Reuters Insider - Fed's Tarullo: Short-term funding remains major bank risk

Tersis Technologies

19/10/2013 16:00

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 Source:             Thomson Reuters                                   
                                                                       
 Description:        Federal Reserve Governor Daniel Tarullo speaks at 
                     a Fed conference on regulating systemically       
                     -important banks in Washington.                   
 
 
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 Transcript (May be auto-generated)                                    
                                                                       
 Here where he is professor of law at Georgetown University Law Center. University he's just a moment ago prior to that he held several senior positions in the Clinton administration. These these dollar tree to buy. Them before that he was. Served as chief counsel. For employment policy and the staff of senator Edward M Kennedy and ask him some time if he's. If he does anybody with the appointment as chief counsel for inflation policy isn't there. A sort of anti trust division. The Department of Justice 
 heart -- monster the Department of Commerce. I'm officer does is -- your own counsel. Foreign relations and it certainly -- privileged to have him interest in this today. Could you please give a warm welcome to go to. Can -- some of the people. Some people won't actually Jeff is one of the great roasters. Are tied it one of the best. Reasons for not -- epilepsy. Is because I think my agent -- Japanese speaking in movies and Europe's fortunately and in mixed company here hasn't gone so. Pleasure to be with 
 all of you today at this conference that that Jeff. Spot. You spoke then and where. Departments Richmond and put this together. And I can tell just from. Conversation ounce from the program that as an unexpected hits and very substantive. Case so far. This week which marks five years since the US government march they Troubled Asset Relief Program TARP. I think particularly good moment all the conference on the resolution. Large important financial institutions. Hours. -- More. That tops extension -- 
 unprecedented capitals were too many of the largest US banks reflected that you went back. Government officials that the failure of these forms but -- great threat to the financial system. The turmoil that followed the failure of Lehman decision to rescue AIG. Each way underscored the absence that there are alternatives to the options. Or disruptive bankruptcy. The creation of such an alternative included it's -- to -- -- -- part reforms that follow the crisis. In fact. The emergence of -- growing consensus 
 on key elements of a credible resolution mechanism. And to work to draft that was elements into appropriate statutory. Administrative. Works. Is one of them are unheralded -- still in progress excesses of the crisis regulatory response. Here in the United States the FDIC has been doing path breaking work to build out the statutory provisions in Dodd-Frank orderly liquidation art. Internationally the financial stability board as elaborate set of principles to guide the development of resolution mechanisms 
 throughout the world. And throughout our process it's there's been fruitful interaction among -- officials. Academics and market participants. My remarks this afternoon. I begin by explaining what from my perspective is the purpose and critical features especially mechanism for solving our financial firms. Next I'll explain why efforts in the FBI's. So important in developing. Type two resolution mechanism. And and identify some important market remains not just the FBI's. But -- ranger officials actor and 
 actors here. Finally and if you thoughts on the relationship between resolution mechanisms. A broader regulatory reform agenda in pursuing. Guests -- -- Stay at my house went. The purpose of the special resolution mechanism -- large financial firms. Is to prevent future situations in which government officials base that -- appealing choice they confronted in Japan. Stick a bit more analytic. A special resolution mechanism is needed to take -- and -- characteristics. Financial markets and a larger firms 
 operating. Those markets that it easily with normal bankruptcy practice. These characteristics and aren't you at least outwardly to a basic function -- financial intermediaries. In providing equity firms house rules. Precisely because financial intermediaries provide Liquidity Services. There's something funny story is one depositors customers are parties. I'm certain of that out of them -- your assets. Years. That was assets are okay. -- indeed a case for example with a portfolio of conventional mountains 
 or to secure -- -- securities that are act any rounds together from various reject. -- incentive to -- up on. Increases. Particularly in periods of stress in the value of property asset classes may be at risk precipitous. It's familiar it is obvious potential problem that you can see here. It becomes a problem for society. Went wanna two things now. First as a classic case its problems -- One financial -- The depositors a counter parties and other. It's fearing that their own institutions. Similar 
 difficulty repaying him because adults assets. Or -- The liquidity squeeze. He's a sizable as far -- fires its assets. In order to raise funds necessary to compensate for the disruption of its normal channels. Don't think sizable book of assets on the market PC adversity back with which -- -- -- -- It's having. -- crisis. A final. Is -- financial firm -- operation -- both of these dynamics. Catch it from being viable to occupy him quite short period of time. And once that confidence counterpart customers 
