New FDIC-Type Authority Urged for Closing Troubled Financial Institutions

Taking a page from the 1930s, the Obama administration is calling for a new authority, modeled after the FDIC, to allow the government to restructure failed large financial institutions in much the same way the FDIC is able to restructure failed banks.

In prepared testimony before the House Financial Services Committee on Tuesday morning, Treasury Secretary Timothy Geithner and Federal Reserve Chairman Ben Bernanke urged Congress to grant the government new authority to intervene in distressed non-bank financial institutions and put a lid on risky financial instruments and transactions.

The calls for the new authority came as both men detailed for the committee the government's actions and reasoning in propping up failed insurance giant AIG, which has been under fire for paying generous bonuses to executives while receiving government bailout funds.

"AIG highlights broad failures of our financial system. Our regulatory system was not equipped to prevent the build-up of dangerous levels of risk." Geithner said. " ... The U.S. government does not have the legal means today to manage the orderly restructuring of a large, complex non-bank financial institution that poses a threat to the stability of our financial system."

Geithner said the Obama administration is proposing legislation that will give the government the same basic tools for addressing financial distress at non-depository financial institutions as it has in the bank context. The proposed resolution authority would allow the government to provide financial assistance to make loans to an institution, purchase its obligations or assets, assume or guarantee its liabilities, and purchase an equity interest.

The parallel to the authority provided to the FDIC (Federal Deposit Insurance Corporation) to deal with failed banks is striking. The FDIC was created in 1933 in the wake of massive bank failures that helped bring on the Great Depression.

Bernanke cited the lack of such authority in limiting the government's options in dealing with the failure of AIG, whose trillion-dollar portfolio linked it to thousands of other companies around the world and threatened to pull them down with it.

"At that time, no federal entity could provide capital to stabilize AIG and no federal or state entity outside of a bankruptcy court could wind down AIG," Bernanke said. "Unfortunately, federal bankruptcy laws do not sufficiently protect the public's strong interest in ensuring the orderly resolution of non-depository financial institutions when a failure would pose substantial systemic risks, which is why I have called on the Congress to develop new emergency resolution procedures."

Had such an authority existed, administration officials have said, the government could have wound the company down more efficiently, including rescinding the controversial bonus payments to AIG executives.