was authorized under the
systemic risk exception.[Footnote 44] For this legal analysis, we
reviewed and analyzed the FDI Act, its legislative history including
the Federal Deposit Insurance Corporation Improvement Act (FDICIA),
and other relevant legislation. We reviewed FDIC regulations and
policy statements as well as written background material prepared by
the agencies. We obtained the legal views of Treasury, FDIC, and the
Federal Reserve on the agencies' legal authority to establish TLGP,
and also obtained the views of banking law specialists in private
practice and academia on these issues.
In describing the likely effects of each determination on the
incentives and conduct of insured depository institutions and
uninsured depositors, as well as assessing proposals to mitigate moral
hazard created by such federal assistance, we reviewed and analyzed
the research reports of one credit rating agency, Congressional
testimonies of regulators and market observers, proposed legislation,
and academic studies. We interviewed officials from Treasury, FDIC,
the Federal Reserve, and OCC as well as one academic, and three market
observers to gain an understanding of how each determination and
action impact the incentives and conduct of insured depository
institution and uninsured depositors. Finally, we reviewed prior GAO
work on the financial regulatory system.
We conducted this performance audit from October 2008 to April 2010 in
accordance with generally accepted government auditing standards.
Those standards require that we plan and perform the audit to obtain
sufficient, appropriate evidence to provide a reasonable basis for our
findings and conclusions based on our audit objectives. We believe
that the evidence obtained provides a reasonable basis for our
findings and conclusions based on our audit objectives.
[End of section]
Appendix II: Analysis of Legal Authority for the Temporary Liquidity
Guarantee Program (TLGP):
Introduction and Summary of Conclusions:
As part of our review of the basis of the systemic risk determinations
made to date under the Federal Deposit Insurance Act's ("FDI Act")
systemic risk exception, we examined whether the legal requirements
for making such determinations were met with respect to the Temporary
Liquidity Guarantee Program ("TLGP") and whether the assistance
provided under that program was authorized under the exception. We
note that the recent financial crisis is the first time that Treasury,
FDIC, and the Federal Reserve ("the agencies") have relied on the
exception since its enactment as part of the Federal Deposit Insurance
Corporation Improvement Act ("FDICIA") in 1991, and that no court to
date has ruled on when or how the exception may be used.[Footnote 45]
We also acknowledge the volatile economic circumstances under which
the agencies created TLGP.
The agencies believe that while the statute could have been drafted
more clearly and that it can be interpreted in different ways, under a
permissible interpretation, a systemic risk determination may be based
on adverse circumstances affecting the banking industry as a whole--
the situation that prompted creation of TLGP--as well as on adverse
circumstances of one or more particular banking institutions. The
agencies also believe a systemic risk determination waives all of the
normal statutory restrictions on FDIC assistance, as well as creating
new authority to provide assistance, both as to the types of aid that
may be provided and the entities that may receive it. Under this
reading, the agencies believe that the statutory criteria were met in
the case of TLGP and that the assistance was authorized.
We agree there is some support for the agencies' position that the
statute authorizes systemic risk assistance of some type under TLGP
facts, as well as for their position that the exception permits
assistance to the entities covered by TLGP. There are a number of
questions concerning these interpretations, however. In the agencies'
view, for example, some of the statutory provisions are ambiguous.
What is clear, however, is that the systemic risk exception overrides
important statutory restrictions designed to minimize costs to the
Deposit Insurance Fund, and, in the case of TLGP, that the agencies
used it to create a broad-based program of direct FDIC assistance to
institutions that had never before received such relief--"healthy"
banks, bank holding companies, and other bank affiliates. Because
these novel legal issues are matters of significant public interest
and importance, and because of the need for clear direction to the
agencies in a time of financial crisis, we recommend that Congress
consider enacting legislation clarifying the requirements and the
assistance authorized under the exception.[Footnote 46]
Background on FDIC's Statutory Authority to Use the Deposit Insurance
Fund:
As described in greater detail in this report, TLGP provided direct
assistance, backed by FDIC's Deposit Insurance Fund, both to insured
depository institutions and to their holding companies and other bank
affiliates. The FDI Act normally permits Deposit Insurance Fund-
supported assistance only to insured depository institutions, however,
and allows assistance to operating ("open") insured depository
institutions (so-called "open bank assistance") only in three
situations, and then only by certain means. As specified in section
13(c) of the FDI Act:
"(c) Assistance to insured depository institutions:
"(1) [The FDIC] is authorized ...to make loans to, to make deposits
in, to purchase the assets or securities of, to assume the liabilities
of, or to make contributions to, any insured depository institution--:
"(A) if such action is taken to prevent the default of such insured
depository institution;
"(B) if, with respect to an insured bank in default, such action is
taken to restore such insured bank to normal operation; or:
"(C) if, when severe financial conditions exist which threaten the
stability of a significant number of insured depository institutions
or of insured depository institutions possessing significant financial
resources, such action is taken in order to lessen the risk to the
[FDIC] posed by such insured depository institution under such threat
of instability."
12 U.S.C. § 1823(c)(1)(A)-(C).
The FDI Act contains a number of additional restrictions on when and
how the FDIC may use Deposit Insurance Fund monies:
First, before FDIC may provide assistance to an open bank, FDI Act
section 13(c)(8) normally requires it to make a formal determination
that the bank is in "troubled condition" under specific
undercapitalization and other criteria and that the bank meets other
requirements. FDIC must publish notice of any such determination in
the Federal Register.[Footnote 47]
Second, if FDIC decides to provide assistance, the assistance normally
must meet so-called "least-cost requirements" in FDI Act section
13(c)(4). Section 13(c)(4)(A) requires FDIC to determine, using
financial data about a specific institution, that the proposed
assistance is necessary to meet FDIC's deposit-insurance obligations
with respect to the institution's insured deposits and is the least
costly of all possible methods of meeting those obligations.[Footnote
48] Section 13(c)(4)(E) prohibits FDIC from providing assistance to
creditors or non-insured depositors of the institution if doing so
would increase losses to the Fund beyond those that otherwise might
result from protecting insured depositors.[Footnote 49]
Third, FDI Act section 11(a)(4)(C) normally prohibits FDIC from using
the Fund to benefit affiliates or shareholders of an assisted
depository institution in any way, regardless of whether such
assistance would cause a loss to the Fund.[Footnote 50]
The agencies believe, however, that if Treasury makes an emergency
determination under the systemic risk exception, this waives all of
the foregoing requirements and also creates new authority to provide
any type of assistance to any type of entity, as long as the
assistance is deemed necessary to avoid or mitigate systemic risk.
