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Advantage in capital costs could be offset by resolution fund fee

By MarketWatch

WASHINGTON (MarketWatch) - Big banks might have a competitive advantage in capital costs over their smaller competitors under the proposed financial reform bill that would designate the big banks as "systemically important," but the advantage would be slight, according to trade groups and financial experts.

Any advantage in capital costs would have to be weighed against other provisions of the bill that would raise costs for big banks, including limits on leverage, capital requirements, higher fees for deposit insurance, and the requirement that all the systemically important firms would have to pay 100% of the costs of the liquidation of any one of them.

As the Senate convenes Monday to vote on moving the financial regulatory overhaul bill forward, lawmakers will consider the consequences of essentially labeling companies that could bring the system down if they were to fail. There is controversy over how the bill gives the government the power to perform a controlled liquidation of a firm that is failing.

In a party-line vote, Democrats passed the measure sponsored by Sen. Chris Dodd, D-Conn., through the Senate Banking Committee in March. Republicans including Senate Minority Leader Mitch McConnell, R-Ky., say that the language in the bill does exactly the opposite of ending "too big to fail."

The bill sets up a method to wind down the operations of "systemically important" companies using a fund ultimately paid for by those same financial giants, intending to end taxpayer bailouts for too-big-to-fail firms. The resolution authority in the bill would wipe out shareholders, management and many creditors of a failed company, just as a bankruptcy does.

But some secured creditors could receive at least partial payments, as the government would try to protect the financial system from the collapse of a huge bank. Those payments create a moral hazard because if creditors think they'll get paid back, they could be more willing to lend against risky assets and more willing give a discount to bigger banks.

Creditors are still nervous that they would lose out in the event of a major collapse, said John Dearie, an executive vice president for policy at the Financial Services Forum. "There are a lot of terms and concepts being used as if they are synonymous," Dearie said. "Potential shareholders and unsecured creditors understand what this bill would mean, which is they would likely lose their investment if the financial institution went into resolution."

The members of the FSF are the chief executive officers of 19 of those large institutions, including Goldman Sachs (NYSE:GS) , JP Morgan (NYSE:JPM) and Citigroup (NYSE:C) .

"If there is a credible resolution framework, even if an institution is designated as systemically significant, you can be taken down in a controlled way and are not too big to fail," Dearie said.

In a recent memo to House Minority Leader John Boehner, R-Ohio, the Lindsey Group contended that Wall Street firms like the resolution provision because they will benefit from having lower borrowing costs. The Lindsey Group is an economic consulting firm headed by three former economic advisers to President George W. Bush.

Douglas Elliott, a fellow at the Brookings Institute, believes the big firms will benefit from lower costs, but only marginally. Brookings is a non-profit public policy organization based in Washington.

"Creditors will be a little more willing to lend and they'll charge a little bit less," Elliott said. "But it's not worth more than 2 basis points," or 0.02%.

"On the one hand, it gives the top 20 firms an advantage; but it subjects the top 20 firms with a special fee they need to pay that could partially offset that advantage," said Rep. Brad Sherman, D-Calif.

Elliott contended that the government must deal with these systemically important companies in some way. "There's not a way around it other than the government to take a suicide pact" by allowing them to fail, as Lehman Bros. did.

"Almost anybody can list three or four systemically important companies, whether Congress lists them that way or not," said Jack Coffee, a law professor at Columbia University. "The failure for any of these firms would set off a panic."

Coffee includes Goldman Sachs, Citigroup, JP Morgan and Bank of America (NYSE:BAC) on the list of companies that are clearly systemically important. Those companies are at the top of a list of risky institutions compiled by scholars at New York University.

 

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The Financial Services Forum is a non-partisan financial and economic policy organization comprising the CEOs of 18 of the largest and most diversified financial services institutions doing business in the United States.

The purpose of the Forum is to pursue policies that encourage savings and investment, promote an open and competitive global marketplace, and ensure the opportunity of people everywhere to participate fully and productively in the 21st-century global economy.