 should -- and funding with strong game is essentially you know. Of course matters to me worse if -- did not maintain adequate capitals. Or rely heavily on short term funding. As as the case with many it firms that came under severe pressure in 2000. However it is important to note that the nature financial. Years. Means that even arms compliance with more rigorous capital. Capital requirements. Put these days these dynamics in -- To be credible. A resolution mechanism for a large financial forms must be 
 capable of dealing with these characteristics. Of arts. This is the premised -- a lot of and I think it's also the premise that not commentators who have proposed to the bankruptcy code or applications -- -- -- There are three key features to. And modify certain respect summer these bankruptcy nineties. That reflects recognition that -- -- financial markets in a way that the current bankruptcy does. The first feature our titled simply -- -- speak. It is -- that result aren't able to quickly. From -- 
 resolution resolutions this while maintaining continuity of operations. As many of Laura -- Some personal experience. Tournament. Financial crisis and makeshift arrangements -- apartments and -- -- -- -- and markets. Usually completed over a single week. The second key feature is a source of immediate funding to continue essential options minimize it by ourselves referred. The bankruptcy code was -- -- possession financing to provide any arm going through bankruptcy process. Such dip financing is not an 
 essential to maximize. -- It's. Such -- that you are quite quickly. And in the arts arms. Eat -- may not be right handers at least not after that before being placed into resolution. For these reasons funding from the FDIC trying to line treasury is available on title to it. It's important -- -- that the underlying concept has its roots as depends. Lending money to increase. In concerns about the firm. Not absorb losses. It is not a capital injection and does not put taxpayers at risk. The FIC has indicated 
 that it will in order to protect taxpayers more well. Required financing be collateralized. And if for any reason the FDIC. Recovered the amount of credit extended a short while -- -- -- -- and other large and months. That's necessary feature is a temporary stay close out rights qualified financial contract guards. The ability of subject to important creditors and it starts to nullified directing -- -- writes that counter parties. All that disruptive uncertainty drag race to -- equity firm's assets the -- 
 and instant. The FDIC authority includes the opportunity to decide whether wants to transfer. Well -- cancel contracts to corporate financial company where others. During one days statutory stay contractual rights and -- firm. As I'll discuss later this authority is not. It's limitations. Particularly across quarter context. It is critical tool for an actor resolution and national firm. With complex workflow. While I don't. -- establishes a special resolution mechanism. And grants the FDIC powers response 
 to the special challenges posed there aren't any institution. It provides only a girlfriend or not and operated description of outlaws powers would be used to resolve systemic importance. Moreover the very large financial firms that are the most likely subjects of the time. -- -- -- an extensive cross border activities and asked implicate the systems are trees. Let me now turn to both of those topics. It's important to develop an articulate critical approach to resolution. For these two reasons. First -- 
 lost creditors and counter parties have well on expectations as to how it will be treated resolution is set. They may eat charge premium to compensate with additional uncertainty. Associated with this position -- kinds. Which in turn lead to a in this price risks. In some cases particularly care increased stress nationals this. And media to deal with certain forms altogether because this happens there. Parties who have been doing short term -- have contractual arrangements with these -- and Iran. As those 
 contracts lapse there are potentially crippling the ongoing business of the firm. Cree creating adverse effects and parts of an angels -- A second reason is some sense that converts -- first. If creditors counter parties did not -- the EC can successfully resolved. And not crisis and potential for loss that should incorporate in your dealings with large firms. That is if investors and have a market actors think the prospects or oceans. Mason. Will be rest Aaron and any moral hazard present those markets 
 will continue. I specify. Which financial obligations will be maintained. And -- FDI CE book two losses well developed approach to this position and create incentives for private. Compatible with the overall games systemic. Change. The FIC made great progress in implementing time to. In particular by developing this on an approach to resolution systemic change. Under the single event you approach the FDIC you pointed receiver. Only the top here. Holding company. After the parent company is placed into 
 receivership. The FIC will transfer assets of the company to outrage oh. The firms operating subsidiaries -- and the -- will remain open for business as usual. To the extent -- The FDIC will then -- available parent holding company assets to. -- as far -- critical opera since years. Equity in you know parent company shareholders. Effectively wiped. And claims that its unsecured debt will be written as necessary to reflect any passes a resolution costs. The FDIC will ultimately exchanged -- claims unsecured 
 creditors. Or equity or names of the British Open. And return to restructure firm active product sector control. This -- approach to resolution titles here. Represents an important step forward toward ending market perception. That any US financial firms to -- too complex. The end of this event approach to stabilize you know -- court. In -- to mitigate the negative impact US financial system. Anti Jews without support -- it -- equity holders and other capital. Holders are exposed US tax -- to us. The single 