Specifically, the words of the statute require Treasury to determine:
(i) that "compliance with subparagraphs (A) and (E) [the least-cost
requirements] with respect to an insured depository institution would
have serious adverse effects on economic conditions or financial
stability"; and (ii) that "any action or assistance under . . . [the
exception] would avoid or mitigate" such effects. If Treasury makes
this determination, the FDIC may then "take other action or provide
assistance under this section as necessary to avoid or mitigate such
effects." The statute imposes significant deliberative and
consultative requirements on the process for making such a
determination: it must be made by the Secretary of the Treasury; the
Secretary must receive written recommendations from both the FDIC
Board of Directors and the Federal Reserve Board of Governors, each
made pursuant to at least a two-thirds vote; and the Secretary must
consult with the President.[Footnote 51]
The Agencies' Reliance on the Systemic Risk Exception to Create TLGP:
The agencies agree that without Treasury's systemic risk determination
for TLGP in October 2008, the above statutory restrictions would have
prohibited FDIC assistance to most of TLGP recipients, either because
the entities would not have met the statutory "troubled condition
criteria" for open banks (in the case of many TLGP participants) or
because they were bank holding companies or other affiliates of
insured depository institutions for which FDIC assistance normally is
unavailable. The agencies clearly followed the requisite process in
issuing the determination: FDIC and the Federal Reserve both submitted
unanimous written recommendations in favor of Treasury making a
systemic risk determination; the Secretary consulted with the
President; and the Secretary signed a formal determination on October
14, 2008. Acknowledging that the systemic risk exception can be
interpreted in different ways, the agencies believe they also met the
statute's substantive requirements under a permissible interpretation
of the statute. We discuss below two key legal issues that the
agencies considered in making their recommendations and determination.
1. Authority to Provide Assistance Based on Problems of the Banking
Industry As a Whole:
In invoking the exception for the other two systemic risk
determinations made to date--with respect to Wachovia in September
2008 and Citigroup in January 2009--the agencies concluded, based on
the facts of those specific institutions, that providing least-cost
assistance to those entities' insured institutions would have had
"serious adverse effects on economic conditions or financial
stability"--that is, would have caused systemic risk.[Footnote 52] The
agencies applied the exception differently for TLGP determination:
they made what they characterized as a "generic systemic risk
determination" made "generically for all [banking] institutions,"
[Footnote 53] that is, a determination made with respect to "the U.S.
banking system in general" and "insured depository institutions in
general."[Footnote 54] According to the agencies, they took this
approach because the problem at hand was not limited to weakness in
one or more individual institutions, but was a banking system problem,
an overall scarcity of liquidity caused by lack of interaction among
institutions. The agencies therefore concluded that providing
assistance on a bank-by-bank basis would not have relieved the
existing instability in the industry and that waiting to provide bank-
by-bank relief after individual banks had begun to fail would not have
mitigated further systemic risk. The agencies also believed that a
bank-specific, wait-for-failure approach would have been more costly
than TLGP assistance provided.
The agencies believe these facts supported the required statutory
finding that "compliance with [the least-cost requirements] with
respect to an insured depository institution" would cause systemic
risk, in that they showed that having to apply the least-cost
requirements on a bank-by-bank basis ("compliance with the
...requirements with respect to an ...institution") would have caused
systemic risk. The agencies also believe the statute permits a generic
rather than a bank-specific determination because under general
statutory construction and grammar rules reflected in the Dictionary
Act, 1 U.S.C. § 1, the required finding regarding compliance "with
respect to an institution" can be read as "compliance with respect to
one or more institutions" unless statutory context indicates
otherwise.[Footnote 55]
Some have noted that a possible reading of the exception authorizes
assistance only to particular institutions, based on those
institutions' specific problems, not, as was done in creating TLGP,
systemic risk assistance to all institutions based on problems
affecting the banking industry in general.[Footnote 56] In our view,
the language, context, and history of the exception do not clearly
restrict its use to assistance to specific institutions. The statute
does not prescribe a detailed method by which Treasury must determine
whether "compliance ...would cause systemic risk," and we agree with
the agencies that "compliance ...with respect to an institution" means
the determination can be based on the circumstances of more than one
bank--that is, "an institution" can mean "one or more institutions."
As to whether the statute permits a determination to be made
generically based on industry-wide problems at insured depository
institutions apart from the health of any particular institution,
nothing in the legislative history of the exception explicitly refutes
the agencies' position that the statute permits such a generic
determination. The debate leading to enactment of FDICIA centered on
FDIC's role in resolving "too big to fail" institutions whose collapse
might pose a risk to the entire financial system, rather than on
banking system-wide problems already posing serious risk. However,
nothing indicates Congress intended to preclude use of the exception
when, as with the facts leading to TLGP, an adverse systemic condition
is itself the cause of imminent bank failures and the agencies
determine that individual least-cost resolutions would not adequately
address the condition and in fact would worsen it. While Congress'
intent to further restrict the FDIC's authority to provide open bank
assistance is clear from the significant new limitations it imposed in
FDICIA, Congress' simultaneous enactment of the systemic risk
exception indicated a parallel objective to avoid wholesale systemic
failure.[Footnote 57] In light of these objectives and the language of
the statute, we believe there is some support for the agencies'
position that the law does not require an institution-specific
evaluation where it would result in systemic risk. Unexcelled Chemical
Corp. v. United States, 345 U.S. 59 (1953) (laws written in
comprehensive terms apply to unanticipated circumstances if they
reasonably fall within the scope of the statutory language); see
generally GAO-08-606R (March 31, 2008) at 13-18.
In sum, given Treasury's factual determination that systemic risk
would have resulted from application of the least-cost requirements to
the circumstances leading to creation of TLGP, we believe there is
some support for the agencies' legal position that systemic risk
assistance of some type was authorized. Whether the particular TLGP
assistance provided was within the scope authorized by the systemic
risk exception was a second issue the agencies considered, and which
we now address.
2. Authority to Provide Assistance to Non-"Troubled" Banks, Bank
Holding Companies, and Other Bank Affiliates:
In addition to considering whether the banking industry-wide liquidity
crisis could be mitigated by providing systemic risk relief, the
agencies considered whether the statute authorized relief for all of
the entities they believed should receive assistance. The agencies
addressed whether the language of the statute--authorizing FDIC, in
the event of a systemic risk determination, to "take other action or
provide assistance under this section [FDI Act section 13] as
necessary to avoid or mitigate" systemic risk--waived the statute's
other restrictions, and they concluded that it both waived the
restrictions and then gave FDIC new authority to provide assistance
even beyond that otherwise authorized by the FDI Act, as long as the
assistance was "necessary to avoid or mitigate" systemic risk. Under
this interpretation, the agencies believe FDIC had authority to
provide TLGP assistance directly to bank holding companies and other
bank affiliates,[Footnote 58] as well as to insured depository
institutions that FDIC had not determined met the statutory troubled-
condition criteria (and would not have met them in most cases because
most of the institutions were "healthy" under the statutory standards).
