US seeks power to wind up 'too big to fail' firms

Government determined to make failing institutions pay for their risk-taking

Shareholders and bondholders in the biggest US financial firms can no longer expect government bailouts, under a reform plan designed to ensure no company is ever again deemed "too big to fail".

The White House and Congressional leaders are close to a consensus on a new mechanism by which even firms woven deep into the fabric of the financial system can be wound down in an orderly way by regulators.

The new laws are intended to avoid a repeat of last year's spectacle, in which the US government was forced to step in to resolve spiralling problems at a string of mighty financial firms. Panicked politicians and regulators at the time believed that the sudden collapse of firms such as Fannie Mae, AIG and Morgan Stanley could bring down the other firms that traded with them – and, ultimately, the financial system itself.

The Financial Services Committee in the US House of Representatives was last night close to publishing legislative proposals, agreed with the Obama administration, that would push the costs of dealing with failed firms on to the finance industry itself.

Most importantly, the plan would give the government legal authority to quickly wipe out shareholders and impose new terms on bondholders in the failed firms, as well as fire managers. Until now, the choice has been between using taxpayers' money to shore up the companies or allowing them to fall into bankruptcy, with drawn-out and unpredictable consequences. The bankruptcy filing of Lehman Brothers, then the fourth-largest investment bank, triggered a financial panic.

A new government-run mechanism for resolving crises at big firms was the best way to ensure that shareholders, bondholders and company managements could be held responsible for the consequences of their risk-taking, but without endangering the financial system, said Sheila Bair, the banking regulator.

Ms Bair, who runs the US bank deposit protection fund called the Federal Deposit Insurance Corp, was speaking at the American Bankers Association conference in Chicago yesterday. "We need to end 'too big to fail'," she said.

The task of unwinding the giant firms would fall to the FDIC under the new proposals, in the same way that the regulator is currently responsible for winding up the retail banks whose deposits it insures. This year, more than 100 small banks have failed in the US, and their assets sold to rivals by the FDIC.

The principles that the FDIC must use under its new powers, however, will be dictated by a larger committee of regulators, which will also include the Treasury Secretary and the head of the Federal Reserve.

The Obama administration backed away from giving the Fed overall responsibility after opposition on Capitol Hill. There has been wrangling, too, over whether government money could be used upfront to help the orderly wind-down of firms, and how it should be paid back later.