Bail-in is Admitted to be probable trigger

November 5, 2013 • 12:01PM

First, European Central Bank chairman Mario Draghi's letter to the EC chief was revealed, warning that "bank bail-ins" had better not be tried in the current environment because their mere possibility would trigger "bondholders' runs" potentially causing big, systemic banks to fail.

Then the Richmond Federal Reserve's Oct. 16 "bail-in seminar" saw three top Fed officials — presidents William Dudley of the New York Fed, Jeffrey Lacker of Richmond, and Fed governor Daniel Tarullo — making clear, even as they praised Title II of the Dodd-Frank Act, they they did not want to use it or even to be seen as expecting to use it.

Dudley made clear, like Draghi, that "uncertainties" surrounding the approach of a bail-in of a big bank could make bondholders bail out, fast, triggering its failure. He acknowledged that the likely privileged position of "derivatives and other qualified financial contracts," escaping bail-in while bondholders and likely uninsured depositors were confiscated, "would ... propagate stress more broadly throughout the financial system" in a crisis. And he added, "FDIC will have a sufficient credit line from the Treasury to ensure a smooth resolution"; that is, the taxpayer bailout will have to be there to facilitate the bail-in.

FDIC vice-chairman Thomas Hoenig, after giving a speech on "a 21st-Century Glass-Steagall Act" at George Washington University Oct. 31, was asked by EIR about the three Fed officials' fear and loathing of bail-in. Hoenig indicated the Oct. 16 Richmond event comments about bail-in were being much discussed. He said, "The only way to prevent "bailing out the bail-in" is to restructure the big banks beforehand as I've proposed [i.e., on the Glass-Steagall principle]. Then you can use a well-prepared Title I bankruptcy [traditional FDIC bank conservatorship] and it's an idiosyncratic event — only that one bank, doesn't hit all the banks. But if we [FDIC] find ourselves in Title II, that means we have a systemic crisis, and no Treasury Secretary is going to say, 'Let them fail.'"