The agencies base their interpretation in part on Congress' use of the
disjunctive term "or" in authorizing "other action or ...assistance
under this section," noting that "or" generally indicates an intention
to differentiate between two phrases. They also rely on a statutory
construction principle known as the "grammatical rule of the last
antecedent,"[Footnote 59] where a limiting phrase--here, "under this
section"--generally should be read as modifying only the words
immediately preceding it--here, "assistance," not "other action." In
the agencies' view, a systemic risk determination creates two distinct
options for assistance: (1) "other action," that is, "action" "other"
than assistance allowed by FDI Act section 13; and (2) assistance
allowed by section 13. "Other action" is not subject to the
restrictions on section 13 assistance, in the agencies' view, because
by definition it is not section 13 assistance, while "assistance under
this section" remains subject to those restrictions unless explicitly
waived by the systemic risk exception, as in the case of the least-
cost requirements. Under this interpretation, TLGP's aid to all open
healthy (non-"troubled") banks, considered as a whole, was authorized
because it constituted "other action" not subject to the section
13(c)(8) ban on relief to healthy open banks, rather than "assistance
under this section" which would have prohibited relief to the same
institutions if considered individually. Likewise, according to the
agencies, TLGP's direct assistance to bank holding companies and other
bank affiliates constituted "other action" rather than "assistance
under this section."[Footnote 60]
The agencies' reading of the statute raises several issues. First,
while rules of grammar and statutory construction can provide general
guidance about what Congress intended, the actual context and
structure of the statute are of equal if not paramount importance.
[Footnote 61] Here, Congress' interchangeable use of the terms
"action" and "assistance" throughout section 13 suggests it did not
intend to differentiate between those terms when it used them in
section 13(c)(4)(G), the systemic risk exception. For example,
although Congress entitled section 13(c), the general FDI Act
provision authorizing FDIC aid to open insured institutions, as
"Assistance to insured depository institutions," it then used the term
"action" to identify each circumstance in which such assistance is
authorized. See, e.g., 12 U.S.C. §§ 1823(c)(1)(A)-(C), 1823(c)(2),
1823(c)(4)(E). This suggests Congress created only one basic option
for systemic risk relief: action or assistance, authorized by section
13 and related restrictions, except restrictions expressly waived by
the systemic risk exception. The sequence of the terms "other action"
and "assistance" in the statute supports this reading, because if
Congress intended to create two types of relief--one subject to the
section 13 restrictions and the other subject to no restrictions--
arguably it would have reversed the order and authorized "assistance
under this section or other action" rather than "other action or
assistance under this section."[Footnote 62]
Second, the fact that the systemic risk exception explicitly waives
the least-cost requirements, by two specific references to
"subparagraphs (A) and (E)," but waives none of the other statutory
requirements, also supports the one-option interpretation because it
suggests Congress did not intend its authorization of "other action"
to override other statutory restrictions. In this regard, FDIC has
long recognized, since promulgation of its revised Open Bank
Assistance Policy in 1992, that the section 13(c)(8) restrictions
against assistance to healthy open banks apply even when there is a
systemic risk determination and that these restrictions must be met
prior to providing systemic risk assistance.[Footnote 63] FDIC thus
applied the restrictions as part of its recommendation for the
Citigroup systemic risk determination in January 2009, and determined
that the open insured depository institutions there were "troubled,"
thus qualifying for open bank--and systemic risk--assistance.[Footnote
64] In FDIC's view, its position that the Citigroup systemic risk
determination did not waive (c)(8) for open depository institutions is
consistent with its position that TLGP determination did waive (c)(8)
for open depository institutions, because the former constituted
"assistance under this section" relief while the latter constituted
"other action" relief.[Footnote 65] FDIC's 1992 Open Bank Assistance
Policy did not address this aspect of the systemic risk exception,
FDIC told us, because until TLGP, no one had considered the
possibility of systemic risk stemming from industry-wide conditions
rather than bank-specific conditions. We recognize that FDIC's
interpretation has evolved in response to new circumstances, but we
believe its current and arguably inconsistent "other action"
interpretation is subject to question for the reasons noted above.
[Footnote 66]
Third, the practical effect of a systemic risk determination under the
agencies' reading is to authorize any type of assistance to any type
of entity, provided the aid is deemed necessary to avoid or mitigate
systemic risk. This is because if relief does not meet the
restrictions imposed on "assistance under this section," the identical
relief is by definition authorized as "other action." If Congress had
intended to give FDIC such broad new authority, however, it could have
simply said so, authorizing FDIC to "take action" in the event of
systemic risk. Instead, Congress added qualifying language apparently
intended to limit FDIC's options, only authorizing it to "take other
action or provide assistance under this section."
Finally, the overall legislative history of FDICIA also suggests
Congress did not intend the exception to provide the breadth of new
authority claimed by the agencies. FDICIA was aimed in part at curbing
what Congress believed had been excessive costs of FDIC bank
assistance that increased the exposure of the Deposit Insurance Fund.
Congress therefore imposed new restrictions intended to raise, not
lower, the bar for FDIC relief. Limits were added, for example, on
which entities could receive assistance (e.g., only open banks in
"troubled condition") and how much assistance could be provided (least-
cost). Congress also imposed so-called prompt corrective action
mandates on the banking regulators, requiring them to take
increasingly severe actions as an institution's capital deteriorates.
[Footnote 67] Additionally, like its predecessor exception, the
systemic risk exception was enacted as part of a provision imposing
cost-based limits on FDIC assistance--the least-cost requirements--
rather than as a separate provision granting new authority.[Footnote
68] In light of FDICIA's overarching remedial purposes, it is
questionable that Congress would have intended to simultaneously
provide FDIC with new and substantially broader authority than the
agency had been given since its creation in 1933, and would have done
so by means of an implication in a narrowed exception to a cost
restriction. Commissioner v. Clark, 489 U.S. 726, 738-39 (1989)("Given
that Congress has enacted a general rule..., we should not eviscerate
that legislative judgment through an expansive reading of a somewhat
ambiguous exception."); Whitman v. American Trucking Ass'n, 531 U.S.
457, 468 (2001)("Congress, we have held, does not alter the
fundamental details of a regulatory scheme in vague terms or ancillary
provisions--it does not, one might say, hide elephants in
mouseholes.") (citations omitted).
In response to these issues, the agencies make two additional points.
First, they suggest that any uncertainty regarding whether "other
action" authorized TLGP assistance to bank holding companies was
resolved by 2009 amendments to the systemic risk exception. At the
time TLGP was created, the exception required FDIC to recover any
losses to the Deposit Insurance Fund caused by its systemic risk
assistance, but authorized recovery only from insured depository
institutions. In response to concerns by FDIC and banking industry
representatives that bank holding companies should also bear some of
TLGP costs because they had received substantial assistance under the
program, Congress modified the provision in May 2009 to permit
assessments against bank holding companies as well as depository
institutions. Pub. L. No. 111-22, sec. 204(d), codified at 12 U.S.C. §
1823(c)(4)(G)(ii). The agencies believe this confirms the FDIC's
authority to provide assistance to bank holding companies under TLGP
because Congress did not simultaneously amend the exception to
explicitly prohibit such assistance going forward. We agree the
amendment provides some support for the agencies' position under a
general tenet of statutory construction that congressional awareness
of an agency's practice in implementing a statute, without striking
down that practice, indicates congressional acquiescence in the
agency's interpretation.[Footnote 69]
Second, the agencies maintain that their interpretation of any
ambiguous aspects of the systemic risk exception warrants substantial
deference under the Supreme Court's decision in Chevron U.S.A. v.
