Overhaul puts more risk with shareholders

WASHINGTON – Creditors and shareholders will now have to absorb some of the losses when the federal government steps in to dismantle large failing financial firms.

The Federal Deposit Insurance Corp. on Tuesday approved the new rule that was required under the financial regulatory law enacted last summer.

“Shareholders and unsecured creditors should understand that they, not taxpayers, are at risk,” FDIC Chairman Sheila Bair said at a meeting of the agency’s five-member board.

In the federal bailouts of big financial firms in 2008-’09, many of the companies that had loaned them money had their debts covered by the government.

Under the financial overhaul law, Congress gave the FDIC the authority to wind down troubled firms and sell off their assets to protect the broader financial system. But it left some details for the FDIC to sort out.

The collapse of Lehman Brothers in the fall of 2008 prompted lawmakers to come up with a new process for dismantling teetering financial firms.

The rule allows the FDIC to make payments to some short-term creditors of the firms, such as to enable the firms to continue operating and pay employees. Creditors such as utility and software companies that provide essential services would be examples, FDIC officials said. The agency also could make payments to creditors in some cases to maximize the amount recovered for taxpayers from sales of the failing firms’ assets.

That could occur, for example, if an investor looking to buy assets of a failed firm is willing to pay a higher price if certain groups of creditors aren’t forced to take losses.

The overhaul law was enacted last July and mandated that federal regulators write hundreds of rules to put it into effect, many of them to be in final form by July of this year and others by next January.

Also Tuesday, a council of regulators including Bair, Treasury Secretary Timothy Geithner and Federal Reserve Chairman Ben Bernanke began laying out how they will enact other key provisions of the financial law, including a limit on banks’ trading and investment activities.

The so-called Volcker Rule – named after former Fed Chairman Paul Volcker – aims to stop banks from trading and investing for their own profit. Financial companies have voiced concerns about the proposed rule, saying they are worried that it will prevent them from buying and selling investments that their clients might want.

The group recommended that regulators collect new types of financial data to help spot banks that are sidestepping the rule. They want bank CEOs to swear that the companies are complying.

The study was issued by the Financial Stability Oversight Council, which was created by the law to monitor risks that span the entire financial system. The council is chaired by Geithner.