Team CoCo wins one

We interrupt our blogging hiatus for this news;

The Federal Reserve Board on Friday proposed a new rule that would strengthen the ability of the largest domestic and foreign banks operating in the United States to be resolved without extraordinary government support or taxpayer assistance.

The proposed rule would apply to domestic firms identified by the Board as global systemically important banks (GSIBs) and to the U.S. operations of foreign GSIBs. These institutions would be required to meet a new long-term debt requirement and a new "total loss-absorbing capacity," or TLAC, requirement. The requirements will bolster financial stability by improving the ability of banks covered by the rule to withstand financial stress and failure without imposing losses on taxpayers.

To reduce the systemic impact of the failure of a GSIB, an orderly resolution process should allow a GSIB to fail, and its investors to suffer losses, while the critical operations of the firm continue to function. Requiring GSIBs to hold sufficient amounts of long-term debt, which can be converted to equity during resolution, would facilitate this by providing a source of private capital to support the firms' critical operations during resolution.

Our bold in the above. Long time readers of this blog will immediately recognize our enthusiasm for the idea of using contingent convertible debentures to provide managers of banks with a powerful market incentive to not take too much risk in the first place. We could point to numerous posts, such as this one from almost a year ago;

HSIB has noted the enthusiasm for this form of bank self-regulation on the part of Columbia economist Charles Calomiris;

...the Columbia economist offers a suggestion to improve the banking system;

 I would establish a minimum uninsured debt requirement for large banks in the form of subordinated debt, known as contingent capital certificates, or "CoCos." The CoCos would automatically convert to equity based on predetermined market triggers, which would be very dilutive to pre-existing shareholders. One banker who understood my proposal for CoCo's said, "You are putting an electric fence behind me."

The potential for dilution of stockholder equity being the key incentive for management to work to prevent that from happening.

Calomiris has said, in speeches, that the Federal Reserve has had the legal authority to do this since the 1999 Gramm, Leach, Bliley Act, but chose not to implement that reform. Now would be a good time to listen to Charlie.

That's right, the 1999 legislative handiwork--which, btw, did not 'repeal Glass-Steagall'--of former Texas A&M economist Phil Gramm is finally being implemented 16 years after it was authorized. Unfortunately, seven years too late to have prevented the financial crisis of 2008.