Natural Resources Defense Council, 467 U.S. 837 (1984), and related
cases. Under Chevron, when the meaning of a statute is unclear, either
because the statute is silent on an issue or the language is
ambiguous, an interpretation by an agency charged with the statute's
administration warrants substantial deference provided the
interpretation is reasonable, even if it is not the only
interpretation or the best interpretation. Whether and to what extent
deference is warranted depends on factors including the agency's
specialized expertise in implementing the statute, whether the
agency's interpretation has been subjected to public scrutiny through
public notice-and-comment rulemaking, and whether its interpretation
is consistent with its previous pronouncements. United States v. Mead
Corp., 533 U.S. 218, 227-29 (2001) (citations omitted). Under Mead,
Chevron deference is warranted where the interpretation is made as
part of an agency rulemaking or other agency action that Congress
intended to carry the force of law, and, even if Chevron deference is
not warranted, lesser deference is warranted under Skidmore v. Swift,
323 U.S. 134 (1944), if the agency's interpretation is "persuasive"
based on factors such as the thoroughness and validity of the agency's
reasoning, the consistency of its interpretation over time, and the
formality of its action.
We believe these deference principles have some force as applied to
the systemic risk exception and TLGP. Congress did not explicitly
address whether FDIC may provide systemic risk relief directly to bank
holding companies or healthy open banks, and a court arguably could
find that the statute's authorization of "other action or assistance
under this section" is ambiguous.[Footnote 70] If it did, we believe
the agencies' reading might merit at least some degree of deference.
Congress charged these three financial regulatory agencies with
implementing the systemic risk exception, and charged FDIC with
implementing other provisions of the FDI Act related to this
exception. The agencies interpreted the exception to authorize
assistance to holding companies, other bank affiliates, and non-
troubled banks as part of the systemic risk determination, and FDIC
exercised its general rulemaking authority to issue regulations
establishing TLGP, including regulations providing for assistance to
these entities. According to the agencies, their interpretation of
what "other action or . . . assistance" authorizes was necessarily
part of the rulemaking because critical aspects of the program--
assistance to "healthy" banks, and to bank holding companies and other
bank affiliates--were premised upon this interpretation and would
otherwise have been prohibited. Further, FDIC's rulemaking preambles
asserted that TLGP was authorized by Treasury's systemic risk
determination.[Footnote 71] The fact that the regulations and
preambles did not solicit public comment on the underlying legal
interpretations--and in fact did not indicate what the interpretations
were--did not disqualify them from Chevron deference, according to the
agencies, because under other Supreme Court precedent, an agency's
interpretation of a statute may warrant deference if the
interpretation was the only logical basis for a rulemaking, even if
the agency does not disclose its interpretation.[Footnote 72] Finally,
we note that the very process Congress established for issuance of
systemic risk determinations reflects great congressional respect for
the agencies' judgment and expertise, if not a strict basis for legal
deference to their interpretation of the statute. We nonetheless
believe the arguments for deference to the agencies' interpretation
are undercut by the statutory interpretation concerns discussed above,
which raise questions about the persuasiveness of the agencies'
arguments, and by the different and arguably inconsistent positions
taken by FDIC regarding whether the systemic risk exception waives the
prohibition against assistance to "healthy" institutions.
Conclusion:
We believe there is some support for the agencies' position that the
systemic risk exception authorizes assistance of some type under TLGP
facts, as well as for their position that the exception permits
assistance to the entities covered by this program. There are a number
of questions concerning these interpretations, however. Because
application of the systemic risk exception raises novel legal and
policy issues of significant public interest and importance, and
because of the need for clear direction to the agencies in a time of
financial crisis, we recommend that Congress consider enacting
legislation clarifying the requirements and assistance authorized
under the exception. Congress is now debating modernization and reform
of the financial regulatory system, including regulation that
addresses systemic risk, and this may provide an opportunity for such
congressional consideration. [Footnote 73] Enacting more explicit
legislation will provide legal clarity to the agencies, the banking
industry, and the financial community at large, and will help to
ensure greater transparency and accountability to the taxpaying
public.[Footnote 74]
The Systemic Risk Exception:
Federal Deposit Insurance Act Section 13(c)(4)(G), Title 12, United
States Code, Section 1823(c)(4)(G):
§ 1823. Corporation monies * * *:
(c) Assistance to insured depository institutions * * *:
(4) Least-cost resolution required * * *:
(G) Systemic risk:
(i) Emergency determination by Secretary of the Treasury:
Notwithstanding subparagraphs (A) and (E) [the least-cost
requirements], if, upon the written recommendation of the [FDIC] Board
of Directors (upon a vote of not less than two-thirds of the members
...) and the Board of Governors of the Federal Reserve System (upon a
vote of not less than two-thirds of the members ...), the Secretary of
the Treasury (in consultation with the President) determines that--:
(I) the Corporation's compliance with subparagraphs (A) and (E) with
respect to an insured depository institution would have serious
adverse effects on economic conditions or financial stability; and:
(II) any action or assistance under this subparagraph would avoid or
mitigate such adverse effects,
the Corporation may take other action or provide assistance under this
section as necessary to avoid or mitigate such effects.
(ii) Repayment of loss:
(I) In general:
The Corporation shall recover the loss to the Deposit Insurance Fund
arising from any action taken or assistance provided with respect to
an insured depository institution under clause (i) from 1 or more
special assessments on insured depository institutions, depository
institution holding companies (with the concurrence of the Secretary
of the Treasury with respect to holding companies), or both, as the
Corporation determines to be appropriate.
(II) Treatment of depository institution holding companies:
For purposes of this clause, sections 1817(c)(2) and 1828(h) of this
title shall apply to depository institution holding companies as if
they were insured depository institutions.
(III) Regulations:
The Corporation shall prescribe such regulations as it deems necessary
to implement this clause. In prescribing such regulations, defining
terms, and setting the appropriate assessment rate or rates, the
Corporation shall establish rates sufficient to cover the losses
incurred as a result of the actions of the Corporation under clause
(i) and shall consider: the types of entities that benefit from any
action taken or assistance provided under this subparagraph; economic
conditions, the effects on the industry, and such other factors as the
Corporation deems appropriate and relevant to the action taken or the
assistance provided. Any funds so collected that exceed actual losses
shall be placed in the Deposit Insurance Fund.
(iii) Documentation required:
The Secretary of the Treasury shall--:
(I) document any determination under clause (i); and:
(II) retain the documentation for review under clause (iv).
(iv) GAO review:
The Comptroller General of the United States shall review and report
to the Congress on any determination under clause (i), including--:
(I) the basis for the determination;
(II) the purpose for which any action was taken pursuant to such
clause; and:
(III) the likely effect of the determination and such action on the
incentives and conduct of insured depository institutions and
uninsured depositors.
(v) Notice:
(I) In general:
The Secretary of the Treasury shall provide written notice of any
determination under clause (i) to the Committee on Banking, Housing,
and Urban Affairs of the Senate and the Committee on Banking, Finance
and Urban Affairs of the House of Representatives.
