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April International Finance Seminar Harvard Law School

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April International Finance Seminar Harvard Law School Powered By Docstoc
					                      David Sheeren


                      April 23, 2010

               International Finance: Seminar

                    Professor Hal Scott




U.S. POLICY TOWARD FOREIGN BANKS DURING THE FINANCIAL
 CRISIS: LESSONS FOR CROSS-BORDER BANKING REGULATION
  U.S. POLICY TOWARD FOREIGN BANKS DURING THE FINANCIAL
   CRISIS: LESSONS FOR CROSS-BORDER BANKING REGULATION
                                                    Table of Contents

I. INTRODUCTION ............................................................................................................... 5

II. BACKGROUND ............................................................................................................... 5

   A. THE ECONOMIC BENEFITS OF CROSS-BORDER BANKING ........................................... 5
   B. SUMMARY OF CURRENT U.S. POLICY APPROACH TOWARD FOREIGN BANKS ............ 7
   C. THE STRUCTURE OF FOREIGN BANKING ACTIVITY IN THE U.S. ............................... 11
III. U.S. POLICY TOWARD FOREIGN BANKS DURING THE FINANCIAL CRISIS ............. 13

   A. TERM AUCTION FACILITY ........................................................................................ 15
   B.   AIG BAILOUT ............................................................................................................. 17

   C. ASSET-BACKED COMMERCIAL PAPER MONEY MARKET MUTUAL FUND LIQUIDITY
             FACILITY ............................................................................................................. 22
   D. CAPITAL PURCHASE PROGRAM ................................................................................ 23
   E. COMMERCIAL PAPER FUNDING FACILITY ................................................................. 31
   F. INCREASE IN FDIC DEPOSIT INSURANCE .................................................................. 32
   G. TEMPORARY LIQUIDITY GUARANTEE PROGRAM ...................................................... 34
   H. TERM ASSET-BACKED LENDING FACILITY ............................................................... 36
   I. CITIGROUP AND BANK OF AMERICA ASSET GUARANTEE PROGRAMS ........................ 36
   J. PUBLIC-PRIVATE INVESTMENT PROGRAM ................................................................. 38
IV. GENERAL POLICY PROBLEMS .................................................................................. 39

   A. THE HIGH COSTS OF BANK BAILOUTS ...................................................................... 39
   B. HOME–HOST COUNTRY CONFLICTS WITH RESPECT TO CROSS-BORDER BANKS ..... 43
V. POLICY SOLUTIONS .................................................................................................... 49

   A. SUBSIDIARIZATION (MAKING CROSS-BORDER BANKS LESS “CROSS-BORDER”) ..... 50
   B. BURDEN SHARING .................................................................................................... 58
   C. HOST COUNTRY EMERGENCY LIQUIDITY ASSISTANCE TO BRANCHES OF FOREIGN
             BANKS………………………………………………………………… ............ 68
VI. CONCLUSION ............................................................................................................. 80


                                                                 2
 U.S. POLICY TOWARD FOREIGN BANKS DURING THE FINANCIAL
  CRISIS: LESSONS FOR CROSS-BORDER BANKING REGULATION
                                Index of Tables



TABLE 1:    Legal Structure of U.S. Operations of Foreign Banks (Dec. 2009)

TABLE 2:    Total U.S. Banking Assets (Dec. 2009)

TABLE 3:    Legal Structure of U.S. Operations of Foreign Banks (June 2008)

TABLE 4:    Total U.S. Banking Assets (June 2008)

TABLE 5:    Location of Uninsured Branches of Foreign Banks

Table 6:    Branches and Subsidiaries of Foreign Banks With More Than $50 Billion
            in U.S. Assets

Table 7:    Foreign Banks With More Than $50 Billion in U.S. Assets Across All of
            Their U.S. Operations

TABLE 8:    Banks With Assets Greater Than $50 Billion

TABLE 9:    Legal Structure of U.S. Operations of Foreign Banks by Home Country

TABLE 10:   Federal Reserve Liquidity Programs For Which Branches and Subsidiaries
            of Foreign Banks Were Eligible

TABLE 11:   Federal Reserve Liquidity Programs For Which Branches and Subsidiaries
            of Foreign Banks Were Eligible (Showing Total Fed Assets)

TABLE 12:   Reproduction of AIG Schedule A: Collateral Postings Under AIGFP CDS

TABLE 13:   Selected Quotations from Sept. 29, 2008 House of Representatives Debate
            On the Emergency Economic Stabilization Act of 2008

TABLE 14:   Selected Quotations from Oct. 3, 2008 House of Representatives Debate
            On the Emergency Economic Stabilization Act of 2008

TABLE 15:   Eligibility of Branches and Subsidiaries of Foreign Banks in U.S.
            Financial Stabilization Programs For Which U.S. Banks Were Eligible




                                        3
 U.S. POLICY TOWARD FOREIGN BANKS DURING THE FINANCIAL
  CRISIS: LESSONS FOR CROSS-BORDER BANKING REGULATION
                                          Abstract



         This paper analyzes U.S. policy toward foreign-owned banks during the financial
crisis. I show that U.S. operations of foreign banks were generally eligible to participate
in the financial stabilization programs in which domestic banks were eligible to
participate, with one important exception: the Capital Purchase Program, which was the
U.S. program to directly re-capitalize the banking sector. I ask whether the financial
crisis illustrates more general policy dilemmas with respect to cross-border banking
regulation. An important question, for example, is whether, and when, host country
taxpayers should be “on the hook” for emergency assistance to foreign-owned banks. I
evaluate several approaches to allocating the burden of rescuing a cross-border bank
between home and host countries. First, I critique an ex ante burden sharing model
proposed by Dirk Schoenmaker and Charles Goodhart. Second, I discuss a policy
approach for which there appears to be growing support: the conversion of branches of
foreign banks into subsidiaries, a process known as “subsidiarization.” I show that ex
ante burden sharing is theoretically satisfying but politically infeasible and that
subsidiarization, in contrast, is theoretically unsatisfying yet politically feasible, probably
dangerously so. I conclude by questioning the provision of host country emergency
liquidity assistance to branches of foreign banks. I suggest that the home country should
instead bear the full burden of such assistance and that this change would further weaken
the case for subsidiarization.




                                               4
I. INTRODUCTION

         The paper is divided into four sections. First, I provide general background on the

role of foreign-owned banks1 in the U.S. economy, summarize the current regulatory

approach toward foreign-owned banks in the U.S., and describe the legal and economic

structure of foreign-owned banks in the U.S. Second, I survey the treatment of foreign-

owned banks in the various stabilization programs undertaken by the U.S. government in

response to the financial crisis of 2007-2009. I limit my analysis to programs in which

domestic banks were eligible to participate and show that foreign-owned banks were

broadly eligible to participate in these stabilization programs, with one important

exception: the Capital Purchase Program, through which the U.S. government directly re-

capitalized the banking sector. Third, I show how the treatment of foreign-owned banks

in the financial crisis illustrates a more general policy dilemma: the difficult allocation of

the burden of rescuing cross-border banks. Fourth, I introduce and critique several

approaches to the allocation of this burden between home and host countries in the

context of broader efforts to overhaul financial markets regulation. I conclude by

suggesting that the home country should bear the full burden of extraordinary liquidity

assistance to branches of foreign banks.

II. BACKGROUND

         A. THE ECONOMIC BENEFITS OF CROSS-BORDER BANKING

         Foreign banks play a vital role in the U.S. economy, providing credit to American

businesses, thousands of jobs to American workers, and liquidity to financial markets.


1
   For clarity, when I refer to foreign-owned banks, I include branches and subsidiaries of foreign banks. I
refer specifically to “branches” or “subsidiaries” of foreign banks whenever that distinction is important, as
it often is.


                                                      5
As of December 2009, foreign-owned banks held approximately $3 trillion in assets in

the U.S., accounting for approximately 25 percent of the total assets held by all banks in

the U.S.2 As of June 2008, the last data available prior to the financial crisis, foreign-

owned banks held approximately $3.1 trillion in assets in the U.S., accounting for

approximately 29 percent of the total assets held by all banks in the U.S.3 A conservative

estimate of foreign-owned banks’ share of commercial and industrial loans, perhaps the

best measure of direct loans to businesses, stood at 22 percent of total commercial and

industrial loans as of June 2008, and 21 percent as of December 2009.4

            Foreign-owned banks also employ thousands of people in the U.S. According to

the Institute for International Bankers, foreign-owned banks directly employed

approximately 250,000 workers in the U.S. as of December 2006.5 Approximately

84,000 of these employees were located in New York, New Jersey, or Connecticut.6

These figures do not take into account the multiplier effects that these operations have on

overall U.S. employment levels.7

            More generally, cross-border banks play an important role in the global economy.

Cross-border banks facilitate credit for international trade, strengthen cross-border
2
    See Tables 1 and 2.
3
    See Tables 3 and 4.
4
  See Tables 2 and 4. As those tables explain, due to data availability, the figures for Commercial and
Industrial loans are based only on the loans held by branches and agencies of foreign banks. If loans held
by subsidiaries of foreign banks were included, these amounts would be significantly higher.
5
  Economic Benefits to the United States From the Activities of International Banks, INSTITUTE OF
INTERNATIONAL BANKERS, February 2008, available at http://iib.org/associations/6316/files/
2008EcoBenefitStudy.pdf.
6
    Id. at 9.
7
  The Institute of International Bankers report estimates that, under the direct-multiplier approach
developed by the Bureau of Economic Analysis of the U.S. Department of Commerce, domestic operations
of foreign banks indirectly created more than 826,000 additional jobs throughout the economy. See id. at 6.



                                                     6
economic ties, and facilitate the flow of capital and liquidity to areas of the globe where

those resources can be put to their best use.8 Cross-border banks are especially well-

positioned to service multinational companies operating throughout the world. U.S.

operations of Japanese banks, for example, are well-positioned to service Japanese

companies engaging in economic activity in the U.S., whether through international trade

or through direct investment. Thus, cross-border banking reduces the cost of capital for

multinational companies. Finally, there is at least some evidence that host country

economies benefit more generally from the entry of foreign banking activity.9

         B. SUMMARY OF CURRENT U.S. POLICY APPROACH TOWARD FOREIGN BANKS

         Perhaps the most important policy challenge with respect to cross-border banks is

the allocation of regulatory and supervisory responsibilities between the home and host

countries.10 Under current U.S. policy, this allocation primarily depends on whether the

cross-border bank operates in the United States as a subsidiary, or as a branch.11 There




8
  See, e.g., Stijn Claessens and Neeltje van Horen, Being a Foreigner Among Domestic Banks: Asset or
Liability?, 2009 INT’L MONETARY FUND WORKING PAPER, available at http://www.imf.org/
external/pubs/ft/wp/2009/wp09273.pdf (surveying foreign bank performance and noting the efficiency of
large foreign banks).
9
  See, e.g., Joe Peek and Eric S. Rosengren, Implications of the Globalization of the Banking Sector: The
Latin American Experience, NEW ENG. ECON. REV. 45 (2000); James R. Barth and Gerald Caprio, Jr. and
Daniel E. Nolle, Comparative International Characteristics of Banking, OFFICE OF THE COMPTROLLER OF
THE CURRENCY (Jan. 2004).

10
  A related, but distinct question is the allocation of the burden of rescuing a failed or failing cross-border
bank. This concept is explored in § IV(A), infra.
11
   Branches and subsidiaries are the two dominant legal structures for foreign-headquartered banks
operating in the United States. See Tables 1 and 3 for more detail on the other operations of foreign
headquartered banks in the United States. Because of data reporting issues, the discussion here of branches
may sometimes include agencies. The key difference between branches and agencies is that agencies can
only accept deposits from foreigners. Agencies of foreign banks play a minor role in the U.S. banking
sector, however, as shown by Tables 1 and 3.



                                                       7
are two fundamental differences between the branch and subsidiary structures, one legal

and the other economic.12

          First, the legal difference. U.S. subsidiaries of foreign banks are separate legal

entities, chartered either with the Office of the Comptroller of Currency or with state

banking agencies, and are regulated largely as if they were domestic banks. Branches, in

contrast, are mere extensions of the parent bank and are subject to more relaxed U.S.

regulation and supervision. That said, both the Federal Reserve and either the

Comptroller of the Currency or a state banking agency must approve a branch license.

Specifically, the Federal Reserve must determine that the branch’s foreign parent is

subject to “comprehensive supervision or regulation on a consolidated basis by the

appropriate authorities in its home country.”13 Also, branches of foreign banks may be

subject to local asset pledges, and may also be subject to asset maintenance requirements

under certain conditions.14 The Federal Reserve and state banking agencies, which

periodically examine branches, may shut down a branch under various scenarios,




12
   For a general overview of the branch-subsidiary contrast in other markets, see Eva H.G. Hupkes, The
Legal Framework for Foreign Bank Entry, 1 BANK AND BANK SYSTEMS 4, 5 (2006), available at
http://www.businessperspectives.org/journals_free/bbs/BBS_en_2006_04_Hupkes.pdf.
13
     See 12 U.S.C. § 3105.
14
   For general background, see Robert A. Eisenbeis and George G. Kaufman, Bank Crisis Resolution and
Foreign-Owned Banks, 90 FED. RES. BANK OF ATLANTA: ECON. REV. (2005). See also N.Y. State Banking
Law §202-b and Parts 51 and 322 of the N.Y. State Banking Regulations. In New York, branches of
foreign banks are required to pledge one percent of the average total liabilities of the branch, excluding
amounts owed to affiliates of the branch’s parent (i.e. third party liabilities). There is a sliding scale for
average total liabilities above $1 billion, dropping to ¼ of one percent for third party liabilities exceeding
$5 billion, with a cap on the total pledge of $100 million. For more information on the asset pledge
requirement, see http://www.banking.state.ny.us/ legal/ar322lt.htm. Also, in New York, the Superintendent
may impose asset maintenance requirements “in such form and subject to such conditions as he or she shall
deem necessary or desirable for the maintenance of a sound financial condition, the protection of
depositors and the public interest, and to maintain public confidence in the business of such branch or
branches or such agency or agencies.” See N.Y. State Banking Law §202-b.



                                                      8
including when a branch is engaged in an unsound banking practice, or whose parent is

deemed not to be subject to comprehensive consolidated supervision as described above.

         Second, the economic difference. Subsidiaries maintain their own balance sheets

and largely operate as “stand-alone” banks with their own capital structure. Branches, in

contrast, lend against their parent’s capital. Therefore, the health of a branch greatly

depends on the health of the parent, and branches almost certainly do not fail unless their

parent fails.15 Also, except for a handful of branches established before 1991, branches

may not accept domestic deposits below $250,000 and are not insured by the FDIC.16

Branches can accept deposits from foreigners in any amount, but those deposits are not

covered by FDIC depository insurance.

         The U.S. approach to home-host country responsibilities for cross-border banks

tracks the Basel agreements concerning home and host country responsibilities.

Supervisory responsibilities of home and host countries were first laid out in the 1975

Basel Concordat on the supervision of internationally active banks.17 The basic vision of

that document, while somewhat difficult to pin down, has largely remained the same over

the years.18 First, the Concordat notes that responsibility for supervising the liquidity of



15
  See, e.g., George G. Kaufman, Bank Regulation and Foreign-Owned Banks, 67 RES. BANK OF NEW
ZEALAND: BULLETIN 65, 71 (2004); Joe Peek and Eric S. Rosengren, Collateral Damage: Effects of the
Japanese Bank Crisis on Real Activity in the United States, 90 THE AM. ECON. REV. 30 (2000).
16
   The maximum depository insurance amount was increased from $100,000 to $250,00 during the
financial crisis. This increase is effective at least through December 31, 2013. See § III(F), infra.
17
  Basel Committee: Report on the Supervision of Banks' Foreign Establishments – Concordat, BANK OF
INT’L SETTLEMENTS, September 1975, at 3, available at http://www.bis.org/publ/bcbs00a.pdf?noframes=1.
18
  The Concordat was revised in 1979 to give the home country authority explicit oversight of the entire
consolidated balance sheet of the parent bank, including foreign subsidiaries and branches, but still left the
host country with responsibility for the stand-alone solvency of subsidiaries. See Richard J. Herring,
Conflicts Between Home and Host Country Prudential Supervisors, in INTERNATIONAL FINANCIAL
STABILITY: GLOBAL BANKING AND NATIONAL REGULATION 201, (Douglas D. Evanoff, George G.


                                                      9
branches and subsidiaries “rest[s] in the first place with the host country,” although

liquidity may be a concern to the parent authorities as well.19 Importantly, in the U.S.,

branches of foreign banks that hold reserves with a Federal Reserve Bank may access the

Discount Window, which can be a key source of liquidity to banks.20 Second, under the

Concordat, the solvency of branches is “essentially a matter for parent supervisory

authorities” while the solvency of subsidiaries of foreign banks primarily rests with host

authorities.21 Subsequent Basel documents have elaborated that the home and host

countries share responsibility for the subsidiary’s solvency.22 To generalize, then, the

host’s responsibilities with respect to branches are largely limited to liquidity supervision,

while the host’s responsibilities with respect to subsidiaries are similar to those owed to

purely domestic banks, including liquidity and capital supervision.

           The allocation of supervisory and regulatory burdens between home and host

countries is a more delicate balance in the case of branches than in the case of

subsidiaries.23 There are several reasons for this.24 First, home countries tend to have

better information about the health of the branch’s parent, which is vital to the health of

the branch. Second, host countries are faced with the possibility that, in the event of



Kaufman & John R. LaBrosse eds., 2007) (describing the Basel approach with respect to conflicts between
home and host country prudential supervisors).
19
     See Basel Concordat (1975), supra note 17 at 3.
20
   See The Federal Reserve Discount Window, available at http://www.frbdiscountwindow.org/
discountwindowbook.cfm.
21
     See Basel Concordat (1975), supra note 17 at 3–4.
22
     See, e.g., Basel Committee Report (1983); Herring, supra note 18.
23
     See generally Eisenbeis and Kaufman (2005), supra note 14.
24
   For an overview of the particular problems with branches of foreign banks, see Hal Scott, Supervision of
International Banking Post-BCCI, 8 GA. ST. L. REV. 487 (1992).


