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Fed Opponent of Glass-Steagall
Reveals the Ugly Alternative, Bail-In

Oct. 21, 2013 (EIRNS)—New York Federal Reserve president William Dudley, an enemy of Glass-Steagall for 30 years, gave a speech "explaining" Dodd-Frank Title II bank resolution at a Richmond Federal Reserve conference Oct. 18. In his 18-minute Richmond presentation, in a surprising manner for a senior Fed official promoting "bail-in", he revealed the glaring dangers of "how the so-called 'single point of entry' framework for large bank resolution will work in practice."

First, said Dudley, "even assuming resolution is successful", "over-the-counter derivatives will be outside the reach of resolution" — they won't be "bailed in" — if located outside U.S. borders (i.e., in London, origin of 50% of OTC derivatives contracts worldwide including for U.S.-based banks). The counterparties to the derivatives "and other qualified financial contracts" will likely declare the FDIC's notice of intent to "resolve" the bank, as a default event, and seize their collatoral, ignoring the one-day stay on this set in Dodd-Frank Title II. "This would also propagate stress more broadly throughout the financial system," he said.

A second characteristic of this process, Dudley said, is that "FDIC will have a sufficient credit line from the Treasury to ensure a smooth resolution"; that is, the taxpayer bailout will be there to facilitate the bail-in.

Thirdly, uncertainty as to whether a SIFI, rumored to have troubles, will be put into conservatorship or into Title II resolution, may cause "unsecured creditors' runs" on such banks, dumping their capital and provoking their failure. (This under the usual pleasant fiction that only bondholders, not depositors, are to be expropriated in bail-in.) This is the same warning just given in Europe by ECB head Mario Draghi in Italy's La Repubblica, to which Draghi evidently leaked his own letter, which pointed to such "creditors' runs" if bail-ins are tried now.

Surprisingly, Dudley even noted that such "uncertainty" might lead foreign bank regulators to attempt ring-fencing or bank separation pre-emptively against the approach of bail-in of a big U.S.-based bank.

Clearly, "bail-in" solves no problems with the banking system, much less the physical economy on which people's lives depend.