(II)Description of basis of determination:
The notice under subclause (I) shall include a description of the
basis for any determination under clause (i).
[End of section]
Appendix III: Comments from the Board of Governors of the Federal
Reserve System:
Board Of Governors:
Of The Federal Reserve System:
Ben S. Bernanke, Chairman:
Washington, D.C. 50551:
April 6, 2010:
Mr. Richard I. Hillman:
Managing Director:
Financial Markets and Community Investment:
Government Accountability Office:
Washington, D.C. 20548:
Dear Mr. Hillman:
The Federal Reserve appreciates the opportunity to comment on a draft
of the GAO's report on the use of the systemic risk exception in the
Federal Deposit Insurance Act (FDI Act) during the financial crisis
(GAO-10-100).
The systemic risk exception may be invoked only through action by the
Federal Reserve, the FDIC's board of directors, and the Secretary of
the Treasury after consultation with the President. It is
extraordinary authority that the agencies have used sparingly and
judiciously since it was enacted in 1991. Prior to the financial
crisis that began in 2007, the exception had not been used at all. And
during the financial crisis, which is widely acknowledged as the worst
financial disruption since the Great Depression, the Secretary has
made the necessary determination and authorized the FDIC to provide
assistance or take action under the exception only three times--to
facilitate the proposed acquisition of the banking operations of
Wachovia Corporation by Citigroup, Inc., to establish the Temporary
Liquidity Guaranty Program (TLGP), and to participate in a package of
loss protections and liquidity supports for Citigroup, Inc. These
determinations are the focus of the GAO's report.
As the report recognizes, in each of these cases the agencies acted in
conformance with the requirements of the systemic risk exception. In
addition, as the report recognizes, the agencies acted to address
circumstances that had the potential to significantly worsen the
already substantial strains on the financial system, and the FDIC's
actions and assistance under the systemic risk exception helped
stabilize the specific institutions involved and promoted confidence
and liquidity in the banking industry generally. Moreover, the report
acknowledges that the agencies' recommendations, decisions, and
analysis regarding each of these actions, including the TLGP, are
supported by the statute.
I am confident that the actions taken by the agencies were fully
consistent with, and authorized by, the terms of the systemic risk
exception. Moreover, the actions taken and assistance provided by the
FDIC under the systemic risk exception were important components of
the response by the U.S. Government to the financial crisis. These
actions, as well as those taken by the Federal Reserve and the
Treasury, helped prevent a further worsening of the financial crisis
and, thus, helped promote the flow of credit to households,
businesses, and state and local governments.
While the agencies' actions were necessary in light of prevailing
conditions, these actions have the potential to increase moral hazard
and reinforce perceptions that some firms are too big to fail. To help
address these negative consequences, your report recommends that
Congress ensure that all systemically important financial institutions
be subject to stronger regulatory and supervisory oversight and that a
resolution system be put in place that would allow the government to
manage the failure of large, complex, and interconnected financial
firms in an orderly manner.
The Federal Reserve agrees with these two recommendations and, indeed,
for some time has strongly advocated that Congress enact comprehensive
legislation that would ensure that all systemically important
financial firms—-including those that do not own a bank-—are subject
to the same framework for consolidated prudential supervision as bank
holding companies. In addition, I and other members of the Federal
Reserve have repeatedly testified that a crucial element of any
regulatory reform agenda must be the development of a new regime that
would allow the orderly resolution of a systemically important
financial firm in a way that imposes losses on shareholders and
creditors while minimizing the potential for systemic consequences. We
must end too big to fail, and a critical step is providing an
alternative to government bailouts or a disorderly bankruptcy of large
interconnected financial firms.
As your report acknowledges, the Federal Reserve already is taking
steps, in conjunction with other domestic and foreign supervisors
where appropriate, to strengthen the supervision and regulation of
large financial firms. The Federal Reserve has played a key role in
international efforts to ensure that systemically critical financial
institutions hold more and higher-quality capital, have enough
liquidity to survive highly stressed conditions, and meet demanding
standards for company-wide risk management. We also have taken the
lead in addressing flawed compensation practices by issuing proposed
guidance and commencing supervisory initiatives to help ensure that
compensation structures at banking organizations provide appropriate
incentives without encouraging excessive risk-taking. In addition, we
are developing an off-site, enhanced quantitative surveillance program
for large bank holding companies that will use data analysis and
formal modeling to help identify vulnerabilities at both the firm
level and for the financial sector as a whole.
We appreciate the time, effort, and professionalism of the GAO review
team. Federal Reserve staff separately has provided GAO staff with
technical comments on the draft report. We hope that these comments
were helpful.
Sincerely,
Signed by:
Ben S. Bernanke:
[End of section]
Appendix IV: Comments from the Department of the Treasury:
Department Of The Treasury:
General Counsel:
Washington, D.C.
April 12, 2010:
Ms. Orice Williams-Brown:
Director of Financial Markets and Community Investment:
U.S. Government Accountability Office:
441 G Street, NW:
Washington, DC 20548:
Dear Ms. Williams-Brown:
The Department of Treasury (Treasury) appreciates the opportunity to
review and comment on the U.S. Government Accountability Office (GAO)
draft report, entitled Federal Deposit Insurance Act: Regulators' Use
of Systemic Risk Exception Raises Moral Hazard Concerns and
Opportunities Exist to Clarify the Provision (GAO 250428). Treasury
also appreciates the GAO's careful and considered review of the facts
and circumstances that resulted in systemic risk determinations
regarding the Wachovia Corporation's subsidiary insured depository
institutions, the FDIC's Temporary Liquidity Guarantee Program
assistance to insured depository institutions, and the asset guarantee
related to Citigroup Inc:5 subsidiary insured depository institutions.
As you know, Treasury made the systemic risk determinations during a
severe and rapidly deteriorating financial crisis to enable the FDIC
to take actions that would stabilize the financial system. Treasury
carefully considered its authority under the Federal Deposit Insurance
Act, and it acted well within that authority.
The GAO recommends that Congress ensure that systemically important
institutions receive greater regulatory oversight. Treasury strongly
agrees and supports swift enactment of regulatory reform legislation
that provides for greater regulatory oversight of the largest, most
interconnected financial films and resolution authority to wind down
failing nonbank financial firms in a manner that mitigates the risks
that their failure would pose to financial stability and the economy.
Once again, Treasury appreciates the opportunity to review this report
and the GAO's thoughtful recommendations.
Sincerely,
Signed by:
George W. Madison:
[End of section]
Appendix V: GAO Contact and Staff Acknowledgments:
GAO Contact:
Orice Williams Brown (202)-512-8678 or mailto:williamso@gao.gov:
Staff Acknowledgments:
In addition to the contacts named above, Karen Tremba (Assistant
Director), Rachel DeMarcus, John Fisher, Kristopher Hartley, Michael
Hoffman, Marc Molino, Akiko Ohnuma, Barbara Roesmann, Carla Rojas,
Susan Sawtelle, and Paul Thompson made key contributions to this
report.