 event approach -- greatest promise that he orderly resolution of a systemic financial under title two. In part because of its potential to eight run risks and credit losses on our company creditors and they -- box. To enhance market this. In the United States the top tier companies aren't banking -- generally is not an operating company hoping. Whose primary purpose is to raise capital and direct the operations. -- six years. It's assets largely consistent cash with the securities equity interest and it's 
 it's yours. This -- organizational feature US and facilitates the single point of entry approach. Because the liabilities at the top tier holding company are structurally subordinated. To customer obligations. -- liabilities that are outraged at city. According under this approach the equity and debt at holding company level. And form a proper that must first ask for any customer -- creditors subsidiaries suffers losses. The work done FDIC building its approach to time to change. And if yes he has indicated 
 that explain this thinking and -- -- detail in public east issue here. In addition if he -- There are other ways. To enhance. For example. Federal Reserve duty FDIC -- joint responsibility. For overseeing the resolution hands. Hartford actually regulated firms -- To improve our ability systemically important change institutions. More. Our nation that was our ability of these large firms has been hurt by this resolution. Process. So -- -- ways in which organizational structure systemic. Reforms. Could -- So 
 as to facilitate this point -- approach. One would be to ensure that process picture operating subsidiaries. Including major currencies. It's pretty transferred to the resolution. The other but -- key difference. And company on operational. Otherwise clean through limits on issues short term debt. And conduct a material business operations in the the single entry strategy will be more credible and effective. -- the only creditors. Holding company. Our holders capital instruments and long term debt well 
 there's a -- where they are subject to -- as part of any time you risk -- A second way to enhance the ability of yet you guys approach is to require -- But lots of sorting capacity in large financial firms that expect to -- team. You know capital requirements conceptual. Are designed to cover losses optimists are statistical. If an extreme -- that occurs and the equity. Is wiped out. Successful resolution without taxpayer assistance would be most effectively accomplished if reform its mission. Long term 
 unsecured -- To absorb additional costs and to recapitalize the business transferred to operating com. The presence of this -- it's just identified a possible and chronic aren't concern basis. Should help out creditors clarified -- position in the orderly liquidation process. Are there aren't a long term debt could also happen and improving market discipline. Since holders -- that would face the prospect of boss should affirm and to resolution. And presumably to -- an appropriate rest. Reserves in 
 consultation the -- yes. Well the issue in the next few months proposal that would require the largest us complex banking firms. -- not so long term unsecured debt at -- This requirement. Effective preventing erosion of long term debt holdings of the largest most complex US earns. Which historical standards our car apparently Apple's. Absent more harm and does. Not expect declines in the levels as the flat yield curves of recent years. Indeed we have recently seen some evidence the beginnings of such 
 declines. At the international level yes that's he has recently announced that it will issue proposals are global standards on I'm concerned losses organs. Well systemically important financial institutions. This point and approach will also be so it presents them as efficient and accessible right types that this. To enable the nation of its material operating subsidiaries. Went mosques have eroded capital of this year's. The right out of equity imposition of haircuts -- holding company debt and -- Do not 
 themselves recapitalize the operating subsidiaries. More hope for operations this. Are more likely to wring -- hands and separately insolvency laws of their host countries. If art directors. Have full confidence that local -- would be protected. Our requirement that this east. And -- -- at the -- Issued it's -- -- it's here it's proper solution to this problem. They don't -- and would be able to reject. Its future operating subsidiaries. Actively hurting its interest. It. Only turned out that cross border 
 issues that second area where suggested its work remains -- Anyway it's time to become -- regulations. And the international. 2000 that the FSB adopted key act it's effective resolution receives financial institutions. Providing new standard for resolution aims for systemic forms. The core features of this global standard or are. Entitled to. I acting -- the passage of the act states that the way in -- development of international policy. Effective resolution genes for systemically important. The FTC's work 
 honest -- approach continues to help the terms of discussions yet that's. Moreover home countries supervisor. Of the 28 global systemically important. That idea that's. The Federal Reserve has responsibility. For establishing. And routinely beaten. Each US US. -- important act crisis management group. All -- that. Any other jurisdictions including pictures. Have not yet enacted legislation. That would create statutory. Solution. Empowers us if it's necessary. To meet -- SB's key actors. Mitigating any 