                                                       10
financial distress, the parent bank could withdraw needed assets or liquidity from the

branch. Given this risk, host countries are more likely to pre-emptively “ring-fence” the

assets of the branch if they suspect that a branch is in distress.25 Subsidiaries, by contrast,

are “structurally” ring-fenced in the host country, so there is less ambiguity with respect

to asset withdrawal. Third, the home and host countries are likely to have different

approaches to bank regulation, resolution procedures, and depository insurance. These

legal differences lead to ambiguity and sometimes distrust between home and host

country regulators, especially in the case of branches. These differences are likely to

exacerbate host country fears about asset withdrawal, and may lead to a lack of effective

coordination in the event that the bank needs to be re-capitalized or needs to access

extraordinary liquidity.

           C. THE STRUCTURE OF FOREIGN BANKING ACTIVITY IN THE U.S.

           As described above, branches and subsidiaries of foreign banks play an important

role in the U.S. economy. This section summarizes Federal Reserve data on the structure

of the U.S. operations of foreign banks. Tables 1 through 9 provide more detailed

information on this structure. Among the most important observations from this data—

collected as of December 2009 unless otherwise noted26 —are that:

           (1) foreign-owned banks hold approximately 25 percent of total U.S. banking

                   assets27;




25
     Id.
26
   As the Tables describe, the data as of December 2009 was substantially similar to data as of June 2008,
the last data available prior to the peak of the financial crisis in the fall of 2008.
27
     See Tables 1 and 2.



                                                    11
           (2) branches and agencies hold 64 percent of all U.S. assets held by foreign-

                    owned banks, and subsidiaries hold 32 percent of all U.S. assets held by

                    foreign-owned banks28;

           (3) New York-licensed branches hold 88 percent of total U.S. branch assets, and

                    49 percent of total U.S. assets held by foreign-owned banks29;

           (4) 9 branches hold more than $50 billion in U.S. assets30;

           (5) 7 subsidiaries hold more than $50 billion in U.S. assets31;

           (6) 21 foreign banks hold more than $50 billion in U.S. assets if one aggregates

                    the assets held by all of their U.S. banking operations32;

           (7) 26 domestic (i.e. not foreign-owned) banks hold more than $50 billion in U.S.

                    assets33;

           (8) 88 percent of assets held by foreign-owned banks are held by banks from nine

                    home countries (in descending order according to assets held): United

                    Kingdom, France, Canada, Japan, Germany, Spain, Ireland, Netherlands,

                    and Switzerland.34

           As these figures and the supporting tables show, foreign-owned banks in general,

and branches in particular, play an important role in the U.S. banking sector. New York

is a key host to foreign banks, serving as the home to the lion’s share of branches of
28
     See Table 1.
29
     See Table 5.
30
     See Table 6.
31
     Id.
32
     See Table 7.
33
     See Table 8.
34
     See Table 9.


                                                 12
foreign banks and half of all of the assets held in the U.S. by foreign-owned banks. Also,

there are a significant number of foreign-owned banks with U.S. assets in excess of $50

billion, an important threshold in the recent legislative proposals covering financial

institutions. For example, $50 billion in assets is the threshold for inclusion in the

recently proposed bank levies and taxes.35 16 U.S. subsidiaries or branches of foreign

banks have assets in excess of $50 billion, while 26 purely domestic banks have assets in

excess of $50 billion.36 Although total assets have been criticized as a proxy for the

systemic risk posed by a financial institution,37 recent legislative proposals suggest that

there is a reasonable possibility that total assets will play a role in ultimate legislation on

systemic risk. In any event, given the obvious importance of foreign-owned banks to the

U.S. banking sector, and the significant presence of foreign-owned banks among banks

holding more than $50 billion in U.S. assets, it is somewhat surprising that the unique

regulatory challenges with respect to foreign-owned banks have not received more

attention in the current policy discussions on financial markets regulation.

III. U.S. POLICY TOWARD FOREIGN BANKS DURING THE FINANCIAL

CRISIS

35
   On December 11, 2009, the U.S. House of Representatives approved H.R. 4173, the “Wall Street
Reform and Consumer Protection Act of 2009.” That bill uses assets to determine whether a financial
company is subject to the assessments that would fund a systemic dissolution fund, and banks with more
than $50 billion in assets would be subject to the assessments. See HOUSE COMMITTEE ON FINANCIAL
SERVICES, available at http://financialservices.house.gov/Key_Issues/Financial_Regulatory_Reform/
Financial_Regulatory_Reform.html; On January 14, 2010, President Obama announced a proposal for a
levy on financial institution liabilities to recover bailout money. The levy would apply to financial
companies with assets of $50 billion or more. See Julianna Goldman, Obama Says Bank Fee Aimed at
Recovering Rescue Money, BLOOMBERG NEWS, Jan. 14, 2010.
36
     See Table 8.
37
   See, e.g., Why ‘Too Big to Fail’ is Too Short-Sighted to Succeed: Problems with Reliance on Firm Size
for Systemic Risk Determination, NERA Economic Consulting (Jan. 2010), prepared for Property Casualty
Insurers Association of America, available at http://www.nera.com/image/PUB_PCI_TooBigToFail.pdf.



                                                   13
           The extensive efforts of the U.S. government to restore stability to financial

markets have been well-documented.38 One aspect of these measures that has received

relatively little attention, however, is the treatment of foreign-owned institutions in the

stabilization programs. With the notable exception of the media reaction to the decision

to compensate foreign counterparties to AIG’s credit default swaps,39 there has been

surprisingly little discussion of how the U.S. bailout programs treated foreign institutions,

and whether that approach was appropriate. One important question in this analysis is

whether U.S. taxpayers should be “on the hook” for the re-capitalization of, or the

emergency provision of liquidity to, foreign-owned banks.40 The rest of this section

presents, in roughly chronological order, selected U.S. government stabilization programs

and analyzes how foreign-owned banks were treated in those programs. The analysis is

limited to programs in response to the financial crisis of 2007-2009 in which domestic

banks were eligible to participate. Hence, there is no discussion about stabilization

programs unrelated to domestic banks, such as the automaker bailouts. Although such

programs may also raise important questions with respect to U.S. treatment of foreign

firms in other ways,41 this paper is limited to the banking sector. The programs discussed

here begin in December 2007 with the Federal Reserve’s announcement of the Term


38
   The U.S. government established a website dedicated to documenting efforts to restore stability to the
financial system. See http://www.financialstability.gov. The financial crisis has also been the subject of
hundreds, if not thousands, of books and academic articles.
39
     See § III(B), infra.
40
     Id.
41
    For example, the automaker bailouts may raise questions about U.S. compliance with its commitments
under international trade law, especially with respect to non-discrimination. For a comprehensive
discussion of the relationship between the national bailouts and international economic law, see Anne Van
Aaken and Jurgen Kurtz, Prudence or Discrimination? Emergency Measures, The Global Financial Crisis
and International Economic Law, 12 J. OF INT’L ECON. L. 859 (2009).



                                                     14
Auction Facility, and go through March 2009 with the announcement of the Public-

Private Investment Program.

           A. TERM AUCTION FACILITY

           On December 12, 2007, with the credit crunch in full swing and short-term inter-

bank lending drying up,42 the Federal Reserve Board announced the creation of the Term

Auction Facility (TAF).43 Under TAF, the Federal Reserve would auction term funds to

depository institutions against the wide variety of collateral that could be used to secure

loans at the Discount Window.44 The stated purpose of TAF was to “address elevated

pressures in short-term funding markets.” Some analysts speculated that TAF was a way

for banks to access Discount Window-like credit without incurring the stigma attached to

the Discount Window.45 In later publications, the Federal Reserve has indicated that

TAF was closely tied to the central bank’s role as lender of last resort.46



42
     See, e.g., David Roche, The Global Money Machine, THE WALL STREET JOURNAL, Dec. 14, 2007.
43
   Federal Reserve Press Release, Dec. 12, 2007, available at http://www.federalreserve.gov/newsevents/
press/monetary/20071212a.htm.
44
     Id.
45
   See, e.g., Scott Patterson, Ahead of the Tape, THE WALL STREET JOURNAL, Dec. 19, 2007 (“[TAF] is
conceived to be a laser-guided cash injection to help thaw frozen credit markets. Lenders, wary of toxic
subprime holdings at other banks, have been reluctant to make short-term loans to one another. They have
also been wary of going to the Fed's discount window for loans directly from the Fed, for fear of being
stigmatized.”).
46
   The Federal Reserve has categorized its efforts to restore stability to the financial markets into three
groups. The first group, closely tied to the Federal Reserve’s lender-of-last-resort role, included TAF, the
Discount Window, the Primary Dealer Credit Facility (PDCF), central bank currency swaps with 14 foreign
central banks, and the Term Securities Lending Facility (TSLF). PDCF and TSLF were programs in which
only the primary dealers could participate, and therefore this paper does not discuss those programs. The
Federal Reserve’s second classification of programs involved the provision of liquidity directly to
institutions in key credit markets. These programs included the Commercial Paper Funding Facility
(CPFF), discussed in § III(E), the Asset-Backed Money Market Lending Facility (AMLF), discussed in §
III(C), the Term Asset-Backed Securities Loan Facility (TALF), discussed in § III(H), and the Money
Market Investor Funding Facility (MMIF), which is not discussed here because eligibility was limited to
money market mutual funds. The Federal Reserve’s third classification of programs involved the purchase
of long-term securities directly for the Federal Reserve’s portfolio. Federal Reserve programs in this


                                                    15
           All depository institutions eligible to borrow under the Primary Credit program

were eligible to participate in the TAF auctions.47 To qualify for the Primary Credit

program, in turn, a depository institution must have access to the Federal Reserve’s

Discount Window and be in generally sound financial condition as determined by its

Reserve Bank.48 As mentioned above, U.S. branches and agencies of foreign banks that

hold reserves at a Federal Reserve bank have access to the Discount Window on the same

terms and conditions as domestic depository institutions.49 Therefore, U.S. domestic

branches and agencies were eligible to participate in TAF as long as they were deemed

“generally sound” by their Reserve Bank and held reserves at their Federal Reserve bank.

In addition, U.S. subsidiaries that held reserves at a Federal Reserve bank could also

participate in the TAF auctions.50

           One unique feature of TAF is that the Federal Reserve announced the program in

the context of coordination with several foreign central banks, which undertook similar

measures in their own countries.51 Specifically, the Bank of Canada, the Bank of

England, the European Central Bank, and the Swiss National Bank undertook similar

measures.52 The explicit coordination of TAF with programs of other significant central



category are the direct purchases of GSE debt, mortgage-backed securities, and longer-term Treasury
securities, through the primary dealers. See http://www.federalreserve.gov/monetarypolicy
/bst_crisisresponse.htm.
47
     See Federal Reserve Press Release, supra note 43.
48
   See The Federal Reserve Discount Window, available at http://www.frbdiscountwindow.org/
discountwindowbook.cfm.
49
     Id.
50
     Id.
51
     See Federal Reserve Press Release, supra note 44.
52
     Id.


                                                     16
banks distinguishes TAF from many subsequent measures by the Federal Reserve to

provide liquidity to U.S. operations of foreign banks. In subsequent programs, as will be

explored below, the Federal Reserve actions lacked at least the appearance of such

coordination.

        Credit under TAF grew to one of the largest assets on the Federal Reserve’s

balance sheet in 2009.53 In early March of 2009, TAF credit amounted to approximately

$493 billion, or about 25 percent of the Federal Reserve’s total assets. See Tables 10 and

11 for a more detailed presentation of key components of the Federal Reserve balance

sheet from 2007 through 2010. Although credit under TAF substantially declined

throughout 2009, TAF was certainly one of the key facilities through which the Federal

Reserve provided liquidity to financial markets. Despite the TAF and other Federal

Reserve programs during the first three quarters of 2008,54 however, the financial markets

did not stabilize. In fact, the worst of the financial crisis had yet to arrive.

        B.   AIG BAILOUT

        On September 16, 2008, the day after Lehman filed for bankruptcy, the Federal

Reserve Board authorized the Federal Reserve Bank of New York to lend up to $85

billion to the American International Group (AIG), exercising authority under Section



53
    See Federal Reserve System Monthly Report on Credit and Liquidity Programs and the
Balance Sheet, at 2 (Feb. 2010), available at http://www.federalreserve.gov/monetarypolicy/
files/monthlyclbsreport201002.pdf. See also Tables 10 and 11.
54
    In March 2008, the Federal Reserve created the Term Securities Lending Facility (TSLF), but that
program was only extended to the primary dealers. See Term Security Lending Facility: Program Terms
and Conditions, FEDERAL RESERVE BANK OF NEW YORK, available at http://www.newyorkfed.org/markets/
tslf_terms.html. Also, in March 2008, the Federal Reserve created the Primary Dealer Credit Facility
(PDCF), but that program was also only extended to the primary dealers. See Primary Dealer Credit
Facility: Program Terms and Conditions, FEDERAL RESERVE BANK OF NEW YORK, available at
http://www.newyorkfed.org/markets/pdcf_terms.html. Because TSLF and PDCF were only extended to
primary dealers, this paper does not analyze those programs.



                                                   17
13(3) of the Federal Reserve Act,55 which authorizes the Federal Reserve to extend credit

in the event of “unusual and exigent circumstances.”56 The loan was collateralized by all

of AIG’s assets, including the stock of substantially all of AIG’s subsidiaries.57 As a

result of the loan terms, the U.S. government received a 79.9 percent equity interest in

AIG.58

          Federal Reserve assistance allowed AIG to meet collateral calls on a variety of

CDS contracts, and eventually to terminate the CDS contracts.59 It has been widely

reported that AIG’s payments to counterparties, including the fair market value of the

counterparty assets plus collateral payments, amounted to face value for the CDOs


55
  See Federal Reserve Press Release, Sept. 16, 2008, available at http://www.federalreserve.gov/
newsevents/press/other/20080916a.htm.
56
   See Federal Reserve Act § 13(3) (“In unusual and exigent circumstances, the Board of Governors of the
Federal Reserve System . . . may authorize any Federal reserve bank . . . to discount for any individual,
partnership, or corporation, notes, drafts, and bills of exchange when such notes, drafts, and bills of
exchange are indorsed or otherwise secured to the satisfaction of the Federal Reserve bank: Provided, That
before discounting any such note, draft, or bill of exchange . . . the Federal reserve bank shall obtain
evidence that such individual, partnership, or corporation is unable to secure adequate credit
accommodations from other banking institutions. All such discounts for individuals, partnerships, or
corporations shall be subject to such limitations, restrictions, and regulations as the Board of Governors of
the Federal Reserve System may prescribe.”).
57
     See Federal Reserve Press Release, supra note 55.
58
   See id. On November 10, 2008, the Federal Reserve and the U.S. Department of Treasury announced a
restructuring of the support to AIG. Under this restructuring, Treasury purchased $40 billion of preferred
shares of AIG under TARP, part of the proceeds of which was used to reduce the Federal Reserve loan
from $85 billion to $60 billion; the interest rate on the AIG loan was reduced, and the Federal Reserve
Bank of New York was authorized to establish two new lending facilities for AIG under which special
purpose entities would purchase residential mortgage backed securities and collateralized debt obligations
from AIG (Maiden Lane III). See Federal Reserve Press Release, Nov. 10, 2008, available at
http://www.federalreserve.gov/newsevents/press/other/20081110a.htm. On March 2, 2009, the AIG
support was further restructured. Under the March 2009 restructuring, AIG received $30 billion of
additional TARP capital, and Treasury exchanged its $40 billion of preferred shares of AIG for new shares
that more closely resembled common equity. Finally, AIG’s credit facility with the Federal Reserve Bank
of New York was reduced from $60 billion to $25 billion and the terms were modified. See Federal
Reserve Press Release, Mar. 2, 2009, available at http://www.federalreserve.gov/newsevents/press/other/
20090302a.htm.
59
  See, e.g., Serena Ng and Liam Pleven, New AIG Rescue Is Bank Blessing—Buyers of Insurer's Default
Swaps Would Recover Most of Their Money, THE WALL STREET JOURNAL, Nov. 12, 2008.



                                                     18
underlying AIGFP’s CDS portfolio.60 Subsequent disclosures and statements from AIG’s

counterparties, however, indicate that AIG had already posted substantial collateral to its

counterparties at the time the government intervened, and that AIG’s counterparties may

have already hedged their AIG exposures.61 In March 2009, AIG released a redacted

version of the schedule of payments (“Schedule A”) to AIG’s CDS counterparties,

identifying the counterparties and the amounts transferred.62 An un-redacted version of

this list was obtained by Representative Darrel Issa (R-CA) in January 2010, identifying

the particular securities on which the CDS contracts were written.63 Importantly, these

disclosures showed that a large number of AIG’s counterparties were foreign banks.64 As

Table 12 shows, 68 percent of the collateral flowing to AIG’s CDS counterparties went to

foreign banks. The payments to foreign banks immediately drew criticism in the press

and from prominent Congressmen.65 The AIG loan has been perhaps the most


60
   See, e.g., Serena Ng and Carrick Mollenkamp, New York Fed Caved in to AIG Creditors, THE WALL
STREET JOURNAL, Nov. 17 2009; Factors Affecting Efforts to Limit Payments to AIG Counterparties,
REPORT OF THE SPECIAL INSPECTOR GENERAL FOR THE TROUBLED ASSET RELIEF PROGRAM, Nov. 17, 2009,
available at http://www.sigtarp.gov/reports/audit/2009/Factors_Affecting_Efforts_to_Limit_Payments_
to_AIG_Counterparties.pdf.
61
  Goldman Sachs has stated that if AIG had failed, Goldman would have had both the collateral posted by
AIG and the proceeds from the CDS protection that it purchased and therefore would not have incurred any
material economic loss. See Overview of Goldman Sachs’ Interaction with AIG and Goldman Sachs’
Approach to Risk Management, Goldman Sachs, March 20, 2009, available at
http://www2.goldmansachs.com/our-firm/on-the-issues/viewpoint/viewpoint-articles/aig-summary.html.
62
  See AIG Press Release, Mar. 15, 2009, available at http://www.aig.com/aigweb/internet/en/files/
Counterparties150309RELonly_tcm385-155648.pdf. See also Attachment A, listing the various
counterparties and the amounts they received, available at http://www.aig.com/aigweb/internet/en/files/
CounterpartyAttachments031809_tcm385-155645.pdf.
63
  See Lavonne Kuykendall, AIG Details Troubled Derivatives, THE WALL STREET JOURNAL, Jan. 30,
2010. The un-redacted Schedule A is available at http://static.reuters.com/resources/media/editorial/
20100127/Schedule%20A.pdf.
64
     See Table 12, reproducing Schedule A.
65
 See, e.g., Liam Pleven, Serena Ng and Sudeep Reddy, AIG Faces Growing Wrath Over Payouts, THE
WALL STREET JOURNAL, Mar. 16, 2009.



