WASHINGTON — Federal Reserve Gov. Jerome Powell Monday said his own skepticism about the feasibility of closing down even the largest banks if necessary has given way to a belief it can be done, but years of preparation are ahead and even then some banks may remain too big to fail.

"The project will take years to complete," Powell told the Institute of International Bankers in prepared remarks. "Success is not assured."

Powell said his initial skepticism about government's capability to close down any of the nation's biggest financial institutions without a lot of damage to the economy was borne of his experience in the 1990s when there were a wave of savings and loan failures that included what was then the third largest bank failure in U.S. history.

Faced with the impending failure of the Bank of New England Corp, Treasury, the FDIC and the Federal Reserve decided they had to protect all the bank's depositors, including those over the insurance limit, "or there would likely be a run on all the money center banks the next morning," Powell said.

After protecting 200,000 deposit accounts and preventing the first big run on a bank since 1933, they were faced a few months later with the potential failure of global investment bank Salomon Brothers, an institution clearly outside the government safety net. Only hours before it would surely have failed and caused massive disruption, Salomon Brothers was resolved.

"Our 'near miss' with Salomon in 1991 presaged the enormous damage that would result from the failure of Lehman Brothers, another investment bank, in 2008," Powell said. "In fact, the dimension of the problem grew substantially over the years" and now the ratio of banking assets to GDP has more than doubled, to 126%, and "the percentage of those assets held by the largest three institutions has increased from 14 to 32 percent."

"From the outset, my earlier experience had led me to be skeptical about the possibility of resolving one of the largest financial companies without destabilizing the financial system," Powell said.

"Today's global financial institutions are of staggering size and complexity." Any attempt to close down a firm "with multiple business lines carried out through countless legal entities, across many jurisdictions and different legal systems -- could easily spin out of control," Powell believed.

Then, he said, while devising a failure simulation, "I came around to the view that it is possible to resolve a large, global financial institution."

What changed his mind, he continued, was a technique worked out by the FDIC to simplify such an endeavor, "the FDIC's innovative 'single-point-of-entry' approach, which was just coming into focus in 2011."

The approach "is a classic simplifier, making theoretically possible something that seemed impossibly complex."

The FDIC would be appointed received "of only the top-tier parent holding company" and then its assets, its investments in subsidiaries, would be transferred to a bridge holding company. Shareholders would be wiped out, and unsecured claims written down "as necessary to reflect any losses" that the shareholders couldn't cover. Remaining claims are exchanged for equity or debt claims on the bridge company and "if necessary, the FDIC would provide temporary liquidity" while the "bail-in" of the failed parent company's creditors can be accomplished.

"The critical operating subsidiaries would be well capitalized, and would remain open for business," he said.

The FDIC, he said, is working to provide the markets "as much clarity as feasible" as to how it would all work.

"As the development of the single-point-of-entry approach continues, it is important to continue to reduce the uncertainties that creditors and other market participants would face," he said.

Questions that remain are "how the FDIC will apply its broad statutory discretion," he continued. "How will the FDIC exercise its discretion to dissimilarly treat creditors of the same class? How will a creditor's "minimum right of recovery" be determined? And how will the FDIC value the failed firm?" Powell asked.

"Stability demands that market participants have a reasonable degree of certainty about their treatment," he said. "This is an important concern."

Two remaining challenges loom large, he said, "ensuring that all systemic financial firms have sufficient unsecured long-term debt at the parent level to recapitalize a bridge holding company" and working out ways to reduce the problems that will develop across borders when multinational firms are involved.

"My own view is that the framework of current reforms is promising, and should be given time to work. In any case, too big to fail must end, even if more intrusive measures prove necessary in the end."

Market News International is a real-time global news service for fixed-income and foreign exchange market professionals. See www.marketnews.com.

Subscribe Now

Independent and authoritative analysis and perspective for the bond buying industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.