 obstacles to this resolution. Over. He foreign jurisdictions. Implement national resolution is consistent with the -- -- it's. While compatible host country resolution genes are nests or cross border resolution. May not these fish. Most important. Home country resolution that global -- so -- it is difficult if creditors are part of the purpose -- relations. As it will be domestic creditors. Excuse. Possibilities percent. Maybe reduced well developed entrance arrangements for cooperation between host -- 
 officials and -- spurns. Recent paper -- yes it is an important example of such outrage. But stand -- even the best. It's not who else obstacles. One key challenge is certain. Stabilization activists including in the newspapers. With respect to derivatives and certain other financial contracts. May not apply outside the United States. Accordingly counterparty to financial contracts with foreign subsidiaries and branches US firm. Have contractual rights and substantial economic incentives to two 
 transactions. As US enters into. Equivalent opportunity and incentives apply to her party's its US operations of our actions. My approach to addressing this. Would domestic legislature's -- and bankruptcy solvency. To Iraqi. I stay. Home country resolution proceed it's consistent with international standards. However. -- difficult to get such changes and roughly comparable terms and all relevant jurisdictions. Much has to include -- union national. These lines. -- -- Currently under consideration I read. We 
 need to seek applications standard contractual cost of -- and practices. This approach we use contractual. To achieve this pain that -- having these arrangements effective corporate partners should decisions. On trees. Of course. Even reached regulators in consultation relevant industry associations. And effective steps were taken implement this game. It could take some time that in terms that he might -- marks. And regulatory timeline could be sent to speed up the process. This approach maybe most passing 
 attack -- The resolution mechanism. Created by two is being greater operational credibility. As the FDIC builds out its point of entry. With each rule policy statement cross border. And specific resolution. It's increased. Additional measures such as I've suggested today. We'll continue to enhance this third option -- resolution -- the government officials hobson's choice that bailout disrupted bankruptcy. For systemically important for -- However. As is apparent from Iran or in. This -- Particularly 
 exclusively on cross border there's construction resolution framework remains on go and check out. Moreover. Even when a large complex are resolved -- cost taxpayers. Without provoking systemic crisis. It will very likely still be significant hit Dexter. In the financial system. And it's even -- is not too big to fail. Still lobbyists. -- patient systemic importance today it's your costs. Thus even -- policy makers try to increase prospects or resolution. Mask PG a reference to reduce prospects for the 
 failure of systemically important firm that would require -- especially Americans. -- -- -- improve going concern NC remain crucial reform agenda directed change if the objective of preventing. And reducing systemic risks passed the senate costs in the event -- -- -- cars. Complimentary. Rap and alternative policy. The most important systemic vulnerability that had not been subject to sufficient regulatory forms are that was created. Short term funding markets. In the recent financial crisis some 
 precautions were felt throughout the financial system. A short term settlement of pending against the very safest -- -- Short term funding levels at HUS and our firms weren't they were outside the crisis. Major global banks remain significant users. -- such finding increased the probability its. Problems have. And asked here major firms. Also complicate the work resolution -- major national. -- -- Precisely because an effective or resolution mechanism. Provides Ricky Jean. Shorts or short term creditors to 
 stop it that is rounds. That type of funding may not be subject to increase market this. Resulting from the creation credible resolution process. This act strengthens the case for measures to limit the potential short term goals -- to Unix out that's it's it's. As I stated apps -- only creation or liquidation. And the -- the FIC development authority. The international consensus on the similar. Dangerous actions and eighteen -- And policy news. Together constitute -- relatively. Modest success. In the world 
 the financial regulatory reforms. Let me close with an observation about the relationship each title to -- And proposals -- special chapter of the bankruptcy code adapted to circumstances. Large financial institutions. As I mentioned. Serious work is being -- various commentators on proposals to adapt the bankruptcy code. To spill -- differences between intentional and most industries. -- watched the back and forth between those officials -- charged with developing or resolution. And I was working on 
 bankruptcy -- proposals. I've known each side taking some points. This out. With attendant applications. Every ones -- Differences remain to be sure such as the trade off between one. Bankruptcy models reminds me independence of the judiciary and related process for dealing with credit card. And up the advantages. To speed. Preexisting knowledge of financial firms and -- and respect. But there has also been productive -- I joined those -- believe that the best. Medium and bankruptcy. -- existing. With the 
 former default -- in the case of -- large financial solvency. And that are mobile. Home when systemic risks more. -- adaptation of the bankruptcy to deal with large but not necessarily systemic financial firms -- itself in importance. And -- this is it to our options -- and bail out or disruptive bankers. We'll be well and anyone who remembers the position of policy makers in the fall 2000. -- That's happening here -- happiness -- -- fair very questions will be happy to take any questions from anyone. 