                                                    19
controversial element of all of the U.S. stabilization measures undertaken from 2009-

2010, and it is often labeled the “backdoor” bailout.66 It has been subject to intense

media scrutiny, sparked congressional hearings,67 and prompted a report by the Special

Inspector General for the Troubled Asset Relief Program, Neil Barofsky (“SIGTARP

Report”).68

           Many unanswered questions remain about the AIG bailout, but the most important

outstanding question with respect to the subject of this paper is why there was no

distinction made between AIG’s foreign and domestic CDS counterparties. In discussing

the decision to cancel the contracts, the SIGTARP Report explains that Federal Reserve

officials “determined that [they] would not treat the counterparties differently, and, in

particular, would not treat domestic banks differently from foreign banks.”69 In

particular, the SIGTARP Report states that Federal Reserve officials felt that treating

foreign counterparties differently than domestic counterparties would have been

inconsistent with principles found in Section 4 of the Federal Reserve Act (requiring the

Federal Reserve to treat member and non-member banks equally) and the principles of

national treatment and equality of competitive opportunity found in the International




66
   See, e.g., Rep. Bachus: We Must End AIG-Style Bailouts, U.S. FED NEWS, Nov. 18, 2009 (quoting
Representative Bachus, the top Republican on the Financial Services Committee, as saying: “Even more
troubling is the fact that the FRBNY, then under the leadership of Tim Geithner, failed to receive any
voluntary concessions by using a strategy that was doomed to fail. What resulted was nothing more than a
backdoor bailout of AIG's largest counterparties, both foreign and domestic, at the expense of taxpayers.”).
67
  See, e.g., Hearing on Factors Affecting Efforts to Limit Payments to AIG Counterparties, Committee on
Government Oversight and Reform, Jan. 27, 2010.
68
     REPORT OF SIGTARP, Nov. 17, 2009, supra note 60.
69
     Id. at 33.



                                                    20
Banking Act of 1978 (requiring that domestic banks and foreign banks be treated

equally).70

           This explanation has been repeated by Federal Reserve officials themselves.

Thomas C. Baxter, Jr., General Counsel of the Federal Reserve Bank of New York,

addressed the issue in his written testimony to a January 27, 2010 hearing of the

Committee on Government Oversight and Reform.71 Mr. Baxter explained that treating

domestic and foreign counterparties differently would have “violate[d] the principle of

equality of treatment, a fundamental value of the Federal Reserve.”72

           Second, the SIGTARP Report notes that the Federal Reserve attempted but was

unsuccessful in extracting concessions from foreign regulators, in particular the French

regulator, Commission Bancair.73 According to the SIGTARP Report, the French

regulator and the French banks led U.S. officials to believe that it would have been

criminal under French law to accept such haircuts, as long as AIG was not in

bankruptcy.74 Testifying before Congress in January 2010, however, Mr. Barofsky noted

that subsequent to the release of the SIGTARP Report, Mr. Barofsky was informed by the

French regulators that they had believed that an exception was possible and had been




70
     Id. at 23.
71
  Thomas C. Baxter, Jr., Written Testimony Submitted to the Hearing on Factors Affecting Efforts to
Limit Payments to AIG Counterparties, Committee on Government Oversight and Reform, Jan. 27, 2010,
available at http://oversight.house.gov/index.php?option=com_content&task=view&id=4756& Itemid=2.
72
     Id. at 14.
73
     REPORT OF SIGTARP, Nov. 17, 2009, supra note 60, at 18.
74
     Id.



                                                   21
willing to discuss potential concessions.75 Although Mr. Barofksy explained in his

testimony that the French regulators did not identify particular statements to the New

York Federal Reserve officials, he explains that they claimed not to have “slammed the

door” to continued discussions with the Federal Reserve.76

           C. ASSET-BACKED COMMERCIAL PAPER MONEY MARKET MUTUAL FUND
           LIQUIDITY FACILITY

           On September 19, 2008, exercising authority under Sections 10B77 and 13(3)78 of

the Federal Reserve Act, the Federal Reserve announced the creation of the “Asset-

Backed Commercial Paper Money Market Mutual Fund Liquidity Facility” (AMLF) to

extend non-recourse loans to U.S. depository institutions and bank holding companies to

finance their purchase of high-quality asset-backed commercial paper from money

market mutual funds.79 According to the Federal Reserve, AMLF was designed to “help

restore liquidity to the [asset-backed commercial paper] markets and thereby to help

money funds meet demands for redemption.”80 The program became effective on




75
  Neil Barofsky, Written Testimony Submitted to the Hearing on Factors Affecting Efforts to Limit
Payments to AIG Counterparties, Committee on Government Oversight and Reform, Jan. 27, 2010, at 14.
Available at http://oversight.house.gov/index.php?option=com_content&task=view&id= 4756&Itemid=2.
76
     Id.
77
  Section 10B of the Federal Reserve Act authorizes Federal Reserve Banks to make advances to
depository institutions. See http://www.federalreserve.gov/aboutthefed/section10b.htm.
78
   Section 13(3) of the Federal Reserve Act permits the Board of Governors, in “unusual and exigent
circumstances,” to authorize Reserve Banks to extend credit to individuals, partnerships, and corporations
that are unable to obtain adequate credit accommodations. See http://www.federalreserve.gov/aboutthefed/
section13.htm. See also supra note 56.
79
   Federal Reserve Press Release, Sept. 19, 2008, available at http://www.federalreserve.gov/newsevents/
press/monetary/20080919a.htm.
80
     Id.



                                                   22
September 22, 2008 and expired on February 1, 2010.81 U.S. subsidiaries, branches, and

agencies of foreign banks were eligible to participate in this program.82 It was not

necessary that borrowers under AMLF held a Master Account at the Federal Reserve,83

implying that banks could participate in AMLF even if they did not hold reserves at the

Federal Reserve. Hence, AMLF invited essentially all U.S. operations of foreign banks

to participate, whether or not they held reserves at a Federal Reserve bank.

           D. CAPITAL PURCHASE PROGRAM

           The week of September 13, 2008 through September 17, 2008 was among the

most extraordinary weeks in the history of American finance. The events of that week

included the bankruptcy filing of Lehman Brothers,84 the purchase of Merrill Lynch by

Bank of America,85 the rescue of AIG by the Federal Reserve,86 the “breaking of the

buck” at the Reserve Primary Money Fund, 87 and an SEC ban on short-selling of

financial sector stocks.88 These events made it clear to market participants and regulators

alike that the financial system itself was at risk. In response, the U.S. government


81
 See Frequently-Asked Questions on AMLF, available at http://www.frbdiscountwindow.org/
mmmf.cfm?hdrID=14#f3.
82
     Id.
83
     Id.
84
     Lehman Bros. Hldgs Statement re Bankruptcy, REGULATORY NEWS SERVICE, Sept. 15, 2008.
85
   Bank of America Buys Merrill Lynch Creating Unique Financial Services Firm, P.R. NEWSWIRE, Sept.
15, 2008.
86
  Federal Reserve Press Release, Sept. 16, 2008, available at http://www.federalreserve.gov/
newsevents/press/other/20080916a.htm.
87
  Diana B. Henriques, Money Market Fund Warns Its Customers Face Losses, THE NEW YORK TIMES,
Sept. 17, 2008 (noting that the net asset value of The Primary Fund had fallen to 97 cents on the dollar).
88
  SEC Issues New Rules to Protect Investors Against Naked Short Selling Abuses, SEC NEWS DIGEST,
Sept. 17, 2008.



                                                     23
admirably undertook a series of unprecedented actions to restore confidence in the

markets. Perhaps the most drastic action taken in response to the events of that week was

a proposal by the U.S. government to purchase $700 billion of “troubled assets” directly

from financial institutions. The proposal to purchase troubled assets eventually turned

into a plan for the U.S. government to directly inject capital into troubled financial

institutions in the form of preferred stock. This program became known as the Capital

Purchase Program (CPP). The treatment of foreign-owned banks in the CPP is among

the most fascinating elements of the CPP’s history.

          On Saturday morning, September 20, 2008, in response to the extraordinary

events of the previous week, the U.S. Treasury Department submitted draft legislation to

Congress for authority to purchase up to $700 billion of troubled assets from financial

institutions.89 Under that draft legislation, the Treasury Secretary would have broad

authorization to purchase mortgage-related assets from any financial institution with its

headquarters in the United States.90 By restricting eligibility to U.S.-headquartered

institutions, this Saturday morning proposal appeared to exclude U.S. operations of

foreign banks. Almost immediately, however, the Administration moved to broaden the

institutions that would be eligible to participate in the program. By Saturday evening,

just hours after the initial announcement, the Administration issued a Fact Sheet that

expanded eligibility to foreign-owned banks.91 Specifically, the Saturday evening Fact


89
     Text-U.S. Treasury Proposal for Asset-Purchase Fund, REUTERS NEWS, Sept. 20, 2008, 10:16 A.M.
90
   See id. (“The Secretary is authorized to purchase, and to make and fund commitments to purchase, on
such terms and conditions as determined by the Secretary, mortgage-related assets from any financial
institution having its headquarters in the United States.”).
91
   U.S. Treasury Keeps Options Open on Asset Purchases, REUTERS NEWS, Sept. 20, 2008, 7:43 P.M.
(“The U.S. Treasury Department said on Saturday that its financial rescue plan could permit it to buy assets
beyond those backed by mortgages and potentially buy them from foreign holders.”).


                                                    24
Sheet stipulated that financial institutions would be required to “have significant

operations in the U.S., unless the Secretary makes a determination, in consultation with

the Chairman of the Federal Reserve, that broader eligibility is necessary to effectively

stabilize financial markets.”92 Remarkably, the Administration also appeared to be

asking Congress for discretion to include financial institutions without a significant

presence in the United States. The Fact Sheet read as if the Administration wanted

unlimited discretion to determine the eligible financial institutions, wherever located.

           On Sunday, September 21st, Secretary Paulson appeared on television to advocate

for the plan. Asked by George Stephanopoulos on ABC’s “This Week” about the

apparent expansion of eligibility to foreign financial institutions, Secretary Paulson

explained:

                  “If a financial institution has business operations in the
                  United States, hires people in the United States, if they are
                  clogged with illiquid assets, they have the same impact on
                  the American people as any other institution. That's a
                  distinction without a difference to the American people.
                  The key here is about protecting the system. Now, I need
                  to say to you that we have a global financial system, and
                  we are talking very aggressively with other countries
                  around the world and encouraging them to do similar
                  things, and I believe a number of them will. But
                  remember, this is about protecting the American people
                  and protecting the taxpayers, and the American people
                  don’t care who owns the financial institutions. If a
                  financial institution in this country has problems, it will
                  have the same impact whether it’s U.S. or foreign-
                  owned.”93 (emphasis added)




92
     Id.
93
   This Week with George Stephanopoulos, Sept. 21, 2008, video available at
http://abcnews.go.com/ThisWeek/story?id=5850225&page=1.



                                                  25
         The Administration’s push to include foreign-owned banks quickly illustrated the

political sensitivity of including foreign banks in any U.S. bailout program. Hundreds of

news articles documented the about-face with respect to the participation of foreign-

owned banks, and noted that foreign institutions had been intensely lobbying to be

included in the program.94 It quickly became clear that trying to sell a bailout of foreign-

owned banks to the American people was going to be a very difficult proposition.

         Also, efforts by the Administration to rally support from foreign governments to

roll out similar programs proved fruitless at first. Reportedly, one of the

Administration’s strategies to build foreign support was to offer preferences to banks

from countries that showed a willingness to help the American effort.95 Apparently,

however, at the time that Treasury unveiled the American program, the feeling in some

countries was that the financial crisis was a U.S. problem that deserved a U.S. solution.96

Whatever the reason for the foreign resistance, the other G7 members quickly made clear

that they were not willing to create their own programs to buy bad assets.97 In October


94
   See, e.g., Elizabeth Williamson, The Financial Crisis: Banks Rush to Shape Rescue Plan—Lobbyists
Face Small Window; No Time for Subtlety, THE WALL STREET JOURNAL, Sept. 22, 2008 (noting that bank
lobbyists had won the inclusion of foreign-owned banks in the bailout plan over the weekend, but that
influential Democrats like Senator Durbin opposed including foreign-owned banks); Nelson D. Schwartz
and Carter Dougherty, Foreign Banks Hope and American Bailout Will be Global, THE NEW YORK TIMES,
Sept. 22, 2008 (chronicling the efforts of foreign bank lobbyists over the weekend and discussing
objections to the inclusion of foreign-owned banks).
95
   See, e.g., Mark Landler and Carter Dougherty, Foreign Nations Pledge Support, but Not Financing, for
Bailout Proposal, THE NEW YORK TIMES, Sept. 23, 2008 (quoting an anonymous source at Treasury: “We
expect other countries to do their part, but we're not insisting their programs be exactly like ours . . . . We're
certainly not prepared to put ourselves in a position where there's a free-rider problem.”).
96
   Carter Dougherty and Matthew Saltmarsh, Europe and Japan Balk at U.S. Request on Bank Aid, THE
NEW YORK TIMES, Sept. 23, 2008 (''There's a view in Europe that this is a U.S.-made problem, and that it
should be solved in the U.S.,'' said Charles H. Dallara, the managing director of the Institute for
International Finance, a group of more than 300 global banks.”).
97
   Id. (noting that the G7 countries had rebuffed American requests to bail out banks in the manner being
proposed in the United States).



                                                       26
and November, however, G7 countries announced a variety of bank re-capitalization and

financial market stabilization plans.98

            On September 29, 2008, the House of Representatives debated the bill submitted

by the Treasury Department requesting authority to purchase troubled assets. With

respect to the eligibility of foreign banks, the final language required that a financial

institution have “significant operations in the United States” but did not grant Treasury

the discretion to “determine otherwise,” as Treasury had asked for on September 20th.99

The bill also excluded any financial institution owned by a foreign government.100

Hence, the Administration had backed down from asking for unlimited discretion to

include institutions without a significant presence in the U.S. See Table 13 for the

precise language of the bill.

            Following a passionate debate, the House of Representatives voted on September

29, 2008 to reject the bill, by a vote of 228 to 205.101 In response to the failure of the bill,

the Dow Jones lost 778 points, its largest point decline in history and the biggest single-

day percentage decline since the 1987 stock market crash.102 If one assumes that the

content of the House debate provides insight into the actual reasons that the bill was
98
   For an overview of European responses to the financial crisis, see Ana Petrovic and Ralf Tutsch,
National Rescue Measures in Response to the Current Financial Crisis, EUROPEAN CENTRAL BANK LEGAL
WORKING PAPERS 8 (July 2009), available at http://www.ecb.int/pub/pdf/scplps/ ecblwp8.pdf. Although a
detailed study of other countries’ stabilization programs is outside the scope of this paper, an initial review
of those programs indicates that subsidiaries of foreign banks were generally excluded from the bank re-
capitalization programs announced by the major banking countries. There is at least one exception to this:
in the UK, Abbey National—which was acquired by Santander in 2004 and is a wholly-owned subsidiary
of Santander—was re-capitalized by the UK. See 2008 Credit Guarantee Scheme, United Kingdom Debt
Management Office, available at http://www.dmo.gov.uk/index.aspx?page=CGS/CGSEligible.
99
      See H.R. 3997, 110th Cong. (2008). See also Table 13 for the precise language.
100
      Id.
101
      U.S. House Rejects $700-bln Wall Street Bailout Bill, REUTERS NEWS, Sept. 29, 2008.
102
      Dow Sets Record Point Drop as House Rejects Bailout, REUTERS NEWS, Sept. 29, 2008.



                                                      27
rejected, it is clear that the inclusion of foreign-owned banks was an important factor in

its rejection. Table 13 collects some of the comments made during the House of

Representatives debate with respect to foreign bank participation in the program.

Perhaps not surprisingly, not a single Representative came to the defense of foreign-

owned banks. To the Congressmen, the foreign ownership of financial institutions was

not a “distinction without a difference,” as Secretary Paulson had suggested on

television.103 In the view of the bill’s strongest opponents, it was simply an unnecessary

taxpayer bailout of Wall Street and foreign banks.104

           The markets and the Administration were clearly disappointed that the bill was

rejected.105 Even Microsoft’s General Counsel, Brad Smith, weighed in, issuing a

statement urging to the House to “reconsider and to support legislation that will re-instill

confidence and stability in the financial markets.”106 Congress did not give up on the bill,

however, and the Senate quickly put another bill to a vote. Late in the evening on

Wednesday, October 1, 2008, the Senate passed a revised version of the bill, The

Emergency Economic Stabilization Act of 2008 (EESA),107 by a vote of 74 to 25.108 The

Senate bill included additional tax breaks for business, energy, and the middle class, and



103
      See Secretary Paulson Interview on ABC’s This Week, supra note 93.
104
      See Tables 13 and 14.
105
   See, e.g., Heather Landy and Renae Merle, A Record Fall on Wall St.; Stocks Dive As Bailout Bill Fails
To Pass, THE WASHINGTON POST, Sept. 30, 2008; Campaign '08: Candidates Try to Sidestep Fallout of
Failed Vote—McCain, Obama Each Say Bailout Must Be Passed, THE WALL STREET JOURNAL, Sept. 30,
2008.
106
      Business Hits Back After U.S. Congress Bailout Vote, REUTERS NEWS, Sept. 29, 2008.
107
      Emergency Economic Stabilization Act of 2008, H.R. 1424, 110th Cong. (2008).
108
      U.S. Senate Passes Historic Financial Bailout Bill, REUTERS NEWS, Oct. 1, 2008, 9:47 P.M.