[End of section]
Footnotes:
[1] Pub. L. No. 102-242, sec. 141 (1991), codified at 12 U.S.C. §
1823(c)(4)(G).
[2] On April 13, 2010, FDIC's Board of Directors approved an interim
rule to extend the program providing transaction account guarantees to
December 31, 2010, and noting FDIC may further extend the deadline to
December 31, 2011.
[3] 12 U.S.C. § 1823(c)(4)(G)(iv).
[4] 12 U.S.C. § 1823(c)(4)(A)-(B), (E).
[5] In an open bank assistance transaction, FDIC provides assistance
to an operating insured institution. Because of the restrictions
imposed by the least cost rules and post-FDICIA statutory limitations
on FDIC assistance, until its recent assistance under the systemic
risk determinations, FDIC had not provided open bank assistance since
1992.
[6] As discussed below and in appendix II, Treasury, FDIC, and the
Federal Reserve believe a systemic risk determination waives all other
restrictions on FDIC assistance and authorizes additional measures not
otherwise allowed by the FDI Act, provided this would avoid or
mitigate the systemic risk.
[7] OCC, the primary regulator for the national bank subsidiaries of
two institutions involved in FDIC's emergency actions, provided
information on the condition of these national banks.
[8] 12 U.S.C. § 1823(c)(4)(G)(iii). GAO has discretionary authority
under the Banking Agency Audit Act, 31 U.S.C. § 714, and GAO's organic
statute, 31 U.S.C. §§ 712, 716, and 717, to obtain documentation of
the agencies' recommendations to Treasury and Treasury's response, and
to evaluate these actions. The systemic risk exception makes GAO
review mandatory and specifies the areas to be covered and reported to
Congress. In the absence of a formal Treasury determination, neither
Congress nor the public can be assured that the agencies will create
or maintain the information needed to conduct a meaningful review.
[9] Payment option ARMs allow borrowers to make payments lower than
what would be needed to cover any of the principal or all of the
accrued interest.
[10] Credit default swaps provide protection to the buyer of the
credit default swap contract if the assets covered by the contract go
into default.
[11] The four insured depository institution affiliates of Wachovia
Bank, N.A. are the following: Wachovia Mortgage, F.S.B.; Wachovia,
F.S.B.; Wachovia Bank of Delaware, N.A.; and Wachovia Card Services,
N.A.
[12] FDIC concluded that Wachovia Bank, NA, in the event of its
failure, would have sufficient uninsured obligations (such as foreign
deposits and senior and subordinated debt) to absorb expected losses
without requiring payments from the Deposit Insurance Fund to protect
insured depositors.
[13] Pub. L. No. 110-343, Div. A, 122 Stat. 3765 (2008), codified at
12 U.S.C. §§ 5201 et seq.
[14] Following the bankruptcy filing of Lehman Brothers, 25 money
market fund advisers had to act to protect their investors against
losses arising from their investments in that company's debt, with at
least one of these funds having to be liquidated with investors
receiving less than $1 dollar per share.
[15] As part of the bidding process, FDIC also noted that Wachovia
Corporation submitted its own proposal for FDIC credit protection on a
fixed pool of the bank's loans.
[16] Citigroup agreed to acquire Wachovia Bank, N.A. and four other
depository institutions that together accounted for the bulk of the
assets and liabilities of the holding company, Wachovia Corporation.
Wachovia Corporation would continue to own Wachovia Securities, AG
Edwards, and Evergreen.
[17] A basis point is a common measure used in quoting yield on bills,
notes, and bonds and represents 1/100 of a percent of yield. It should
be noted that while the spread is large, the actual LIBOR rate is
lower than the average rate for 2005 through mid-2007.
[18] Commercial paper is an unsecured, short-term debt instrument
issued by a corporation, typically for the financing of accounts
receivable, inventories, and meeting short-term liabilities.
Maturities on commercial paper rarely range any longer than 270 days.
[19] The G7 is an informal forum of coordination among Canada, France,
Germany, Italy, Japan, the United Kingdom, and the United States.
[20] The Capital Purchase Program was created in October 2008 to
stabilize the financial system by providing capital to viable banks
though the purchase of preferred shares and subordinated debentures.
The Commercial Paper Funding Facility provided a broad backstop to the
commercial paper market by funding purchases of 3-month commercial
paper from high-quality issuers.
[21] U.S. insured depository institutions were automatically enrolled
in the TAGP as of October 14, 2008. TLGP rule did not permit FDIC to
prospectively cancel eligibility for the TAGP, which was intended to
assure holders of covered deposits of the safety of these deposits
until the end of the program. On April 13, 2010, FDIC approved an
interim rule extending the TAGP to December 31, 2010, and reserving
FDIC's "discretion to extend the program to the end of 2011, without
additional rulemaking, if it determines that economic conditions
warrant such an extension." FDIC Press Release, April 13, 2010,
available at [hyperlin,
http://www.fdic.gov/news/news/press/2010/pr10075.html].
[22] Furthermore, FDIC estimates that it will recover about $4.9
billion of the TAGP claims from its claims on the receiverships of the
failed institutions.
[23] In addition, surcharges assessed on debt issued under the
extension of TLGP are added directly to the deposit insurance fund. As
of November 30, 2009, FDIC has collected $872 million in such
surcharges.
[24] FDIC press release, March 17, 2009.
[25] According to regulatory officials, advantages of issuing debt
outside TLGP included sending a positive signal to the market that
government assistance is no longer needed and issuing debt at longer
and varying maturities (to avoid having too much debt mature at once).
[26] The Primary Dealer Credit Facility (PDCF) was an overnight loan
facility through which the Federal Reserve provided funding to primary
dealers in exchange for a specified range of eligible collateral and
was intended to foster the orderly functioning of financial markets
more generally. The PDCF began operations on March 17, 2008, and was
closed on February 1, 2010.
[27] Banks and thrifts are required to meet two risk-based capital
ratios, which are calculated by dividing their qualifying capital
(numerator) by their risk-weighted assets (denominator). Total capital
consists of core capital, called Tier 1 capital, and supplementary
capital, called Tier 2 capital. Tier 1 capital can include common
stockholders' equity, noncumulative perpetual preferred stock, and
minority equity investments in consolidated subsidiaries. To be well-
capitalized under Federal Reserve definitions, a bank holding company
must have a Tier 1 capital ratio of at least 6 percent. A 2.6 percent
reduction in the Tier 1 regulatory capital would represent a
significant loss, even for a banking organization holding an amount of
Tier 1 capital in excess of the minimum 6 percent requirement.
[28] The fixed pool of assets is the pool of assets protected by
Treasury and FDIC guarantees and a residual financing arrangement from
the Federal Reserve.
[29] In June 2009, Treasury and FDIC exchanged this preferred stock
for an equal value of trust preferred securities as part of a series
of transactions designed to realign Citigroup Inc.'s capital structure
and increase its tangible common equity.