 Before you have to move on to the next. -- question I think. Right there's statutory mandate and the FDIC. Refers you the bankruptcy. But I think you know the convergence -- in thinking about a bankruptcy colony. Title too -- model. Reflects the fact that a substantial. Amount. We are orderly resolution. Is this gonna be very similar ones thinking in terms of actress model or in art terms any time to a special resolution. And I think I will fast enough having sat. This. Plant has been put it and actually 
 myself having read them word for word but in getting. Briefings. As its -- parties have some of these plans it it becomes apparent to immediately east that. Could get what. We would like she will be at their accuracy -- -- it. Why has the potential destination. One of these firms -- a resolution plans actually. There's a lot and he's got. Some suggestions that day. -- see it in my text I think -- act it would actually be equally applicable. Some of that and its he -- So. Now back thinking -- fourteen. Work 
 in the case of this century approach and make some modifications. Approach and again I think. About here. Would be equally useful here. -- preparing fresh off her -- pressed. So that. It's susceptibility. To do not disruptive resolution. Would be would be increased. And that which it is possible routes that one. It. Yeah. And so mark. Or so. It. There are more. -- An effort. To keep. It. -- There. That that is right and I think you're also correct in -- from my remarks about -- And and I write it I don't 
 regard that this. Eight grades generally that exists. With this system today. One that could it make the onset I'm stressed more likely Atlanta which. Resolution. Substantially more cops. And more concerned with him bankruptcy work so yeah you're right to point it. That maybe 20%. The plan that don't -- And producing different kind of challenge I think. In -- process. Well. That process will prompt both institutions. Us. I think to get a better sense of how the fine institutions particularly short term self 
 funding does create. Vulnerabilities and how those vulnerabilities. Yeah. These budget meetings for. You know -- -- I'm sure divide. It. Governor -- you provide. Assurance to their host countries supervisors that he. Situation host countries subsidiaries Wikipedia has this thing. Writes at that's an excellent question I think act. That is -- that's the answer to that. Several different kinds I think first. I think it will help if you have. Roughly compatible roughly comparable. Structures in two countries 
 these guys. -- bursts -- in. Host country. That treatment there's there's an anterior approach will be pretty well understood. If and activism and yet. -- sure. To I think that that I discussions. And again. Discussions between now and yes yes yes and then there. Bank of England and the other probably exemplary in this regard but. There's opportunity for more this on. Me in some cases trial. Basis. Everybody just a better understanding. What the other guy is gonna do. And how to do it again proceed. We're 
 finding out how recapitalization. Will take place that you have structures in the abstract. It's -- entity that when people sit down. And say okay this is this is what actions do aside and say what about this. And that's that's a lot of what we at least. -- at our house our. Its concerns. And FDIC permits are you getting from -- two point of view I think. That's what we've seen coming these areas process. Consultations. Thought the resolution plan management. So quickly colleges. Colleges provide an opera 
 which -- So so I think those of the Asian routes. I do think -- some of these questions to UNC question. And each of the -- because. That's why now and that's one winner as everybody here knows it's not -- confidence. That. -- in the country. To just say okay let's recognize. One others do and if so is this legal rights that are outs setup on them. Legal system enforceable. Traditionally rather than straight. -- and add to that degree that those of -- -- to create problems. Mine passed it yet to give 
 assurance about the whole host countries that these problems in eked out. I am as as you can tell from -- That that a lot faster our actions are probably not here because there. Yeah really thirty years now pricey -- articles pop up every once a while proposing. International resolution very user and -- you know -- international industries this. They keep -- not -- not happen. And and I think that has pushed -- it took things more in terms that our nation. The US -- themselves. Act Selanne has to be able 
 sense internalized it and our contractual arrangements. That kind of press and other provisions that would allow for this move. Resolution. Cross border basis. That in size and some -- back and forth when it. The people actually draft. Any -- that -- that are used in more standardized form that is our. Or other entities out. I think if you put all those things together. Moved towards the situation in which -- accident never going to be a 100% you know financial crises happen to be some. Question -- in which 
 people have a lot more assurance. If terrorists you know you've got. Well capitalized. Large subsidiaries as a host and then you see for example it is convertible. Debt. That is necessary the use it gives you assurance. That you can if -- our presumptive basis to. The home country. Regulator and our resolve or as it -- so I think that. Those levels of assurances that those areas points of assurance it will what will make this event. Any successful system on its instruments. It's going to be a variety of 
 these disagreements just. It structures. And importantly I think change in terms. -- Just this will be -- out there pointing the way