                                                     28
increased depository insurance from $100,000 to $250,000.109 By October 3, the House

passed the bill by a vote of 263 to 171,110 and President Bush promptly signed it into

law.111

            Interestingly, however, the final version of EESA signed into law by President

Bush had the exact same language with respect to foreign eligibility as the initial bill

rejected by the House of Representatives on September 29, 2008.112 The final bill

defined eligible financial institutions to include U.S. operations of foreign banks.113

Although the language had not changed, the House of Representatives’ second debate

over the bailout bill did not focus on the foreign eligibility. See Table 14 for relevant

excerpts from that debate. This could be due to several factors. First, the House’s earlier

rejection of the bailout had clearly shocked the markets, and it would have been difficult

to imagine a repeat of that experience, especially given the Senate’s passage of the bill.

Second, there were significant changes to the bill that may have persuaded the

Representatives that it was a good bill overall, despite the apparent inclusion of foreign-

owned banks. Third, in the second House debate on the bill, Representative Blunt (R-

MO) actually entered into the Record a letter that he had received from Secretary


109
      Id.
110
      See Table 14 for relevant quotes from the second House of Representatives debate on the bill.
111
   U.S. House Passes Bailout, Sends to Bush, REUTERS NEWS, Oct. 3, 2008; U.S. House Grits Teeth,
Approves Wall St. Bailout, REUTERS NEWS, Oct. 3, 2008.
112
    Id. (“Financial Institution” was defined as “any institution, including, but not limited to, any bank,
savings association, credit union, security broker or dealer, or insurance company, established and
regulated under the laws of the United States or any State, territory, or possession of the United States . .
. and having significant operations in the United States, but excluding any central bank of, or institution
owned by, a foreign government.”) (emphasis added); see also Table 13 for the complete relevant
language.
113
      Emergency Economic Stabilization Act of 2008, H.R. 1424, 110th Cong. (2008).



                                                      29
Paulson, which stated that “The Act requires that eligible financial institutions must be

established and regulated and have significant operations in the United States.”114 Mr.

Blunt interpreted Mr. Paulson’s letter to mean that “they’re not talking about foreign

banks.”115 Thus, it is possible, though I highly doubt, that at least some Congressmen

had the impression that Treasury would exclude foreign-owned banks from the actual

bailout programs. The language of the bill explicitly said otherwise.

            In any event, although the final statutory language of EESA gave Treasury the

discretion to include foreign banks with significant U.S. operations in any program

carried out under the authority of the EESA, Treasury did not exercise that discretion in

carrying out the CPP. On October 14, 2008, the Treasury Department announced that it

would make available $250 billion of capital to U.S. institutions, in the form of a direct

preferred stock investment.116 The term sheet for the program made clear that any

institution controlled by a foreign bank would not be eligible for the program.117 Thus,

although the final language of EESA gave Treasury the discretion to include U.S.

operations of foreign banks in the program, Treasury chose to exclude them from CPP.

In other programs authorized by EESA, however, Treasury, the FDIC, and the Federal

Reserve have included U.S. operations of foreign banks.118 The CPP is an exception in

this regard. On October 28, 2008, Treasury purchased a total of $125 billion in preferred
114
      See Table 14.
115
      Id.
116
    U.S. Department of Treasury Press Release, Oct. 14, 2008, available at http://www.ustreas.gov/press/
releases/hp1207.htm.
117
    Term Sheet for TARP Capital Purchase Program, U.S. DEPARTMENT OF TREASURY, available at
http://www.ustreas.gov/press/releases/reports/document5hp1207.pdf.
118
   U.S. government stabilization measures undertaken at least in part under EESA include the Commercial
Paper Funding Facility (CPFF) and the Term Asset-Backed Securities Loan Facility (TALF). See Table 15.



                                                   30
stock in nine U.S. banks under the program, followed by additional purchases in many

other banks.119 Despite lobbying efforts,120 eligibility was never expanded to foreign-

owned banks, and not a single branch or subsidiary of a foreign bank ever received CPP

capital injections.

            E. COMMERCIAL PAPER FUNDING FACILITY

            On October 7, 2008, the Federal Reserve announced the creation of the

Commercial Paper Funding Facility (CPFF).121 The stated purpose of the program was to

help provide liquidity to term funding markets and to provide a liquidity backstop to

issuers of commercial paper.122 Under the CPFF, the Federal Reserve would create a

Special Purpose Vehicle (SPV) that would purchase three-month unsecured and asset-

backed commercial paper directly from eligible issuers.123 The SPV would be funded

through a loan from the Fed, secured by the SPV’s assets, and in the case of unsecured

commercial paper, secured by the retention of up-front fees paid by the issuers or by

other forms of security.124 The Treasury Department made a special deposit at the

Federal Reserve Bank of New York in support of the program.125


119
      See http://www.financialstability.gov.
120
    See, e.g., International Banking Focus, INSTITUTE OF INTERNATIONAL BANKERS, Feb. 27, 2009,
available at http://www.iib.org/associations/6316/files/20090223News.pdf (explaining that the efforts of
the Institute of International Bankers and others helped lead to the eligibility of U.S. operations of foreign
banks to receive assistance under EESA, but noting that the Treasury Department had excluded such
institutions from the CPP, and that the Institute was not successful in asking the Treasury Department to
revise the CPP eligibility criteria to include foreign-owned U.S. banks).
121
   Federal Reserve Press Release, Oct. 7, 2008, available at http://www.federalreserve.gov/newsevents/
press/monetary/20081007c.htm.
122
      Id.
123
      Id.
124
      Id.
125
      Id.


                                                      31
           Eligible issuers included all U.S. issuers of commercial papers, including U.S.

issuers with a foreign parent.126 Therefore, branches of foreign banks were eligible

issuers, whether or not they held reserves with a Federal Reserve Bank, as Discount

Window liquidity requires. In this regard, eligibility was identical to eligibility under

AMLF. Branches, however, were not allowed to “sell any commercial paper issued by

other parts of the banking organization to the SPV.”127 CPFF, like TAF, grew to account

for a large portion of the Federal Reserve’s assets during 2009. At the peak of CPFF, the

Federal Reserve held approximately $350 billion of commercial paper under CPFF,

accounting for about 17 percent of the Federal Reserve’s total assets. This amount

declined to $7.7 billion as of February 24, 2010.128

           F. INCREASE IN FDIC DEPOSIT INSURANCE

           On October 7, 2008, the FDIC announced an increase in deposit insurance

coverage from $100,000 to $250,000 per depositor129 as authorized by the Emergency

Economic Stabilization Act of 2008.130 The stated purpose of the increase in coverage

was to help consumers maintain confidence in the banking system and the

marketplace.131 The increase in coverage applied to each of the FDIC-insured U.S.



126
  Commercial Paper Funding Facility: Frequently Asked Questions, FEDERAL RESERVE BANK OF NEW
YORK, available at http://www.newyorkfed.org/markets/cpff_faq.html.
127
    Id. Presumably, this exception was designed to prevent branches from “purchasing” commercial paper
issued by their parent or other affiliates, and then selling it to the SPV.
128
      See Tables 10 and 11.
129
   FDIC Press Release, Oct. 7, 2008, available at http://www.fdic.gov/news/news/press/2008/
pr08093.html.
130
      Emergency Economic Stabilization Act of 2008 § 136.
131
      FDIC Press Release, Oct. 7, 2008, supra note 129.



                                                     32
subsidiaries of foreign banks and to the grandfathered, FDIC-insured branches of foreign

banks. On May 20, 2009, this was extended through December 31, 2013.132

            In September 2009, the FDIC amended Part 347 of the FDIC’s regulations, which

restrict the deposit-taking activities of uninsured domestic branches of foreign banks to

wholesale deposits.133 Since 1978, $100,000 had marked the difference between “retail”

deposits and “wholesale” deposits, but on September 17, 2009, the FDIC increased that

threshold to $250,000, the same amount as the temporary increase in maximum

depository insurance.134 One practical implication of this change is that uninsured

branches of foreign banks holding deposits between $100,000 and $250,000 may have

been in violation of Section 6 of the International Banking Act, referring to “domestic

retail deposit activities requiring deposit insurance protection.”135 Efforts to reverse this

amendment to Part 347, led by the Institute of International Bankers (IIB), were

unsuccessful.136 Recently, the FDIC explained that its rule was final, and that uninsured

branches would be prohibited from accepting new deposits in initial amounts of less than

$250,000 after February 5, 2010.137 The legality of uninsured branch deposits between



132
      FDIC Press Release, May 20, 2009, available at http://www.fdic.gov/deposit/deposits/changes.html.
133
    See 74 Fed. Reg. 47711, 47718 (Sept. 17, 2009). Section 6 of the International Banking Act of 1978
limits deposit-taking activities of uninsured U.S. branches of foreign banks to wholesale deposits and
prohibits the establishment of new insured branches.
134
      Id.
135
      International Banking Act of 1978 § 6.
136
    See International Banking Focus, INSTITUTE OF INTERNATIONAL BANKERS, Dec. 23, 2009, available at
http://www.iib.org/associations/6316/files/20091223Focus.pdf; International Banking Focus, INSTITUTE OF
INTERNATIONAL BANKERS, Feb. 26, 2010, available at http://www.iib.org/associations/6316/files/
20100226Focus.pdf.
137
      Id.



                                                     33
$100,000 and $250,000 between September 17, 2009 and February 5, 2010, remains

unclear.138

            G. TEMPORARY LIQUIDITY GUARANTEE PROGRAM

            On October 14, 2008, the FDIC announced the creation of the Temporary

Liquidity Guarantee Program (TLGP).139 The stated purpose of TLGP was “to

strengthen confidence and encourage liquidity in the banking system by guaranteeing

newly issued senior unsecured debt of banks, thrifts, and certain holding companies, and

by providing full coverage of non-interest bearing deposit transaction accounts,

regardless of dollar amount.”140 The TLGP had two components: the “Debt Guarantee

Program,” under which the FDIC guaranteed the payment of certain newly-issued

unsecured debt, and the “Transaction Account Guarantee Program,” under which the

FDIC guaranteed certain noninterest-bearing transaction accounts, such as payroll

accounts used by businesses.141

            Insured domestic depository institutions, including U.S. subsidiaries of foreign

banks, were eligible to participate in the Debt Guarantee Program.142 U.S. branches and

agencies of foreign banks (including the grandfathered FDIC-insured branches of foreign

banks), however, were ineligible for the Debt Guarantee Program.143 In the Final Rule on


138
      Id.
139
   U.S. Department of Treasury Press Release, Oct. 14, 2008, available at http://www.fdic.gov/news/
news/press/2008/pr08100.html.
140
      Id.
141
   Id. See also 73 Fed. Reg. 229 (Nov. 26, 2008), available at http://www.fdic.gov/news/board/
08BODtlgp.pdf.
142
      Id.
143
      Id. See also Temporary Liquidity Guarantee Program Frequently Asked Questions, U.S. DEPARTMENT
OF TREASURY,     available at http://www.fdic.gov/regulations/resources/TLGP/faq.html#eligibility.


                                                  34
the Debt Guarantee Program, the FDIC addressed the exclusion of the insured branches

of foreign banks, which came as a surprise to some:

                   Definition of an Insured Depository Institution

                   A commenter requested explanation for the exclusion of an
                   insured branch of a foreign bank from the definition of
                   Insured Depository Institution for the purposes of the Debt
                   Guarantee Program. The commenter expressed concern that
                   excluding insured branches placed them at a potentially
                   serious competitive disadvantage relative to other insured
                   institutions. The FDIC intended for the Debt Guarantee
                   Program to be available to insured depository institutions
                   and other eligible entities that are headquartered in the
                   United States. The FDIC did not intend to guarantee
                   debt issued by foreign entities, including domestic
                   branches of foreign banks or foreign subsidiaries of
                   eligible U.S. entities. Foreign entities may be eligible for
                   similar debt guarantee programs available in the
                   countries in which they are domiciled.144 (emphasis
                   added)

            Under the Transaction Account Guarantee Program, the FDIC provided unlimited

depository insurance on certain noninterest-bearing transaction accounts.145 U.S.

subsidiaries of foreign banks and the grandfathered FDIC-insured branches of foreign

banks were eligible, but un-insured branches and agencies of foreign banks were

ineligible for the Transaction Account Program.146 The FDIC did not explain why the

insured branches of foreign banks were included in the Transaction Account Guarantee

Program but excluded from the Debt Guarantee Program. That said, it is questionable

whether branches of foreign banks even issue the kind of senior unsecured debt meant to

be covered by the Debt Guarantee Program. Moreover, this exception only applied to the


144
      See 73 Fed. Reg. 229 (Nov. 26, 2008), available at http://www.fdic.gov/news/board/08BODtlgp.pdf.
145
      Id.
146
      Id.



                                                    35
dozen or so grandfathered branches of foreign banks. Therefore, this was not a

significant exclusion of foreign-owned banks from the government’s financial

stabilization programs.

            H. TERM ASSET-BACKED LENDING FACILITY

            On November 25, 2008, the Federal Reserve Board announced the creation of the

Term Asset-Backed Securities Lending Facility (TALF), under which the Federal

Reserve Bank of New York would lend up to $200 billion on a non-recourse basis to

holders of asset-backed securities.147 The Treasury Department provided $20 billion of

TARP money for the program.148 Subsidiaries of foreign banks were eligible to

participate in the program, and branches and agencies of foreign banks were eligible if

they held reserves at a Federal Reserve Bank.149 For an ABS to be eligible collateral

under TALF, 95 percent or more of the underlying credit exposure of the security was

required to be to U.S.-domiciled obligors or with respect to U.S. real property and must

have originated with U.S.-organized entities, including U.S. branches and agencies of

foreign banks.150 Credit held on the Federal Reserve’s balance sheet under TALF has

grown steadily throughout 2009 and 2010, and as of February 2010, TALF accounted for

approximately $47 billion of the Federal Reserve’s assets.151

            I. CITIGROUP AND BANK OF AMERICA ASSET GUARANTEE PROGRAMS

147
   Federal Reserve Press Release, Nov. 25, 2008, available at http://www.federalreserve.gov/newsevents/
press/monetary/20081125a.htm.
148
      Id.
149
  Term Asset-Backed Securities Loan Facility: Frequently Asked Questions, FEDERAL RESERVE BANK OF
NEW YORK, available at http://www.newyorkfed.org/markets/talf_faq.html.
150
      Id.
151
      See Tables 10 and 11.



                                                  36
            On November 23, 2008, Treasury, FDIC, and the Federal Reserve Board

announced an agreement with Citigroup that provided an asset guarantee and a re-

capitalization.152 Under the program, Treasury and FDIC agreed to share losses on

approximately $300 billion of Citigroup’s commercial and residential securities, a pool of

assets that would remain on Citigroup’s balance sheet.153 Under the asset guarantee,

Citigroup would take the first $29 billion of losses, with the government taking 90

percent of any additional losses.154 In return for this insurance, Citigroup issued

preferred shares to Treasury and FDIC.155 At the same time, Treasury purchased an

additional $20 billion of Citigroup preferred shares under TARP.156 This arrangement

was followed by an announcement on February 27, 2009 that the U.S. government would

take a 36% equity stake in the company by converting $25 billion in emergency aid into

common shares.157 On January 16, 2009, a substantially similar program was announced

with respect to a $118 billion portfolio of loans, securities, and other assets held by Bank

of America.158

            The Citigroup and Bank of America asset guarantee programs are relevant to this

paper because there were provisions in the asset guarantees that excluded assets not based


152
   Federal Reserve Press Release, Nov. 23, 2008, available at http://www.federalreserve.gov/newsevents/
press/bcreg/20081123a.htm.
153
      Id.
154
      Id.
155
      Id.
156
      Id.
157
      Id.
158
   Federal Reserve Press Release, Jan. 16, 2009, available at http://www.federalreserve.gov/newsevents/
press/bcreg/20090116a.htm.



                                                   37
on loans to U.S.-domiciled entities. Specifically, under the “Master Agreements”

covering the asset guarantees, “foreign assets” were not covered by the guarantee.159

Foreign assets included, among other things, loans to non-U.S. entities, loans secured by

non-U.S. real estate, and any asset-backed security ultimately secured by more than 15%

of foreign assets.160

            J. PUBLIC-PRIVATE INVESTMENT PROGRAM

            On March 23, 2009, Treasury announced details of the Public-Private Investment

Program for Legacy Assets (PPIP).161 The stated purpose of PPIP was “to repair balance

sheets throughout our financial system and ensure that credit is available to the

households and businesses, large and small, that will help drive us toward recovery.”162

There were to be two components to PPIP: the “Legacy Loans Program” and the “Legacy

Securities Program.”163 Under the Legacy Loans Program, Treasury planned to create

individual “Public-Private Investment Funds” (PPIF) to purchase distressed loans held by

banks.164 Treasury would provide 50 percent of the equity for the funds, and private

investors would provide the remaining equity capital.165 The Legacy Securities Program

was structured similarly, but the PPIFs would purchase securities instead of loans.166


159
   See Financial Stabilization Contracts, available at http://www.financialstability.gov/impact/
contracts_list.htm.
160
    See, e.g., Citigroup Master Agreement at 19, available at http://financialstability.gov/docs/AGP/
Citigroup_01152009.pdf (defining “foreign assets”).
161
    U.S. Department of Treasury Press Release, Mar. 23, 2009, available at http://www.treas.gov/press/
releases/tg65.htm.
162
      Id.
163
      Id.
164
      Id.
165
      Id.


