There are Three, not Two, Kinds of Financial Institutions in the New Resolution Regime

Recent events at CIT have led observers to focus on the apparent differences between financial institutions deemed too-big-to-fail and others, the “haves” and the “have nots,” respectively. But to make that simple distinction is to ignore broader developments in regulatory policy. Too-big-to-fail has been around far too long for there to have been so little progress made in resolving large banks. Favorable de facto developments in resolution policy (what is actually happening, rather than what is supposed to or is proposed to happen) increase hopes of a sensible regulatory approach going forward, albeit one far less radical than the White House’s proposed financial reforms. Finance, however, can never be far removed from politics. Hence, it makes sense to analyze financial policy through the lens of political economy, rather than a narrower view of economic efficiency.

In reality, therefore, there appear to be three sets of institutions separated not by “systemic risk” or even ability to resolve (too-big-to-fail), but by political connectedness: (1) Too-connected-to-ignore; (2) Not-connected-enough-to-matter, and (3) Too-big-to-payout. I review each of those in turn.

The top set of institutions (not all of them banks) in this hierarchy are those that suffered in the recent crisis but promised to be around afterward to play their part in future lobbying efforts. Those institutions were able to attract government assistance, whether indirectly through support for their counterparties or directly through special loans or capital assistance in the name of “systemic risk.” Those institutions are demonstrating the benefits and advantages of their status in recent earnings announcements showing stellar financial performance while others continue to suffer. Those are the institutions that Neil Barofsky, Special Inspector General for TARP, is targeting (in a politically palatable approach) for better disclosure. Those “too-connected-to-ignore” institutions have worked hard to make sure the crisis only temporarily affected their earnings, lobbying hard for protected status and receiving such from a favorable Treasury that cowed a central bank with little real understanding of modern financial arrangements (and that is still trying to catch up from behind the curve).

The next set of institutions is being identified by recent appeals for forbearance or government aid that are repeatedly rebuffed by Administration officials. Those medium- to large-sized institutions receive no special dispensation regardless of their support for or performance in mortgage modification efforts (e.g., First Federal Bank of California),  importance to small business lending (e.g., Advanta, CIT), or ability to absorb distressed assets (e.g., private equity and venture capital firms). Those institutions are argued to pose little or no “systemic risk,” and cannot be conceived to be important for economic growth, individually. Equally important, weak banks in this category can be shut down and disposed of within the FDIC’s budget, thereby posing little or no political risk to bank regulators or their funding sources.

The last set of institutions cannot be resolved by traditional means within current FDIC programs, but resolution is keeping apace, nonetheless. It should be clear by now that both Citi and Bank of America have been working closely with the FDIC to restructure their operations in a manner that could result in a combination of asset sales and a core going concern. While it remains to be seen whether the going concerns will be a substantially different size from the current operations, the point, nonetheless, is that both institutions are being taken through a “resolution lite,” a confidential procedural mechanism to stabilize the operations using at least the intent, if not the legal and regulatory rules, of bridge bank mechanisms and influence. Hence, the FDIC continues to develop its large bank resolution techniques, and those still seem to be effective at getting the attention of large diversified bank holding companies, despite Administration rhetoric.

Finance can never be far removed from politics and politics is all about appearances. Hence, it is important to separate de jure regulatory authority from what is actually happening in the crisis. Large weak banks are being resolved, and contrary to the allegations of “too-big-to-fail.” Political influence, however, has (once again) expanded the liberal use of Federal Reserve section 13(3) emergency powers, linking those with similar uncodified Treasury extensions to form a new source of de facto government backstop that is already being critically leveraged by institutions that have proven in the crisis they are “too-connected-to-fail,” albeit politically, not economically, connected.

† Hermann Moyse, Jr./Louisiana Bankers Association Professor of Finance, Louisiana State University, Senior Fellow at the Wharton School, and Partner, Empiris LLC. Contact information:; (202) 683-8909 office. Copyright Joseph R. Mason, 2009. All rights reserved. Past commentaries and testimony are blogged on