[30] The loss-sharing arrangements were put in effect for 10 years for
residential assets and 5 years for nonresidential assets. Treasury's
Targeted Investment Program was designed to prevent a loss of
confidence in financial institutions that could result in significant
market disruptions, threaten the financial strength of similarly
situated financial institutions, impair broader financial markets, and
undermine the overall economy.
[31] As part of the termination, Treasury and FDIC are exchanging $1.8
billion of the trust preferred securities that were issued under the
agreement. Citigroup is reducing the aggregate liquidation amount of
the trust preferred securities issued to Treasury by $1.8 billion and
FDIC initially is retaining all of its trust preferred securities
until the expiration date of all guarantees of debt of Citigroup and
its affiliates under TLGP. When no Citigroup TLGP guaranteed debt
remains outstanding, FDIC will transfer $800 million of the trust
preferred securities to Treasury along with accumulated dividends and
less any payments it makes under TLGP guarantees on the Citigroup debt.
[32] Sheila C. Bair, Testimony before the U.S. Senate Committee on
Banking, Housing and Urban Affairs (Washington, D.C.: Mar. 19, 2009).
Transactions between a bank and an affiliate, such as loans, asset
purchases, and other transactions that expose the bank to the risks of
the affiliate, are subject to limitations imposed by sections 23A and
23B of the Federal Reserve Act, 12 U.S.C. §§ 371c, 371c-1, the Board's
implementing Regulation W, 12 C.F.R. Part 223, and corresponding
provisions of the Federal Deposit Insurance Act and the Home Owners
Loan Act. See Transactions Between Member Banks and Their Affiliates,
67 Fed. Reg.76560 (December 12, 2002); see also, Federal Reserve
Supervisory Letter SR 03-2 (Jan. 9, 2003).
[33] Wall Street Reform and Consumer Protection Act of 2009, H.R.
4173, 111th Cong. § 1103 (2009); see also Restoring American Financial
Stability Act of 2010, 111th Cong., § 113 (Senate Banking Committee,
available at [hyperlink, http://banking.senate.gov/public/index.cfm]).
[34] Basel II is an effort by international banking supervisors to
update the original international bank capital accord (Basel I), which
has been in effect since 1988. The Basel Committee on Banking
Supervision on which the United States serves as a participating
member, developed Basel II. The revised accord aims to improve the
consistency of capital regulations internationally, make regulatory
capital more risk sensitive, and promote enhanced risk management
practices among large, internationally active banking organizations.
[35] 74 Fed. Reg. 55227 (Oct. 27, 2009).
[36] See, e.g., id. at 55228, 55232.
[37] GAO, Financial Regulation: Review of Regulators' Oversight of
Risk Management Systems at a Limited Number of Large, Complex
Financial Institutions, [hyperlink,
http://www.gao.gov/products/GAO-09-499T] (Washington, D.C.: Mar. 18,
2009).
[38] Daniel K. Tarullo, Testimony before the U.S. Senate Committee on
Banking, Housing and Urban Affairs (Washington, D.C.,: Aug. 4, 2009).
[39] Tarullo (2009).
[40] We are currently reviewing the Supervisory Capital Assessment
Program and assessing the process used to design and conduct the
stress test, how the stress test methodology was developed and how the
stress test economic assumptions and bank holding companies'
performance have tracked actual results as well as describing bank
officials' views on the stress test process. We plan on issuing a
report in the summer of 2010.
[41] GAO: Troubled Asset Relief Program: Status of Federal Assistance
to AIG, [hyperlink, http://www.gao.gov/products/GAO-09-975]
(Washington, D.C.: Sept. 21, 2009).
[42] GAO, Financial Regulation: A Framework for Crafting and Assessing
Proposals to Modernize the Outdated U.S. Financial Regulatory System,
[hyperlink, http://www.gao.gov/products/GAO-09-216] (Washington, D.C.:
Jan. 8, 2009).
[43] Sheila C. Bair, Testimony before the U.S. House of
Representatives Committee on Financial Services (Washington, D.C.,
Oct. 29, 2009).
[44] We did not review other legal aspects of TLGP or the legal
aspects of the other systemic risk determinations or agency actions.
[45] The only reported decision involving the systemic risk exception
appears to be Wachovia Corp. v. Citigroup Inc., 634 F. Supp. 2d 445
(S.D.N.Y. 2009). The court there noted, by way of background, that
Treasury had made a systemic risk determination with respect to
Wachovia, but it did not address the issues analyzed here.
[46] As part of our legal review and similar to our regular practice
in preparing legal opinions, see GAO, Procedures and Practices for
Legal Decisions and Opinions, GAO-06-1064SP (Washington, D.C.:
September 2006), [hyperlink, http://www.gao.gov/htext/d061064sp.html]
(last visited April 12, 2010), we obtained the legal views of
Treasury, FDIC, and the Federal Reserve on their authority to
establish TLGP. We also obtained the views of banking law specialists
in private practice and academia on these issues.
[47] 12 U.S.C. § 1823(c)(8).
[48] 12 U.S.C. §1823(c)(4)(A)-(B).
[49] 12 U.S.C. § 1823(c)(4)(E).
[50] 12 U.S.C. § 1821(a)(4)(C).
[51] 12 U.S.C. § 1823(c)(4)(G)(i). The text of the systemic risk
exception is set forth in full following this analysis.
[52] The agencies concluded that a least-cost resolution of the
insured institutions, with no assistance provided to uninsured
creditors and losses imposed on creditors of the insured institutions'
holding companies, would have had significant adverse effects on
economic conditions and the financial markets.
[53] Memorandum to FDIC Board of Directors, Oct. 22, 2008, at 1, 3.
[54] TLGP Determination, Oct. 14, 2008, at 1-2; Action Memorandum for
Secretary Paulson, Oct. 14, 2008, at 3; Memorandum to Federal Reserve
Board Chairman, Oct. 12, 2008, at 1.
[55] The Dictionary Act provides that "[i]n determining the meaning of
any Act of Congress, unless the context indicates otherwise [,] words
importing the singular include and apply to several persons, parties,
or things ...."
[56] See, e.g., Congressional Oversight Panel, "November Oversight
Report: Guarantees and Contingent Payments in TARP and Related
Programs," Nov. 6, 2009, at 36 (also noting FDIC's belief that statute
is sufficiently broad to authorize TLGP); L. Broome, "Extraordinary
Government Intervention to Bolster Bank Balance Sheets," 13 N.C.
Banking Inst. 137, 150 (March 2009). Cf. Testimony of Edward Yingling,
American Bankers Association, before the Committee on Financial
Services, U.S. House of Representatives, Feb. 3, 2009, at 4 (reliance
on systemic risk exception to create TLGP reflected use of the statute
"in ways that no one could have predicted when this authority was
enacted in 1991 ...The programs ...have taken the FDIC well beyond its
chartered responsibilities to protect insured depositors in the event
of bank failure.").