                                                    38
          A term sheet issued for the Legacy Loans Program indicated that any bank with a

foreign parent would be ineligible to participate.167 Since then, the Legacy Loans

program appears to have been shelved.168 In a July 2009 publication on the Legacy

Securities Program, however, the Treasury Department explained that broad participation

of foreign and domestic institutions would help to achieve the goal of the program: “to

increase the liquidity and functioning of markets for legacy assets.”169 Although the

Legacy Securities Program has been significantly scaled down (it was originally

envisioned to hold billions of dollars of “toxic assets”), the Treasury Department recently

disclosed that nine funds in the Legacy Securities Program held $3.4 billion in mortgage

bonds as of December 31, 2009.170

IV. GENERAL POLICY PROBLEMS

          A. THE HIGH COSTS OF BANK BAILOUTS

          The fiscal costs of responding to a financial crisis can be very high.171 The U.S.

government commitments to stabilize financial markets, for example, have amounted to



166
    Under the Legacy Securities Program, Treasury would approve certain asset managers that would raise
private capital to acquire distressed securities held by banks. See id.
167
    Term Sheet, Legacy Loans Program, U.S. DEPARTMENT OF TREASURY, available at
http://www.treas.gov/press/releases/reports/legacy_loans_terms.pdf.
168
     See Edmund L. Andrews, Plan to Help Banks Clear Their Books is Halted, THE NEW YORK TIMES,
June 4, 2009 (explaining that “the F.D.I.C. acknowledged that it had not been able to get banks interested in
its so-called Legacy Loans Program. Scheduled to start later this month, the pilot program was aimed at
selling off $1 billion in troubled home mortgages.”).
169
    Legacy Securities Public-Private Investment Program Additional Frequently Asked Questions, U.S.
DEPARTMENT OF TREASURY, July 8, 2009, available at http://www.treasury.gov/press/releases/reports/
legacy_securities_faqs.pdf.
170
      US Treasury Public-Private Funds Hold $3.4 bln MBS, REUTERS NEWS, Jan. 29, 2010.
171
   See, e.g., Charles Goodhart and Dirk Schoenmaker, Burden Sharing in a Banking Crisis in Europe,
2006 LSE FINANCIAL MARKETS GROUP SPECIAL PAPER 2; Patrick Honohan & Daniela Klingebiel, The
Fiscal Cost Implications of an Accommodating Approach to Banking Crises, 27 J. OF BANKING & FINANCE


                                                    39
trillions of dollars.172 Although the exact amount of taxpayer assistance to domestic

operations of foreign banks in the U.S. cannot be known precisely,173 branches and

subsidiaries of foreign banks were largely eligible to participate in the financial

stabilization programs discussed above and summarized in Table 15. The most important

exception, of course, was the CPP, which excluded even U.S. subsidiaries of foreign

banks. Due to the scale of the CPP and its importance in re-capitalizing troubled banks,

this was a significant exception. Assuming that branches and subsidiaries of foreign

banks actually participated in the numerous programs in which they were eligible to

participate, however, the U.S. taxpayer has committed a great deal of assistance, directly

and indirectly, to foreign-owned banks through these programs.

         Importantly, branches and subsidiaries of foreign banks were eligible to

participate in every one of the liquidity programs created by the Federal Reserve during

the financial crisis in which domestic banks were generally eligible to participate. Even

though the Federal Reserve received valuable collateral in exchange for this liquidity,

there is no question that, to the extent that foreign-owned banks actually participated in

these facilities, the Federal Reserve took on direct credit exposure to branches and

subsidiaries of foreign banks. Most worrisome, by taking on direct credit exposure to

1539 (finding that governments spent, on average, 13% of their national GDPs to clean up a sample of 40
banking crises).
172
    See, e.g., SIGTARP Quarterly Report to Congress, July 21, 2009, available at http://www.sigtarp.gov/
reports/congress/2009/July2009_Quarterly_Report_to_Congress.pdf (finding that “total potential Federal
Government support could reach up to $23.7 trillion” but that the then-current total government exposure
was approximately $3 trillion). Of course, the precise cost of the stabilization programs will not be known
for some time, if ever, because, among other reasons, (1) the government held and in many cases continues
to hold valuable collateral in exchange for various commitments, (2) some of the government’s
commitments were contingent liabilities, and (3) the government is currently in the process of being repaid
on many of its commitments.
173
    This is partly due to the lack of public disclosure of the actual institutions participating in the various
stabilization programs discussed above.



                                                       40
branches of foreign banks, the Federal Reserve effectively took on direct credit exposure

to the parent bank as well, because branches are part and parcel of the parent.

           As Tables 10 and 11 show, the assets held by the Federal Reserve during the peak

of the financial crisis attributable to programs in which branches of foreign banks were

eligible to participate peaked at 44% percent of the Federal Reserve’s total assets. Of

course, Tables 10 and 11 do not show the actual participation of branches and

subsidiaries of foreign banks in these liquidity facilities. Without full disclosure of which

institutions borrowed from the Federal Reserve—which the Federal Reserve has

vigorously fought, at least for now174—it is impossible to disaggregate foreign-owned

banks’ participation from domestic banks’ participation in these facilities. That said,

prior to the financial crisis, the only significant Federal Reserve liquidity facility open to

branches of foreign banks was the Discount Window.175 Yet, prior to the financial crisis,

the Discount Window was seldom used, and therefore, credit under the Discount Window

accounted for a very small portion, if any, of the Federal Reserve’s assets. Moreover, it

is well-known that there was a shortage of dollar liquidity in foreign markets during the

financial crisis; this was the reason for the Federal Reserve’s foreign currency swap lines.

Hence, one might speculate that, in light of the worldwide dollar shortage, branches of

foreign banks would have jumped at the opportunity to access dollar liquidity through the

Federal Reserve. At this point, this is just conjecture. In any event, what one can say for

sure is that the financial crisis marked a significant departure from past practice in the



174
   See, e.g., David Glovin and Thom Weidlich, Federal Reserve Seeks to Protect U.S. Bailout Secrets,
BLOOMBERG NEWS, Jan. 11, 2010.
175
      See § II(B), supra.



                                                  41
sense that the Federal Reserve opened up a whole new array of liquidity facilities—not

merely the seldom used Discount Window—to U.S. branches of foreign banks.

         Moreover, one could argue that a better estimate of Federal Reserve credit

exposure to foreign-owned banks would include the foreign currency swap lines

established by the Federal Reserve to create additional dollar liquidity in foreign

markets.176 A recent working paper of the Bank of International Settlements notes that,

through these currency swap lines, the Federal Reserve effectively acted as the

“international lend[er] of last resort” and that the provision of U.S. dollars to foreign

central banks effectively made “US dollar liquidity accessible to commercial banks

around the world, including those that have no US subsidiaries or insufficient eligible

collateral to borrow directly from the Federal Reserve System.”177 Thus, through these

currency swap lines, although the Federal Reserve did not lend directly to the ultimate

beneficiary banks of dollar liquidity (presumably foreign-headquartered banks and other

foreign-headquartered non-bank institutions), the Federal Reserve facilitated other central

banks’ lending to these institutions. In any event, if one includes these foreign currency

swap lines, during the peak of the financial crisis, the assets held by the Federal Reserve

attributable to programs in which foreign banks were eligible to participate peaked at 67

percent of the Federal Reserve’s total assets, as shown in Table 11. Again, the caveat

here is that one cannot disaggregate domestic bank participation from foreign bank

176
    The Federal Reserve’s credit exposure under the swaps was limited to the counterparty Central Banks.
The exchange rates for unwinding these swap lines were fixed at the exchange rate at the time of the initial
swap agreements, so the Federal Reserve did not assume exchange rate risk. See Central Bank Liquidity
Swaps, Board of Governors of the Federal Reserve System, available at
http://www.federalreserve.gov/monetarypolicy/bst_liquidityswaps.htm.
177
    See Patrick McGuire & Götz von Peter, The US Dollar Shortage in Global Banking and the
International Policy Response, 2009 BANK OF INTERNATIONAL SETTLEMENTS WORKING PAPER 291,
available at http://www.bis.org/publ/work291.pdf?noframes=1.



                                                     42
participation, due to the refusal of the Federal Reserve to disclose the borrowing

institutions under these liquidity facilities.

            B. HOME–HOST COUNTRY CONFLICTS WITH RESPECT TO CROSS-BORDER BANKS

            This section steps back from the measures taken by the U.S. government during

the financial crisis to explore the more general policy dilemmas that these measures

illustrate. First, one should note that although cross-border banks are increasingly

managed on a global scale,178 bank supervision, regulation and rescues are still

fundamentally national responsibilities.179 Of course, there are mechanisms of

international cooperation among national authorities in some areas,180 but there is no

supra-national banking authority. Thus, the decision to provide fiscal assistance to cross-

border banks is fundamentally a national decision funded by domestic taxpayers.181 In

principle, taxpayers fund bank rescues in two ways. First, they can fund the assistance

explicitly, through direct cash transfers from the government to the troubled banks, either

in the form of debt or equity capital. Second, they can fund the assistance implicitly,

through contingent liabilities, asset guarantees, and other risks which do not result in

immediate cash outlays but which subject the taxpayer the risk of bearing the cost of




178
   See, e.g., Rosa M. Lastra, UK Bank Insolvency and Cross-Border Bank Insolvency, 9 J. OF BANKING
REG. 165, 175.
179
      Id.
180
   See, e.g., Cornelia Holthausen and Thomas Ronde, Cooperation in International Banking Supervision,
316 EUROPEAN CENTRAL BANK WORKING PAPER SERIES (2004), available at http://www.ecb.int/pub/pdf/
scpwps/ecbwp316.pdf.
181
    See, e.g., John Plender, Economic Nationalism Points to Parochial Banks, FINANCIAL TIMES, April 29,
2009 (“The more fundamental point, illustrated by the collapse of Lehman Brothers, Landsbanki and
others, is that, while big banks are global, crisis management in international banking is resolutely
national.”).



                                                  43
future outlays.182 Before moving on to policy solutions, I make four general observations

about the problematic current approach to cross-border banking regulation, supervision,

and crisis management.

         First, in principle, one can expect national governments to generally pursue the

self-interest of their taxpayers.183 Thus, one can assume that a country would provide

assistance to a cross-border bank only if the expected domestic social benefits outweigh

the expected fiscal costs of that assistance. Given this principle of national self-interest,

conflicts between a home and host country are most likely to occur when there is a net

domestic social benefit caused by the rescue of a cross-border bank in one country where

the bank operates, but no such benefit in the other country. For example, this outcome is

likely where there are asymmetries concerning the systemic importance of the parent

bank to the home country and the systemic importance of the host country bank to the

host country.184 These conflicts are especially likely to occur during periods of financial

distress, when insolvencies are likely.185



182
    The U.S. programs to stabilize financial markets were a mix of these two types. Asset guarantees, for
example, impose implicit costs on taxpayers, while direct capital injections impose explicit costs on
taxpayers.
183
    This assumption is widely-used. See, e.g., Report and Recommendations of the Cross-Border Bank
Resolution Group, BANK OF INTERNATIONAL SETTLEMENTS CROSS-BORDER BANK RESOLUTION GROUP 15
(Sept. 2009), available at http://www.bis.org/publ/bcbs162.htm (“National resolution authorities will seek,
in most cases, to minimise the losses accruing to stakeholders . . . in their specific jurisdiction to whom they
are accountable.”).
184
    See, e.g., Herring, supra note 18 (pointing out that from the home country’s perspective, “the nightmare
scenario is . . . where the foreign office is not regarded as systemically important by the host country, but is
a significant part of a systemically important bank in the home country” and the “nightmare scenario” from
the host country’s perspective is where “[t]he foreign entity is assumed to have a large enough share of
local markets to be systemically important, while at the same time, being so small relative to the parent
group that it is not regarded as significant to the condition of the parent banking group.”).
185
   See, e.g., Thomas C. Baxter, Jr., Joyce M. Hansen & Joseph H. Sommer, Two Cheers for Territoriality:
An Essay on International Bank Insolvency Law, 78 AM. BANKR. L.J. 57, 79.



                                                      44
           Second, the decision to provide assistance to troubled foreign banks is likely to

face intense political opposition, even if host taxpayers would ultimately benefit from

supporting the foreign-owned bank. Hence, all other things equal, this would imply an

under-provision of host country assistance to cross-border banks, even assuming that

assistance would provide a net host country social benefit. This is to say that a net host

country social benefit is a necessary but not sufficient condition for the provision of host

country taxpayer support to a foreign-owned bank.186 As the recent financial crisis

showed, there are often strong political pressures to discriminate against foreign firms

during times of economic distress.187 For example, as described above, there was intense

backlash to the proposed inclusion of foreign banks in the CPP bank recapitalization, and

foreign-owned banks were eventually excluded from the program.188

           Third, host country taxpayer assistance to a cross-border bank will benefit home

country taxpayers, independent of whether the home country government acts too.189 In

economic terms, there are positive home country externalities to host country assistance

186
   The change of the Administration’s position on the inclusion of foreign banks in the CPP is a good
example of this observation. Although the Administration apparently viewed the participation of foreign
banks in the CPP to be a “distinction without a difference” to the American people, the Treasury
Department appeared to acquiesce to intense political opposition and excluded foreign banks from CPP,
despite the fact that they had the statutory authority to include foreign banks in the CPP.
187
    Examples of such political impulses are shown in Tables 13 and 14. Additional examples of this
phenomenon can be seen in the development of the “Buy American” and “Hire American” provisions of
the U.S. fiscal stimulus, passed in February 2009. See, e.g., Alan Beattie, Hire American Calls Raise
Protectionist Fears, FINANCIAL TIMES, Feb. 14, 2009. Finally, the recently proposed bank levies, which
aim to recoup the cost of the TARP program, have been proposed to apply to foreign-owned banks too,
even though they were not eligible to receive CPP capital injections. See Julianna Goldman, Obama Says
Bank Fee Aimed at Recovering Rescue Money, BLOOMBERG NEWS, Jan. 14, 2010.
188
      For a full list of the CPP transactions, see http://financialstability.gov/.
189
    One could imagine that the benefit of host country action to home country taxpayers is two-fold. First,
the home country taxpayers are relieved of providing fiscal support to the particular bank, assuming that,
but-for the host country action, they would have provided such support. Second, the home country
taxpayers also benefit from the spill-over effects of a more stable financial system. To be sure, third party
countries share in the second type of benefit too.



                                                          45
of cross-border banks.190 This phenomenon creates collective action problems among

home and host countries in providing assistance to troubled cross-border banks. These

problems have been explored in the academic literature. Xavier Freixas, for example,

shows that countries have incentives to shirk from responsibility when it comes to bailing

out cross-border banks operating in their borders.191 Since some of the benefits of a

national recapitalization of a cross-border bank will accrue to foreign countries, Freixas

argues, the incentives for a particular country to bear the cost of recapitalization are

reduced.192 Freixas predicts that this collective action problem will lead to an under-

provision of recapitalization, because countries have incentives to minimize their role in

the crisis and to downplay the need of a bailout in the first place.193 Freixas notes that

this coordination problem tends to leave the largest country facing a tough decision: it

can either “go it alone,” or let the bank fail.194

            Fourth, conflicts between home and host countries with respect to a decision to

bailout a particular bank are likely to be most intense in the case of branches, rather than

subsidiaries. There are at least three reasons for this. First, host countries have

incentives to ring-fence branch assets in times of financial distress, fearful that the parent

bank will siphon assets from the branch. The impulse to ring-fence is exacerbated by

different approaches in the home and host country to bank insolvencies. The U.S., for

190
   The reverse is true as well: there are positive host country externalities of home country assistance of
cross-border banks.
191
    Xavier Freixas, Crisis Management in Europe, in FINANCIAL SUPERVISION IN EUROPE 102 (J. Kremers,
D. Schoenmaker & P. Wierts eds. 2003).
192
      Id.
193
      Id.
194
      Id.



                                                     46
example, takes a “territorialist” approach to the insolvency of branches,195 conducting its

own insolvency proceedings based on local assets (not just of the branch, but also other

local assets of the parent bank) and liabilities, while Europe takes a “universalist”

approach to bank insolvencies.196 Second, host countries tend to have worse information

about the financial condition of branches than they do about the condition of

subsidiaries.197 This is especially problematic during crises, when home and host

countries are least likely to share information.198 Third, the home country may not be

able to make a credible commitment to absorb the costs of the branch’s recapitalization,

which under the Basel system is principally the home country’s responsibility.199 In other

words, the bank may be “too big too save” by the home country alone.




195
    For a more general discussion of the current U.S. approach to foreign bank insolvencies, see Steven L.
Schwarcz, The Confused U.S. Framework for Foreign-Bank Insolvency: An Open Research Agenda, 1
REV. OF LAW & ECON. (2005), available at http://www.bepress.com/rle/vol1/iss1/art6; see also
International Banking Act of 1978, Pub. L. No. 95-369, 97 Stat. 607 (codified in scattered sections of 12
U.S.C.); NYBL § 605.
196
   It should be noted that there have been suggestions to harmonize national insolvency proceedings for
cross-border banks or to establish a supra-national insolvency regime for cross-border banks. These
suggestions are good proposals, but are outside the scope of this paper. See, e.g., Final Report of Group of
Twenty, Working Group on Reinforcing International Cooperation and Promoting Integrity in Financial
Markets (2009), available at http://www.g20.org/Documents/ g20_wg2_010409.pdf; Report of Cross-
Border Bank Resolution Group, supra note 183.
197
      See, e.g., Eisenbeis & Kaufman, supra note 14, at 12.
198
    See, e.g., Baxter et al., supra note 185, at 79 (“[O]nce the bank’s condition degrades, supervisors think
less about monitoring and more about protecting their creditors. This creates conflict among supervisors.
The host-country supervisors will seek to squirrel away as many assets as possible. The home-country
supervisors will seek to keep the assets in the home country or, perhaps, favored branch jurisdictions: e.g.,
ones with universal proceedings or territorial jurisdictions that already have enough assets to generate a
surplus for the head office. These conflicts can degrade supervisory information sharing in times of
stress.”); Herring, supra note 18 (“Experience has shown that in times of stress, information-sharing
agreements are likely to fray. Bad news tends to be guarded as long as possible. An example is the
reluctance of the Japanese supervisory authorities to share with the US authorities the news of trading
losses in Daiwa’s New York branch.”).
199
      See Herring, supra note 18.



