I expect I am one of the only persons left who didn’t realize that MF Global is the successor to what once was the derivatives firm, Refco, which collapsed in 2006. Consequently, I wasn’t aware that this firm had endured the shame of seeking bankruptcy protection twice in the span of just a few short years. That takes some doing.
But MF Global isn’t the first member of the Dubious Distinction Club. The former FirstCity Bancorp went through receivership twice in the span of five years. The first came in 1987 due to a loan portfolio that combined the crushing burdens of energy and commercial real estate. Under new management headed by former First Chicago Corp. CEO, Robert Abboud, the company quickly touted its profitability, which was largely due to its “bad bank” arrangement with the FDIC. When those payments fell, so did the reported profitability. The company was soon hurtling back toward receivership, and the FDIC stepped in again in 1992.
Which brings us to Dodd-Frank. The 2010 financial regulatory reform bill expressly gave the FDIC power to act preemptively in the future should it believe a banking firm is failing. The goal is to quickly resolve the failure and allow the branches to open quickly for the benefit of depositors. The problem is, there is a legal precedent here that makes such preemptive action questionable, and it deals with FirstCity.
See, a funny thing happened on the way to its second bankruptcy. When the FDIC liquidated FirstCity’s assets, it generated a surplus over the company’s liabilities. In other words, its actions were too preemptive because the bank wasn’t insolvent after all. Needless to say, FirstCity shareowners and creditors sued the FDIC, and some three years later, the FDIC and the company reached a settlement that the regulator estimated to be worth $350 million (for a $10 billion institution).
Many people, including the legislators who wrote the legislation, believe it is better for the regulators to act in anticipation of failure rather than to wait and deal with a corpse post-collapse. Maybe. But as the old FirstCity case from the ’90s suggests, this strategy runs the risk of pulling the plug on a solvent institution, which is a particularly big risk for a free society.