[57] See generally S. Rep. No. 167, 102d Cong., 1st Sess. (1991) at 4,
45; "Strengthening the Supervision and Regulation of Depository
Institutions," Hearings Before the Senate Banking, Housing and Urban
Affairs Committee, 1991 S. Hrg. 102-355, Vol. I, at 74 (Treasury),
1318 (Federal Reserve), 1381 (FDIC). But see 138 Cong. Rec. 3093, 3114
(Feb. 21, 1992)(post-enactment analysis submitted by Chairman Riegle
stating that systemic risk determination must be based on effect of
least-cost requirements on "a specific, named institution").
[58] As noted in this report, the agencies approved assistance
directly to a holding company as part of the 2009 systemic risk
determination made for Citigroup, as well as the 2008 TLGP
determination.
[59] Jama v. Immigration and Customs Enforcement, 543 U.S. 335, 343
(2005), quoting Barnhart v. Thomas, 540 U.S. 20, 26 (2003).
[60] In support of this position, the agencies assert that FDI Act
section 1821(a)(4)(C) provides independent authority, in the event of
a systemic risk determination, to provide FDIC assistance normally
prohibited under section 1823(c), specifically assistance that
benefits shareholders. Section 1821(a)(4)(C) states in part,
"[n]otwithstanding any provision of law other than [the systemic risk
exception,] -.the Deposit Insurance Fund shall not be used in any
manner to benefit any shareholder or affiliate" of an insured
institution. In our view, however, this language is better read simply
as a recognition that a systemic risk determination permits use of the
Fund to benefit shareholders to the extent authorized by the
exception--that is, to the extent permitted by section 1823(c)--rather
than representing new authority.
[61] See, e.g., Conroy v. Aniskoff, 507 U.S. 511, 515 (1993); Meredith
v. Federal Mine Safety and Health Review Com'n, 177 F.3d 1042, 1054
(D.C. Cir. 1999).
[62] The agencies suggest that this one-option interpretation
conflicts with the general rule of statutory interpretation against
surplusage, which disfavors interpretations that render part of a
statute superfluous, because the one-option interpretation reads
"other action" out of the statute. This would only be the case if
"action" and "assistance" have different meanings, however, and as
noted above, the statutory context suggests they do not. The one-
option interpretation thus satisfies a more fundamental canon of
statutory interpretation: that statutes are to be read as a whole. As
the Supreme Court has observed, the preference for avoiding surplusage
"is not absolute" and can be "offset by the canon that permits a court
to reject words 'as surplusage' if 'inadvertently inserted or if
repugnant to the rest of the statute.'" Lamie v. United States
Trustee, 540 U.S. 526, 536 (2004) (quoting Chickasaw Nation v. United
States, 534 U.S. 84, 94 (2001).
[63] FDIC first noted these requirements in the 1992 update to its
Open Bank Assistance Policy. FDIC explained there that under the 1991
FDICIA amendments, aid to open banks can be provided "only" if, among
other things, the "new prerequisite[s] to the FDIC's authority to
provide assistance" in section 13(c)(8) are satisfied and any
assistance provided to banks meeting section 13(c)(8) criteria "must"
then meet the least-cost requirements unless Treasury makes a systemic
risk determination. 57 Fed. Reg. 60203, 60203-04 (Dec. 18, 1992). FDIC
later withdrew its Open Bank Assistance Policy for unrelated reasons--
reasons that confirmed, rather than detracted from, its interpretation
that section 13(c)(8) restrictions apply even if there is a systemic
risk determination. See 62 Fed. Reg. 25191, 25191-92 (May 8, 1997).
The agency has confirmed that this reading of section 13(c)(8) remains
its position today, except, as discussed below, in cases such as TLGP.
[64] FDIC Board of Directors Resolution, Nov. 23, 2008, at 2;
Memorandum for FDIC Board of Directors, Nov. 23, 2008, at 3; Letter
from FDIC Chairman Bair to Treasury Secretary Paulson, Nov. 24, 2008,
at 1, 2. FDIC apparently did not, however, follow the requirement in
section 13 (c)(8)(B) that it publish its determination in the Federal
Register.
[65] Under the Citigroup systemic risk determination, FDIC also
provided direct assistance to Citigroup, Inc., the holding company,
and to other non-depository Citigroup affiliates. As with TLGP
recipients, FDIC was prohibited from providing "assistance under this
section" relief to these recipients; it instead provided "other
action" assistance not subject, in its view, to the section 13(c)(8)
limitations.
[66] The issue of whether Congress intended the exception to override
all restrictions on FDIC's authority helps illustrate why
congressional clarification of the exception could be appropriate.
Even though, as discussed above, a permissible reading of the
exception might permit a determination that is not tied to specific
institutions, the continuing applicability of section 13(c)(8)
suggests that the resulting assistance still would have to be
institution-specific--as reflected in FDIC's application of section
13(c)(8) in recommending systemic risk assistance for Citigroup.
[67] 12 U.S.C. § 1831o(e)-(i).
[68] Prior to FDICIA, the FDI Act limited assistance that FDIC could
provide to open insured institutions to the amount reasonably
necessary to save the FDIC the cost of liquidating the insured bank,
but provided an exception where the FDIC determined that continued
operation of the bank was "essential to provide adequate banking
services in the community." 12 U.S.C. § 1823(c)(4)(A) (1988)(Supp. II
1991). FDICIA replaced this liquidation-cost test with the more
restrictive least-cost test and replaced the essentiality exception
with the more restrictive systemic risk exception.
[69] See generally Commodity Futures Trading Com'n v. Schor, 478 U.S.
833 (1986); Creekstone Farms Premium Beef v. Dep't of Agriculture, 539
F.3d 492, 500-01 (D.C. Cir. 2008).
[70] The agencies assert that the fact that it is possible to read the
systemic risk exception in different ways demonstrates the statute is
ambiguous. Mere disagreement over the meaning of statutory language
does not itself create ambiguity, however. Brown v. Gardner, 513 U.S.
115, 118 (1994)(citation omitted)("Ambiguity is a creature not of
definitional possibilities but of statutory context.").
[71] See, e.g., 73 Fed. Reg. 64179, 64179-80 (Oct. 29, 2008).
[72] National Railroad Passenger Corp. v. Boston & Maine Corp., 503
U.S. 407, 428 (1992)(Chevron deference given to ICC interpretation
that was "a necessary presupposition" of agency order even though
agency was silent about its legal interpretation). It is not clear
whether the Supreme Court's seminal decision in Mead, decided in 2001,
may have undercut the precedential value of National Railroad
Passenger Corp., decided in 1992.
[73] We have previously reported on the need for such reform. See,
e.g., GAO, "Financial Regulation: A Framework for Crafting and
Assessing Proposals to Modernize the Outdated U.S. Financial
Regulatory System," [hyperlink,
http://www.gao.gov/products/GAO-09-216] (Washington, D.C. Jan. 8,
2009).
[74] According to FDIC, the Debt Guarantee portion of TLGP is backed
by the full faith and credit of the United States. See 57 Fed. Reg.
72244, 72252 (Nov. 26, 2008); FDI Act section 15(d), 12 U.S.C. §
1825(d).
[End of section]
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