                                                      47
            Britain’s use of its anti-terrorism laws in October 2008 to ring-fence the branch

assets of Landsbanki, the failed Icelandic bank, is a helpful example of the acute home-

host problems in the case of branches. Landsbanki’s internet operations in the UK—

known as Icesave—had attracted about 300,000 British depositors (roughly equal to

Iceland’s population), lured by high interest rates.200 Under its membership in the

European Economic Area, Iceland had committed to paying the first approximately

£16,000 in depository insurance, and the British depository insurance scheme would have

covered up to approximately £35,000. However, there were doubts about Iceland’s

ability to make whole on its commitment, so Britain invoked anti-terrorism laws to seize

the branch assets.201 The UK then guaranteed full reimbursement of all British

depositors.202 Subsequently, Britain sought full compensation from Iceland for the

payments to British depositors, but Iceland has so far not lived up to its commitments to

make Britain whole for payments made to UK depositors.203 Most recently, more than 93

percent of Iceland voters rejected a referendum on a plan to repay Britain and the

Netherlands (which undertook similar actions as Britain) approximately €3.9 billion paid

to British and Dutch depositors.204

            The failure of Icesave and the British response illustrates each of the three

particular problems with branches. First, it illustrates the strong incentives by the host
200
    See, e.g., Jeanne Whalen and Charles Forelle, The Financial Crisis: Aftershocks Felt From Iceland—
‘Like Lehman,' the Small Nation's Turmoil Has Far-Reaching Economic Effects, THE WALL STREET
JOURNAL, Oct. 9, 2008; Charles Forelle, The Isle That Rattled the World—Tiny Iceland Created a Vast
Bubble, Leaving Wreckage Everywhere When It Popped, THE WALL STREET JOURNAL, Dec. 27, 2008.
201
      Id.
202
      Id.
203
      Id.
204
      See, e.g., Andrew Ward, Iceland Voters Vent Anger Over Bank Deal, FINANCIAL TIMES, Mar. 8, 2010.



                                                   48
country to quickly ring-fence the assets of a branch in the event of financial distress.

That the British used an anti-terrorism law to accomplish this shows just how strong this

incentive can be. Second, it shows the inability of the home and host countries to share

information and to otherwise effectively cooperate with each other. Even after the crisis,

Iceland has refused to make Britain whole on its original commitments to Britain.

Finally, and perhaps most acutely, the Icesave failure is a perfect example of the “too big

to save” problem. The government of Iceland was clearly unable to live up to its

commitments to provide deposit insurance to all of the Icelandic banks’ foreign

branches.205

V. POLICY SOLUTIONS

           In principle, there are two competing policy approaches to mitigate home-host

country problems with respect to troubled cross-border banks.206 The first policy

approach is to make cross-border banks less “cross-border.” An extreme version of this

approach would be to entirely eliminate cross-border banks: cross-border banks would

simply re-patriate and operate exclusively in their home countries. Of course, with

complete re-patriation, there would be no need for international coordination of bank

rescues, since each country would have clearly defined responsibilities to bear all of the

costs of assisting banks within their borders, and no other responsibilities. At the same

time, all of the benefits of cross-border banking described in Section II(A), infra, would

be eliminated too, with disastrous consequences for the global economy. In recognition

of this damage, a more common suggestion along the same lines is to require that cross-

205
      See news articles on the Icelandic banking crisis, supra note 200.
206
      See, e.g., Report and Recommendations of the Cross-Border Bank Resolution Group, supra note 183, at
4.



                                                       49
border banks organize as stand-alone subsidiaries in host countries, rather than as

branches. This approach is known as “subsidiarization.”

         A second fundamental approach is to establish more effective burden sharing

mechanisms among home and host country authorities for spreading the cost of rescuing

cross-border banks.207 Essentially, this approach calls for a more efficient and more

equitable system of burden sharing among national authorities for cross-border bank

rescues. “Efficient” is used here in the sense of minimizing the value destruction caused

by the home-host country conflicts described above. “Equitable” is used here in the

sense that the countries benefiting from the cross-border bank rescue should be the same

countries paying for the bank rescue, in proportion to the benefit received.

         A. SUBSIDIARIZATION (MAKING CROSS-BORDER BANKS LESS “CROSS-BORDER”)

         The first policy approach, subsidiarization, is essentially a way to make cross-

border banks less “cross-border.” Under this approach, cross-border banks would be

forced to convert into a collection of stand-alone subsidiaries in host countries, with the

parent bank playing a much reduced role in managing the global bank on a consolidated

basis. Host countries would have nearly complete supervisory and regulatory

responsibility for the subsidiary’s capital and liquidity. One proponent of

subsidiarization, Lord Turner, Chairman of the British FSA, envisions global banks



207
    The focus of this section is on international coordination of bank rescues. For a more general survey of
efforts to improve coordination of international financial regulation and supervision during normal times,
see, e.g., Douglas W. Arner and Michael W. Taylor, The Global Financial Crisis And The Financial
Stability Board: Hardening The Soft Law Of International Financial Regulation? (working paper) (2010),
available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1520887; Chris Brummer, How
International Financial Law Works (And How It Doesn’t) (working paper) (2010), available at
http://papers.ssrn.com/sol3/ papers.cfm?abstract_id=1542829; Edward J. Kane, Confronting Divergent
Interests in Cross-Country Regulatory Arrangements, NBER WORKING PAPER 11865 (2005), available at
http://www.nber.org/papers/ w11865.



                                                    50
converting into a “constellation” of stand-alone subsidiaries.208 A natural consequence of

subsidiarization would be host country capital requirements for former branches, and the

reduction, although probably not the elimination, of globally managed liquidity pools.209

            To be sure, subsidiarization, like the complete repatriation of cross-border banks,

would have the virtue of aligning ex ante supervisory and regulatory responsibilities with

ultimate ex post responsibilities for rescuing a particular cross-border bank. Lord Turner,

among others, has noted that subsidiarization would “make it clear in advance that each

country might consider itself responsible for the rescue or resolution of the operations in

its own country, but not for others.”210

            Moreover, proponents of subsidiarization may point out that there is at least some

evidence that subsidiaries are more stable in host countries than branches are, which is a

potential host country benefit of subsidiarization.211 That said, there did not appear to be

any large differences between the stability of U.S. branches and subsidiaries of foreign

banks throughout the 2007-2009 financial crisis. Tables 1 and 3 show that both U.S.

subsidiaries and branches of foreign banks remained stable between June 2008 and


208
     Speaking to the British Bankers’ Association annual conference in July 2009, Lord Turner speculated
that “[o]ne possible way forward is that across the world we will see an increasing focus on local legal
entities, making large global banks essentially holding companies of standalone national banks and perhaps
making an overt agreement that in the condition of failure there is no one country responsible for rescue but
rather different nations responsible for rescue of the specific legal entities.” He acknowledged that this
approach might mean that large cross-border banks might have to hold more capital than a purely national
but “too big too fail” bank, but noted that “if there are additional systemic risks arising from their cross-
border operations, that may be appropriate.” See Mortgages: Branch Lines, MONEY MARKETING, July 9,
2009.
209
      Id.
210
      Id.
211
    See, e.g., Heather Montgomery, The Role of Foreign Banks in Post-Crisis Asia: The Importance of
Method of Entry, 2003 ASIAN DEVELOPMENT BANK RESEARCH PAPER 51, available at
http://www.adbi.org/research-paper/2003/01/01/39.the.role.of.foreign.banks./ (finding that foreign bank
branches were more volatile than locally capitalized foreign subsidiaries in Asian markets).



                                                     51
December 2009, both in terms of the number of branches and subsidiaries, and in terms

of the assets held by branches and subsidiaries. In June 2008, branches held 66% of

foreign bank assets in the U.S., and in December 2009, branches held 64% of foreign

bank assets in the U.S. Branches’ share of Commercial and Industrial Loans also

remained stable over that period, going from 22% to 21%, as Tables 2 and 4 show.

Finally, as Tables 2 and 4 show, foreign banks’ total assets accounted for 29% of total

U.S. banking assets as of June 2008, and 25% as of December 2009. Of course, one

could argue that this apparent stability was at least partly due to U.S. government

assistance to branches and subsidiaries of foreign banks during the financial crisis. It is

unclear how branches and subsidiaries of foreign banks would have performed in the

absence of that assistance.

        Although subsidiarization would mark a drastic departure from the current system

of cross-border branching, it is a very real possibility and has drawn the attention of

prominent commentators from the public and private sectors. For example, addressing

this year’s annual conference of the Institute of International Bankers (IIB), the most

important trade group representing U.S. operations of foreign banks,212 Lawrence Uhlick,

the Chief Executive of IIB, focused the first half of his remarks on the dangers of the re-

nationalization of cross-border banking, and in particular the troubling growing support

for subsidiarization.213 Sheila Bair, Chairman of the FDIC, speaking to the International

Institute of Finance in October 2009, noted that subsidiarization may achieve “near term



212
    About the Institute of International Bankers, INSTITUTE OF INTERNATIONAL BANKERS, available at
http://www.iib.org/displaycommon.cfm?an=1.
213
    Remarks by Lawrence R. Uhlick, Annual Conference of the Institute of International Bankers, available
at http://www.iib.org/associations/6316/files/2010AWC.LRURemarks.pdf.



                                                   52
benefits.”214 Others taking note of subsidiarization as a viable policy outcome, especially

in Europe, include Josef Ackermann,215 Dominique Strauss-Kahn,216 Willem Buiter,217

and Lord Turner.218 Most recently, a March 2010 report published by the Treasury

Committee of the British House of Commons on the “Too Big To Fail” problem spoke

very favorably of subsidiarization.219

            There are strong political reasons to believe that subsidiarization is a likely near-

term policy outcome, at least in some countries. There are especially strong political

reasons for subsidiarization in Europe, which saw several high profile cross-border bank

failures during the financial crisis. The rushed reorganization of Fortis along national

lines, for example, has also exposed the largely nationalistic approach to cross-border

bank failures in Europe, where Continental coordination in the area of bank regulation

was supposedly higher than Transatlantic coordination.220 Under the European

“passporting” system, moreover, several of the home-host problems with respect to
214
    See Remarks by FDIC Chairman Sheila Bair to International Institute of Finance, Istanbul, Turkey,
STATES NEWS SERVICE, October 4, 2009 (“Today, the lack of any internationally agreed resolution
protocols for cross-border financial firms means that it is likely that a ring fencing or territorial approach
will control. The logic seems to suggest that banking activities outside individual home countries or
regional grouping should be conducted through subsidiaries rather than branches so that the host country
clearly has control. This would be a departure from past practice, but with international cooperation it could
achieve near term benefits.”).
215
      See infra note 232.
216
      Id.
217
      See infra note 248.
218
      See supra note 208.
219
   Too Important to Fail—Too Important To Ignore, House of Commons, Treasury Committee, March 29,
2010, at 43-47, available at http://www.publications.parliament.uk/pa/cm200910/cmselect/
cmtreasy/261/261i.pdf.
220
   See John Plender, Economic Nationalism Points to Parochial Banks, FINANCIAL TIMES, April 29, 2009
(noting that “throughout the crisis fiscal support for big, failing international banks has been organized
purely on a national basis” and that “[t]here is bound to be political pressure for cross-border activity to be
channeled into subsidiaries, over which watchdogs have greater powers, rather than branches”).



                                                      53
branches are even more acute in the EU than they are in the U.S. Under the passporting

system, any bank chartered in a member country can freely establish foreign branches in

other member countries without needing separate host country licenses. Also, in Europe,

almost the entire burden of supervising and regulating the cross-border bank falls on the

home country: the home country (supposedly) provides depository insurance to all

foreign depositors, and in the event of insolvency, there is a single insolvency

proceeding, run by the home country on a “universalist” basis.221 Finally, unlike the

U.S., where branches of foreign banks cannot accept deposits from U.S. depositors of less

than $250,000 and where deposits above $250,00 are not covered by FDIC insurance,222

retail deposits in branches of foreign banks in the EU are (supposedly) covered by home

country depository insurance.223 The principal exception to home country control of

branches in Europe is that the host and home countries share the burden for branch

liquidity supervision.224

           The financial crisis exposed severe flaws in the European passporting system.

The invocation by Britain of anti-terrorism laws to seize domestic branch assets shows

the inadequacy of the European regulatory structure with respect to cross-border branch

networks. In any event, the recent failures of major European branch networks, the

almost complete impotence of European host countries with respect to branches, and the

more general “too big to save” problem have coalesced to build at least some political



221
      Winding Up Directive, European Parliament (2001).
222
      This is not true for the handful of grandfathered branches. See §II(C), supra.
223
      This was the root of the Icesave problem. See § IV(B), supra.
224
      See Capital Requirements Directive Art. 41.



                                                       54
momentum for a more nationalistic approach to cross-border banking in Europe, perhaps

in the form of subsidiarization.

         Furthermore, there is some precedent for subsidiarization. In New Zealand, for

example, Australian banks make up 85% of the domestic banking sector. Given this

concentration of foreign-owned banks, the New Zealand banking authorities require any

“systemically important” foreign-owned bank to operate as a subsidiary and not as a

branch.225 The banking regulator determines “systemically important” banks based on a

minimum liabilities threshold, currently at approximately $10 billion.226 Moreover, New

Zealand’s approach to subsidiaries of foreign banks ensures that the subsidiary is truly a

stand-alone entity that could withstand the death of its parent.227 This general approach

of limiting subsidiarization to only systemically important branches has also been

proposed by Charles Goodhart, among other prominent academics and regulatory

officials.228 Although this approach is better than full subsidiarization, branding a

subsidiary of a foreign bank as systemically important will lower its cost of capital



225
   See Alan Bollard, Being a Responsible Host: Supervising Foreign-Owned Banks, in SYSTEMIC
FINANCIAL CRISIS: RESOLVING LARGE BANK INSOLVENCIES (D. Evanoff & G. Kaufman eds. 2005);
Herring, supra note 18.
226
   See Statement of Principles: Bank Registration and Supervision, RESERVE BANK OF NEW ZEALAND
(2007) at 7, available at http://www.rbnz.govt.nz/finstab/banking/Regulation/bs1.pdf.
227
    See id. at 8 (“The Reserve Bank considers that these directors’ duties together with a legal entity
structure provide much greater certainty in a failure situation and increase the likelihood that value will be
retained in the local bank in the lead up to a failure.”).
228
    See, e.g., Nations Need Right To Force Creation Of Bk Subsidiaries-Study, DOW JONES CAPITAL
MARKETS REPORT, July 1, 2009; Markus Brunnermeier, Andrew Crocket, Charles Goodhart, Martin
Hellwig, Avinash D. Persaud, Hyun Shin, The Fundamental Principles of Financial Regulation, CEPR,
July 2009, available at http://www.cepr.org/pubs/books/cepr/booklist.asp?cvno=p197 (“[W]e would
suggest that any branch (of foreign-owned) banks designated as 'systemic' by a host country should
automatically be required to change its status to being a separately capitalized subsidiary. Then exactly the
same capital and liquidity adequacy requirement calculations would apply to foreign-owned systemic
subsidiaries as to domestic banks.”).



                                                      55
relative to non-systemically important subsidiaries of foreign banks, and may create

moral hazard problems.

         Despite the principal virtue of subsidiarization (the matching of ex ante

supervisory and regulatory responsibility with ex post responsibility for rescue), and the

political ease with which national authorities could accomplish subsidiarization, it would

come at an incredibly high cost to the global economy and should be avoided if at all

possible. There are at least four serious problems with subsidiarization that should give

pause to even the most nationalistic policymakers. First, subsidiarization would result in

less efficient global movements of capital and liquidity pools to countries where those

resources could be put to their best use. This would lead to a more “fragmented” global

banking system, undermining the efficiency and flexibility provided by cross-border

liquidity and capital management.229 Branch structures benefit from a more efficient

internal market for bank capital than subsidiary structures do.230 Without branches,

cross-border banks would no longer be able to manage their capital and liquidity on an

integrated basis.231 Without the ability to manage their resources in this way, global

banks will be prevented from allocating resources to areas where they are most needed.

This is likely to slow global economic growth.

229
    Lord Turner recognizes the risk of fragmentation of global capital flows. But he notes that his “own
feeling [is] that a greater focus on standalone national subsidiaries will be an element of the way forward at
least for some banking groups.” See Lord Turner Speech, supra note 208.
230
    See, e.g., Giovanni Dell’Ariccia and Robert Marquez, Risk and the Corporate Structure of Banks, J. OF
FINANCE 13 (forthcoming) (2010), available at http://fic.wharton.upenn.edu/fic/papers/08/0815.pdf (noting
with respect to branch structures the “benefits stemming from what is in essence an internal market for
bank capital to which banks with branch structures have easy access, while those with subsidiary structures
find it more difficult to reallocate capital across affiliates.”); Lawrence G. Goldberg, Richard J. Sweeney &
Clas Wihlborg, From Subsidiary to Branch Organization of International Banks: New Challenges and
Opportunities for Regulators, 2005 COPENHAGEN BUSINESS SCHOOL WORKING PAPER 5, available at
http://openarchive.cbs.dk/handle/10398/6783 (noting the scale and scope advantages of the branch structure
over the subsidiary structure).
231
    See Herring, supra note 18.



                                                     56
         Second, subsidiarization is likely to result in trapped pools of capital and liquidity,

which may actually increase systemic risk.232 As Lord Turner envisioned,

subsidiarization would result in “constellations” of stand-alone subsidiaries throughout

the globe. A problem with such a constellation, it seems, is that while one group of stars

may be healthy, other stars could be starved for capital and liquidity. Unfortunately,

subsidiarization would not allow for transfers of needed resources from the healthy to the

troubled stars, as global branch banking networks currently allow. Perversely, this is

likely to increase systemic risk in the global banking system by making it more difficult

for cross-border banks to respond to localized crises as they emerge.

         Third, the elimination of branch lending, which relies on the capital of the parent,

will probably increase the cost of capital in host countries, especially for multinational

companies that have historically relied on branch lending to fund their operations around

the globe. Perversely, without “parental support,” the newly-created subsidiaries would

probably be more likely to require a host country taxpayer rescue. Although U.S.

regulation views the foreign parents of subsidiaries as a “source of strength” to the

subsidiary, the foreign parent may refuse to rescue the subsidiary. Although foreign

parents may determine that the reputational costs of allowing a U.S. subsidiary to fail are

232
     See, e.g., Josef Ackermann, Smaller Banks Will Not Make Us Safer, FINANCIAL TIMES, July 30, 2009
(“[Subsidiarization] would enhance rather than reduce risks to financial stability, as it would create trapped
pools of liquidity and capital. Banks would not be able to manage their risk, capital and liquidity on a
consolidated basis. This would make the allocation of capital in the economy less efficient in normal times
and render an efficient response more difficult in times of tension. It would also have severe implications
for the growth prospects of smaller countries with a limited deposit base.”); Dominique Strauss-Kahn,
Nations Must Think Globally on Finance Reform, FINANCIAL TIMES, Feb. 18, 2010 (“A number of
countries have decided that foreign banks, even if they are operating as foreign branches, should maintain
higher liquidity locally to withstand a potential freeze in access to local funding. On the face of it, this is
prudent. But major banks manage their funding and lending risks globally. If banks have to lock up pools
of liquidity in every national jurisdiction, their capacity for intermediating capital across borders could fall,
and their charges for doing so rise, to the detriment of the world economy. Such considerations need to be
thought through and debated at the multilateral level prior to agreeing reforms, even ones that seem
perfectly reasonable, in any one particular direction.”).



                                                       57
too great, parental support is much more likely in the case of branches, which almost by

definition do not fail in the absence of their parent’s failure.

        Fourth, although proponents of subsidiarization argue that the subsidiary structure

will clarify which country would bear the burden of rescuing the bank, there are still

reasons to believe that host countries would be reluctant to rescue subsidiaries of foreign

banks, even if doing so would provide a net domestic social benefit. As discussed above,

there is likely to be significant political opposition to any rescue of a foreign bank,

whether organized as a subsidiary or a branch, in the host country. Nationalistic impulses

may prove too strong, and home-host conflicts may prove significant. Moreover, during

the financial crisis, the major banking countries generally excluded subsidiaries of

foreign banks from their bank re-capitalization programs.233 This initial observation puts

into doubt whether subsidiarization will actually significantly clarify whether the home or

the host country would bear the burden of rescuing the subsidiary.

        B. BURDEN SHARING

        As the previous Section suggests, although subsidiarization may clarify who will

bear the burden of rescuing troubled cross-border banks, it would do so only at

significant costs to global economic growth and perhaps with the perverse consequence

of increasing systemic risk in the global banking system. Given the high costs of

subsidiarization, the stakes of developing an effective system of burden sharing between




233
    See supra note 98. Although a more detailed study of other countries’ bank rescues would be necessary
to fully understand how countries treated foreign-owned banks in their rescue programs, a preliminary
review of the re-capitalization programs indicates that subsidiaries of foreign banks were generally
excluded from bank re-capitalization programs. This is an important question, and further study of these
programs would be valuable.



                                                   58
home and host countries are high.234 In light of these high stakes, the rest of this section

introduces burden sharing in its pure and theoretical sense, and then evaluates a recent

proposal to design a burden sharing system that is more politically feasible.

         One way to promote greater cooperation between home and host countries in the

context of cross-border bank failures is to have governments agree in advance on how to

share the burdens of rescuing cross-border banks. Goodhart and Schoenmaker (2009)

focus on an ex ante general rescue fund235 in the context of the European Union and

suggest two policy approaches to overcome the home-host country problems discussed

above.236 Although their analysis is pursued in the context of the European Union, the

approach could be generalized to burden sharing arrangements among the major banking

countries identified in Table 9. Given that 89 percent of the U.S. assets held by U.S.

operations of foreign banks are held by banks from nine home countries (United

Kingdom, France, Canada, Japan, Germany, Spain, Ireland, Netherlands, and

Switzerland), one could imagine an agreement just among these major banking centers.



234
    Some commentators have warned that subsidiarization—or some form of de facto subsidiarization—
will likely result in the absence of more effective international cooperation and coordination. See., e.g,
Josef Ackermann, Smaller Banks Will Not Make Us Safer, FINANCIAL TIMES, July 30, 2009 (“There is a
danger that changes in the regulatory environment will, by accident or design, lead to a refragmentation of
markets. It is understandable that national regulators and governments, chastened by the experience of
having to clean up after banking failures, try to limit the potential costs to their jurisdictions. But the
proposal that large, internationally active financial institutions should essentially be reduced to holding
companies of national operations that are organised as stand-alone units is not the right answer.”).
235
   Another possible mechanism to accomplish more effective burden sharing would be a multinational
depository insurance scheme. See, e.g., Eisenbeis & Kaufman, supra note 14, at 15. Thomas Altmann,
among others, has proposed that the members of the European Monetary Union adopt a common insurance
scheme that would better align supervisory responsibilities and financial burdens for members of the EMU.
See Thomas Altmann, Cross-Border Banking in Central and Eastern Europe, Issues and Implications for
Supervisory and Regulatory Organization on the European Level, 2006 WHARTON WORKING PAPER,
available at http://fic.wharton.upenn.edu/fic/papers/06/0616.pdf.
236
   Charles Goodhart & Dirk Schoenmaker, Fiscal Burden Sharing in Cross-Border Banking Crises, 5
INT’L. J. OF CENT. BANKING 141 (2009).



                                                    59
           First, Goodhart and Schoenmaker suggest “generic” burden sharing, in which the

burden of cross-border bank assistance is shared among countries on the basis of their

GDP, which is a proxy for the benefits of financial system stability.237 Second, they

suggest “specific” burden sharing, in which the burden of cross-bank bank assistance is

shared on the basis of some measure of the bank’s operations in the participating

countries.238 In this model, each participating country pays its “relevant” share of the

burden. Of course, the question then becomes how to define the “relevant” burden. The

goal of selecting an appropriate “key” is to align the benefits to the countries with the

costs of the assistance.239 Although Goodhart and Schoenmaker discuss several potential

keys, the best measure of the relevant burden that they present is probably the assets held

by the cross-border bank in each of the participating countries.240 Note that other

potential keys that would more accurately capture the systemic risk characteristics of the

cross-border banks—such as the interconnectedness problem241—do not lend well to hard

and fast rules, and thus are impractical as an ex ante burden sharing key.242


237
      See id. at 9.
238
      See id. at 11.
239
      See id. at 12.
240
    Assets are perhaps the best measure of the bank’s credit capacity in each participating country, which is
an important benefit to participating countries. Goodhart and Schoenmaker also present other measures of
the relevant burden, including income and employees. See Goodhart & Schoenmaker (2009), supra note
236, at 9.
241
    See, e.g., Why ‘Too Big to Fail’ is Too Short-Sighted to Succeed Problems with Reliance on Firm Size
for Systemic Risk Determination, NERA Economic Consulting (Jan. 2010), prepared for Property Casualty
Insurers Association of America, available at http://www.nera.com/image/PUB_PCI_TooBigToFail.pdf.
242
    Because the pre-determined key will be a Rule and not a Standard, it will be both under-inclusive and
over-inclusive. Simply put, it will not be a perfect proxy for the reasons that taxpayer assistance of a failed
bank is justified in the first place: systemic risk, including the interconnectedness problem. Sometimes, the
error will be too much weight given to assets, and sometimes the error will be too little weight given to
assets.



                                                      60
           There are obvious political challenges to each of these two burden sharing

approaches. With GDP-based burden sharing, countries with small economies but large

banking sectors (e.g. the UK) may refuse to participate. More generally, however, it

seems politically impractical to convince taxpayers to support bailouts of foreign-owned

banks ex ante. As explained above, and illustrated by the comments in Tables 13 and 14,

it is politically difficult even in times of financial distress to commit host country

taxpayer assistance to rescuing foreign-owned banks, even assuming that such assistance

would provide a net host country social benefit.243 Moreover, a broad-based burden

sharing agreement among countries could be characterized a “blank check” to rescue

foreign banks, whether or not the particular bank is worthy of taxpayer assistance. There

are also some technical issues with both generic and specific burden sharing. Since the

burden sharing system would be an opt-in system, it would face adverse selection and

moral hazard problems.244 The adverse selection problem would occur because the

countries that would most likely need assistance in sharing the burden are likely to be

most interested in the program.245

           The moral hazard problem would occur in two ways. First, by adopting a burden

sharing program ex ante, participating countries would signal to the cross-border banks

themselves that the banks can count on a rescue in the event of a crisis. Moreover, if the

bank observes multiple countries committing to its rescue, the bank may expect the

magnitude of a future rescue to be larger, simply because more countries would be

243
      See notes 184 through 188 and accompanying text, supra.
244
   Goodhart and Schoenmaker acknowledge these issues. See Goodhart & Schoenmaker (2009), supra
note 236.
245
    Such countries would prefer to share the burden either because they lack the fiscal strength to bear the
burden alone, or because, absent a burden sharing agreement, they would be individually responsible for
rescuing a cross-border banks with known troubles.


                                                     61
contributing to the rescue. Second, countries would have reduced incentives to

effectively monitor cross-border bank activities within their own borders, because they

would expect that if the bank becomes troubled, other countries would contribute to its

rescue. These two moral hazard problems may lead to unchecked and excessively risky

activity by cross-border banks.

       One simple way to mitigate the first moral hazard problem—that the very

existence of burden sharing agreements signals to banks that they are government-

backed—is not to publicly disclose the details of the burden sharing agreement. A policy

of “constructive ambiguity” concerning the details of the burden sharing agreement

would significantly reduce this moral hazard problem. Also, one could argue that the

large cross-border banks already have implicit guarantees from individual countries.

Hence, the only change implied by a burden sharing agreement may be which countries

would write the check, which may be irrelevant to the bank. The relevant question, then,

is the marginal increase in moral hazard that a burden sharing agreement would cause,

relative to the already existing implicit government guarantees. That marginal increase

may be small.

       The second moral hazard problem—concerning the incentives of governments to

shirk from their supervisory and regulatory roles—is unfortunately a more difficult

problem. The only certain way to solve this problem is to tie the ex post burden of

assistance to ex ante regulatory and supervisory responsibility. In principle, this is the

key virtue of subsidiarization, although it is unclear whether host countries will live up to

their commitments to rescue subsidiaries of foreign banks. Theoretically, the only other

way to get to the same result is to create a supra-national banking authority, which would




                                             62
have both the ex ante supervisory and regulatory responsibility for cross-border banks,

and the ex post responsibility to rescue failed cross-border banks. The supra-national

authority would have to be created by Treaty in order to be legally binding on

participating countries. In the event of a capital or liquidity crisis of a cross-border bank,

the supra-national authority could then allocate the costs of providing whatever assistance

is needed to participating countries according to their pre-determined share of the burden.

         Of course, a supra-national banking authority is a far-fetched idea, simply outside

the realm of current political discourse. It is nearly impossible to imagine a sufficient

number of countries agreeing to surrender sovereignty to such an authority. Lord Turner,

for example, speaking in November 2009, noted that while better global burden sharing

agreements are “theoretically desirable,” they are “probably very difficult to achieve in

practice.”246 This view is consistent with the academic literature on the subject. Richard

Herring, for example, explains that these agreements are simply too politically difficult to

negotiate.247 The troubling implication of this is that, without an effective burden sharing

mechanism for cross-border banks, the support for subsidiarization may grow. For

example, Willem Buiter, formerly with the Bank of England and now Chief Economist at




246
   Large systemically important banks: addressing the too-big-to-fail problem. Speech of Lord Turner
During TURNER REVIEW CONFERENCE: PROGRESS TOWARD GLOBAL REGULATORY REFORM, Nov. 2, 2009,
available at http://www.fsa.gov.uk/pages/Library/Communication/Speeches/2009/1102_at.shtml.
247
    See Herring, supra note 18 (“Loss-sharing agreements are very difficult to negotiate either ex ante or ex
post and conflicts over the allocation of losses may undermine efforts to manage a crisis and achieve an
appropriate resolution. International cooperation may breakdown precisely when it is most needed.”);
Henrik Borchgrevink & Thorvald Moe also note that “the idea of establishing a supranational European or
giving the ECB supervisory responsibility has met with strong resistance.” See Henrik Borchgrevink &
Thorvald Moe, Management of Financial Crises in Cross-Border Banks, 2004 RESERVE BANK OF NORWAY:
BULLETIN (2004), available at http://www.norges-bank.no/upload/import/english/publications/
economic_bulletin/2004-04/borchgrevink.pdf.



                                                     63
Citigroup, predicts that without a Europe-wide regulator and supervisor, cross-border

branching will become a thing of the past.248

         In the context of the Europe Union, the political difficulty of negotiating such a

burden sharing agreement is well-known. One might assume that an ex ante burden

sharing agreement might be more likely in Europe, given the high degree of cross-border

branching and the existence of the common market and currency, which show a

willingness to sacrifice national sovereignty.249 Then again, Europe still does not have a

common European Union banking charter, and the high profile nationalistic approaches

to recent bank failures have shown that the European Union banking system is still

fundamentally national.250 The current coordination problems in dealing with the Greek



248
    See William Buiter, Ruminations on Banking, Blog Post, available at http://blogs.ft.com/maverecon/
2009/04/ruminations-on-banking/ (explaining that “[a]ny systemically important financial institution has to
be backed by a central bank (for short-term liquidity support) and by a Treasury or ministry of finance (for
recapitalisation and other long-term financial support when insolvency is the issue). If both your liquidity
and your solvency are publicly insured or guaranteed (at highly subsidised rates), you need to be regulated
and supervised, lest you be tempted to take insane risks. This means that conventional border-crossing
banks and other systemically important financial institutions will become a thing of the past. We will not
see the kind of cross-border branch banks that we have seen during the past decades for very much
longer.”); see also Sudip Roy, Emerging Europe: Bank Chiefs Face Up to the Risks of Tighter Regulation,
EUROMONEY, Jan. 1, 2010 (with respect to subsidiarization proposals, Mr. Buiter notes that [i]t will
increase the cost of cross-border banking but it’s the price you pay for not having a common regulator and
common lender of last resort").
249
   See Herring, supra note 18 (“Although there has been some discussion of an [“Uber-Supervisor”]
model in the context of the European Monetary Union, where countries have already ceded one important
aspect of sovereignty, control of the money supply, to the European Central Bank, such proposals have
encountered seemingly insuperable concerns about how to share fiscal costs should a capital injection
become necessary.”).
250
    During the financial crisis, the European Union actually had in effect a “Memorandum of
Understanding” covering cooperation on cross-border financial stability. Although the document is quite
vague, it provides that the home country should coordinate the “process of deciding on whether, to what
extent and how public funds will be used, with the relevant Finance Ministries in other countries; and
involve relevant Financial Supervisory Authorities and Central Banks” and that “agreement should be
reached on the sharing of the direct budgetary net costs among the affected countries on the basis of
equitable and balanced criteria.” See Memorandum of Understanding on Cooperation Between The
Financial Supervisory Authorities, Central Banks and Finance Ministries of The European Union on
Cross-Border Financial Stability (June 2008), available at http://www.finance.gov.ie/documents/
publications/other/MOUcbankjune08.pdf



                                                    64
debt crisis have perhaps made the political climate there even more volatile.251 Then

again, it is possible that the current coordination problems are exactly the kind of

“existential” moment that the European Union needs to build political support for a

reliable burden sharing mechanism to deal with localized financial crises.252 Recent calls

for a European Monetary Fund may illustrate the latter possibility.253 In any event,

despite calls for an ex ante burden sharing approach for cross-border banks in Europe, 254

the proposal has stalled, and there are some indications that the Europeans have moved

away from a strict ex ante burden sharing proposal toward an ad hoc, ex post approach to

burden sharing.255


251
    See, e.g., Wolfgang Munchau, Europe Needs to Show It Has a Crisis Endgame, FINANCIAL TIMES, Feb.
8, 2010 (“At the moment, it is totally unclear what would happen should one eurozone country become
unable to refinance its debt. I suspect there will be a bail-out, but I am no longer as certain as I once was.”).
252
    See,. e.g., First Big Step Towards More Integrated Eurozone, FINANCIAL TIMES, Mar. 8, 2010 (“The
admission by Wolfgang Schäuble, the German finance minister, that he believes the European Union needs
a monetary fund marks the first big step towards designing a more economically integrated monetary
zone.”); Europe Decides What Union Means; Greek Crisis Calls Bluff on National Fiscal Independence,
FINANCIAL TIMES, Feb. 11, 2010 (“The European Union does not handle every crisis well, but it has at
times shown a remarkable ability to grit its teeth and stay on course. Reading the euro's doom in the entrails
of market jitters or hectic meetings over Greece's fiscal woes is mistaken. The euro will survive, and the
spectre of a Greek default may even reignite a long-stalled drive towards greater co-operation.”).
253
      See id.
254
    In February 2009, the “LaRosiere Report” discussed the need for a clearer burden sharing agreement
and more effective coordination among national authorities. The LaRosiere Report speculated that burden
sharing could be accomplished on the basis of such measures as deposits, assets, revenue, share of payment
systems, and division of supervisory responsibility. See Jacques de Larosiere, Chair, THE HIGH LEVEL
GROUP ON FINANCIAL SUPERVISION IN THE EU (Feb. 25, 2009), 35–37, available at http://ec.europa.eu/
internal_market/finances/docs/de_larosiere_report_en.pdf. The European Commission adopted a
Communication on Financial Supervision in Europe in May 2009 that set out a legislative reform agenda.
This agenda included a section supporting efforts on burden sharing. See Communication from the
European Commission on European Financial Supervision 11 (May 27, 2009), available at
http://ec.europa.eu/internal_market/finances/docs/committees/supervision/communication_may2009/C-
2009_715_en.pdf. (“[P]rogress on burden sharing and resolution mechanisms is critical to reinforcing trust
between national authorities and strengthening the functioning of the ESFS, work which must advance as
soon as possible.”).
255
    Although legislative efforts are still ongoing in the European Union on this issue, ex ante burden
sharing appears to have been rejected at least by the Economic and Financial Committee of the Council of
the European Union. See Press Release, Economic and Financial Affairs, COUNCIL OF THE EUROPEAN
UNION 22 (Dec. 2., 2009), available at https://ue.eu.int/uedocs/NewsWord/en/ecofin/111706.doc (“In


                                                       65
           Given the intense political challenges to theoretically satisfying international

agreements on burden sharing, Goodhart and Schoenmaker, along with Emilios

Avgouleas, have more recently proposed a scaled-down model of burden sharing that

could be incorporated into bank-specific “living wills” and facilitated by supervisory

colleges.256 The rest of this section is largely based on their proposal. I would point out

that living-will based burden sharing agreements could be negotiated for only the largest

cross-border banks, and among only the very few important banking countries.257

           This scaled-down burden sharing model would have two essential components.

First, a bank-specific burden sharing agreement would be contained in a “living will” for

the cross-border bank.258 The living will would be written collaboratively by the bank

and the countries in which it conducts major operations. It could identify corporate

groups and sub-groups and describe which countries would supervise and regulate

particular groups or sub-groups.259 Importantly, the burden sharing agreement could



respect of burden sharing, the Council TAKES STOCK of the pragmatic approach to burden sharing
outlined by the EFC, which does not consist of ex-ante agreements on the precise allocation of costs among
Member States but of an increased preparedness for ex-post burden sharing, as appropriate.”).
256
    See Emilios Avgouleas, Charles Goodhart & Dirk Schoenmaker, Living Wills as a Catalyst for Action,
DUISENBERG SCHOOL OF FINANCE WORKING PAPER 7 (Feb. 2010), available at
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1533808.
257
      See Table 9.
258
    See Tables 6 through 8 for the most systemically important foreign banks from a U.S. perspective.
Similar tables should be made for the top ten or so banking countries, and the handful of banks with
significant overlaps across those tables could be required to create living wills, which would be negotiated
in concert with the home country and each of the important host countries. Moreover, where a cross-border
bank is systemically important to only two or three countries (i.e. the Nordea Group in the Nordic
countries), a living will could be negotiated by just those countries. See Avgouleas et al., supra note 256,
at 8.
259
    See also Report and Recommendations of the Cross-Border Bank Resolution Group, supra note 183, at
Recommendation 5 (“Supervisors should work closely with relevant home and host resolution authorities in
order to understand how group structures and their individual components would be resolved in a crisis. If
national authorities believe that financial institutions’ group structures are too complex to permit orderly
and cost-effective resolution, they should consider imposing regulatory incentives on the institutions,


                                                    66
specify “triggering events” that would require execution of extraordinary assistance by

the participating home and host countries. These triggering events could be different

according to the different corporate groups and sub-groups. Of course, the burden

sharing agreements would also be required to include a “key” of the relevant burden.

         An incidental benefit of this system is that the negotiation itself would provide

valuable information to national authorities about the systemic importance of cross-

particular border banks to other countries. For example, through these negotiations, a

host country could quickly determine whether a bank that it considers to be systemically

important is also considered systemically important by the home country. If it is not

important to the home country, then the host country could either (1) exercise additional

supervision of the bank within its borders or (2) drive a harder burden sharing bargain

with the home country.

         Second, a college of supervisors would serve as an institutional mechanism that

would facilitate periodic monitoring of the bank. Supervisory colleges would meet

regularly to exchange information and to conduct joint examinations of the covered

cross-border banks. In this way, supervisory colleges could provide a monitoring

mechanism, which could help to mitigate the potential moral hazard problem among

national authorities caused by burden sharing agreements.260

         There are precedents for this type of institutional arrangement for cross-border

banks, albeit without explicit agreements on burden sharing. Norway, Finland and


through capital or other prudential requirements, designed to encourage simplification of the structures in a
manner that facilitates effective resolution.”).
260
   Recall that burden sharing agreements create moral hazard among national authorities not to adequately
supervise the bank’s operations within their borders, since other nations will bear part of the cost of an
eventual rescue. See note 245 and accompanying text, supra.



                                                     67
Sweden, for example, have established a supervisory college to oversee two banks that

are very important to each of those countries: Nordea Group and Sampo Group.261

Further, the agreement defines groups and subgroups (i.e. holding companies and their

subsidiaries), and the responsibilities of each of the national authorities with respect to

supervision of the groups and the various parent companies, subsidiaries, and branches.262

The college meets quarterly and there are regular overall risk appraisals and joint

examinations of the banking groups.263

            The principal weakness of the living will-based burden sharing proposal is that

living wills are not self-executing. That is to say, one should not confuse a burden

sharing plan in a living will with an actual resolution procedure for a cross-border bank.

Without an effective resolution procedure for cross-border banks, any plan in the living

will is just that: a plan. The plan is not binding on home or host countries. Moreover, as

the response to the financial crisis showed, home and host counties will continue to face

the temptation of nationalistic approaches to bank rescues. The impulse to ignore living

wills in the event of an actual crisis may be strong.

            C. HOST COUNTRY EMERGENCY LIQUIDITY ASSISTANCE TO BRANCHES OF
            FOREIGN BANKS

            This paper has so far explored three policy solutions to the home-host country

conflicts discussed above. Unfortunately, there are serious problems with each of the

proposals. Subsidiarization, the first proposal, is a politically feasible yet economically

harmful approach. Broad-based ex ante burden sharing agreements, in contrast, are

261
  See, e.g., Martin Cihak & Jorg Decressin, The Case For a European Banking Charter, 2007 IMF
WORKING PAPER 26, available at http://imf.org/external/pubs/ft/wp/2007/wp07173.pdf.
262
      Id.
263
      Id.



                                                68
theoretically satisfying, yet politically impractical at this time. Finally, although scaled-

down burden sharing agreements incorporated into living wills appear more realistic than

broad-based ex ante agreements, their utility is limited in the absence of an actual

resolution procedure for cross-border banks. In light of these difficulties, here I propose

a policy to mitigate at least some of the home-host country problems discussed above:

eliminate the possibility of emergency liquidity assistance from host country central

banks to branches of foreign banks. This policy change could be accomplished quickly,

cheaply, without political resistance, and may weaken the case for subsidiarization.264

         The U.S. provision of extraordinary liquidity assistance to branches of foreign

banks during the financial crisis illustrates a mismatch between ambiguous ex ante

supervisory and regulatory responsibility for branch liquidity, on the one hand, and ex

post responsibility for emergency liquidity assistance to branches, on the other. Under

the Basel agreements, home and host countries share responsibility for supervision of the

liquidity of branches, with the host country taking the primary role.265 This ambiguous ex

ante responsibility contrasts with what now appears to be, at least in the U.S., explicit

host country responsibility for ex post provision of emergency liquidity to troubled

branches.266 In the face of the 2007-2009 financial crisis, the Federal Reserve welcomed


264
    To be clear, this policy change would not require any change to existing U.S. supervisory and
regulatory powers with respect to branches of foreign banks. As an extra layer of support to U.S.
taxpayers, it would simply deny branches of foreign banks access to liquidity assistance from the Federal
Reserve. The Discount Window in particular would be closed to branches of foreign banks.
265
    See, e.g., 1975 BASEL CONCORDAT, supra note 17; with respect to the European Union, see also Capital
Requirements Directive Art. 41.
266
    The difficulties of host country lender-of-last resort assistance to branches of foreign banks have been
known for some time. See, e.g., Hal Scott, supra note 24 at 497 (“Unlike the case of the failure of a
foreign-owned subsidiary, the failure of the foreign bank itself, along with its host-country branch offices,
raises significant lender-of-last resort issues for the United States . . . While the Federal Reserve could, in
principle, itself extend credit in dollars to the foreign bank, it will be reluctant to do so. Such lending might
expose it, and ultimately U.S. taxpayers, to losses. This will be hard to justify when support could have
come instead from the home-country central bank.”).


                                                       69
U.S. branches of foreign banks into each of its liquidity-oriented financial stabilization

programs, as shown in Tables 10 and 11. I would argue that this policy toward U.S.

branches of foreign banks has created a serious moral hazard problem with respect to

branches of foreign banks: branches of foreign banks (and therefore the entire global

bank, assuming cross-border liquidity management) can expect to rely on Federal

Reserve support in the event of a liquidity crisis. In this way, U.S. branches of foreign

banks expose the U.S. taxpayer to significant potential losses.

         Here, I assume that, at least to a significant degree, cross-border banks manage

the liquidity of their worldwide branch networks as a single pool.267 If that assumption is

true, then one cannot truly understand the liquidity of a U.S. branch of a foreign bank in

isolation from the liquidity of the entire global branch network. Recent statements by

IIB, the most important trade group representing U.S. operations of foreign banks,

suggest that global parents really do manage the liquidity of their branch networks on a

consolidated basis. For example, in commenting on the recently proposed Basel liquidity

standards, IIB has argued that the global parent bank should maintain “flexibility to




267
     See, e.g., Discussion Paper, Harmonising Liquidity Risk Reporting Through Colleges of Supervisors,
INTERNATIONAL BANKING FEDERATION (Dec. 2009) 4, available at http://www.ibfed.org/content/1/
c6/01/71/25/IBFed_Final_Discussion_Paper_Harmonising_Liquidity_Risk_Reporting_though_Colleges_of
_Supe.pdf (“International banks by and large manage their funding centrally using whichever global market
is the deepest and most active to provide liquidity in a range of currencies and maturity profiles. They then
deploy it to meet the needs of its group businesses around the world. Funding liquidity risk is also typically
managed centrally with large holdings of cash and fully liquid assets, which creates significant opportunity
costs in the form of lower interest income.”); Charles Goodhart, Liquidity Management, at 13 (working
paper), available at http://www.kansascityfed.org/publicat/sympos/2009/papers/Goodhart.08.06.09.pdf
(“[M]any, perhaps most, though not all, large, cross-border international banks have become used to
managing their liquidity as a single pool, transferring it around the world both with the sun and as seems
best allocated by headquarters. They generally claim that it is efficient and cost saving. But it does mean
that liquidity moves in, and again out of, host countries in a daily rhythm in a way that that host countries
cannot control . . . .”).



                                                     70
deploy liquidity throughout their global [branch] network . . . .”268 Also, in a recent public

comment on U.S. interagency guidelines on liquidity risk management, the IIB stated that the

“U.S. operations of [global banks] typically play a key role in providing the [global bank’s]

dollar funding, but risk management of these activities is coordinated with the [global bank’s]

overall, global liquidity requirements and, especially with respect to activities undertaken by

U.S. branches/agencies, due account must be taken of the responsibilities exercised by the

institution’s head office in managing the institution’s global position.”269 These statements

underscore the importance of cross-border liquidity management to global branch networks,

and also highlight the importance of U.S. branches of foreign banks in meeting the banks’

worldwide dollar liquidity needs. Finally, there is at least some anecdotal evidence that

cross-border liquidity management proved valuable during the financial crisis.270

         Assuming, then, that global banks manage the liquidity of their branch networks

on a consolidated basis, it is somewhat difficult to conceptualize how the U.S. could

exercise effective supervision and regulation over the true liquidity position of a U.S.

branch, unless it either (1) imposed significant stand-alone liquidity buffers for branches

of foreign banks, which may amount to de facto subsidiarization, or (2) supervised and

regulated the worldwide liquidity of the entire global bank. Above, I explained why

subsidiarization is a bad outcome. And, it probably goes without saying that U.S.

268
   Comment of the Institute of International Bankers on Basel Proposals to Strengthen Global Capital and
Liquidity Regulations, April 16, 2010, at 4, available at http://www.bis.org/publ/bcbs165/cacomments.htm.
269
    Comment of the Institute of International Bankers on Proposed Interagency Guidance Regarding
Funding and Liquidity Risk Management, Sept. 3, 2009, available at
http://www.federalreserve.gov/generalinfo/foia/index.cfm?doc_id=OP-1362&doc_ver=1.
270
    See, e.g., Sudip Roy, Emerging Europe: Bank Chiefs Face Up to the Risks of Tighter Regulation,
EUROMONEY, Jan. 1, 2010 (“Joachim Bartsch, treasurer for emerging Europe and the Middle East at
Deutsche Bank, says that managing liquidity centrally proved crucial during the crisis. ‘It allowed us to
manage our liquidity risk appropriately,’ he says. ‘All of our entities in the region are fully integrated into
our global liquidity management framework so we were well-prepared to weather the crisis. We knew
immediately what our liquidity positions were.’”).



                                                       71
supervisors are not in a good position to supervise the worldwide liquidity of global

banks. Moreover, U.S. regulators simply lack the authority to regulate the worldwide

liquidity of a global bank with a U.S. branch.

            I would argue, instead, that the home country is in the best position to supervise the

overall liquidity of a global bank’s branch network, which is difficult to isolate from the

liquidity of the U.S. branch. The IIB appears to agree with this assessment. Commenting on

the proposed Basel liquidity standards, the IIB has stated that, with respect to branch

networks, the “liquidity of the parent bank as a global institution [is a] matter[] uniquely

within the supervisory oversight of the home country authority.”271 Thus, to the IIB,

supervisory responsibilities over the global bank’s consolidated liquidity should be

concentrated “in the hands of home country authorities,” which are “in the best position to

comprehend and assess a global banking institution’s condition.”272 The IIB does recognize

that the host country should have some role, especially in providing the home country

supervisor “information and insight” on the liquidity conditions in the host country.273 Yet,

the IIB clearly advocates the home country supervisor taking the primary supervisory role

with respect to “the liquidity of the parent bank as a global institution.”274

            To summarize, I argue that (1) the liquidity of a branch of a foreign bank is difficult

to isolate from the overall liquidity of the entire global branch network, assuming

consolidated cross-border liquidity management and (2) the home country supervisor is in the

best position to supervise the overall liquidity of a cross-border branch network. Therefore, I

271
   Comment of the Institute of International Bankers on Basel Proposals to Strengthen Global Capital and
Liquidity Regulations, April 16, 2010, at 6, available at http://www.bis.org/publ/bcbs165/cacomments.htm.
272
      Id. at 5.
273
      Id. at 6.
274
      Id.



                                                   72
suggest that the home country should always bear the full burden of providing emergency

liquidity assistance to branches of foreign banks. This policy change would better align ex

ante supervision over the liquidity of global branch networks with ex post responsibility for

emergency liquidity assistance to those branch networks.275

        Two important incentive effects would flow from the elimination of any host

country emergency liquidity assistance to branches of foreign banks. First, global banks

would be incentivized to more fully internalize the risks of inadequate liquidity across

their branch network. Going forward, they would rely exclusively on the home country

central bank for lender-of-last-resort liquidity assistance. Second, home countries, whose

central banks (and therefore whose taxpayers) would bear the entire burden of providing

emergency liquidity assistance to foreign branches, would have stronger incentives to

effectively monitor the liquidity of the global branch network.

        In addition, eliminating any host country responsibility for emergency liquidity

assistance to branches of foreign banks would provide a political argument against

subsidiarization. In the U.S., for example, I have explained that Federal Reserve lending

to branches of foreign banks puts U.S. taxpayers at risk. Thus, by ending Federal

Reserve liquidity assistance to branches of foreign banks, the U.S. taxpayer would be

better protected from branches of foreign banks. So, to the extent that taxpayer-

protection is an argument for subsidiarization, the case for subsidiarization would be

weaker if the Federal Reserve simply refused to lend to branches of foreign banks. Of

course, U.S. taxpayers are already in a better position than taxpayers in other host

275
    Of course, I implicitly assume here that host country emergency liquidity assistance to branches of
foreign banks amounts to liquidity assistance of the entire global branch network. This assumption flows
from my explicit assumption that global parent banks manage the liquidity of their branch networks on a
consolidated basis. This means, for example, that emergency dollar liquidity provided to a U.S. branch of a
foreign bank may flow to non-U.S. operations of the global bank.



                                                    73
countries with respect to branches of foreign banks. As discussed above, this is because

(1) the U.S. generally does not provide depository insurance to branches of foreign banks

and (2) in the event of insolvency, the U.S. ring-fences local assets of branches of foreign

banks, as well as the local assets of their affiliates. So, this policy change would provide

an additional layer of protection for U.S taxpayers. With three layers of protection to

U.S. taxpayers from branches of foreign banks, it would be more difficult to argue that

subsidiarization is necessary, at least from a “taxpayer-protection” perspective.

            The issue of host country emergency liquidity assistance to branches of foreign

banks may become increasingly important if the proposed Basel liquidity standards gain

traction. In December 2009, the Basel Committee released its “consultative document”

on liquidity risk management, and it invited public comments on the proposal, which

were due April 16, 2010.276 The two most important substantive proposals in the Basel

proposal are (1) a “Liquidity Coverage Ratio,” requiring high quality assets to meet

liquidity needs over a 30-day window and (2) a “Net Stable Funding Ratio,” designed to

promote more medium and long-term funding of the assets and activities of banks over a

one-year time horizon.277 An interagency policy document issued by U.S. regulators also

recently supplemented the Basel proposals on liquidity risk management.278 This

interagency policy statement followed a draft policy statement, as well as a period of

276
    Basel Committee, International Framework for Liquidity Risk Measurement, Standards and
Monitoring, December 2009, available at http://www.bis.org/publ/bcbs165.pdf?noframes=1. The Basel
Committee received many comments on the proposal. Comments are available at
http://www.bis.org/publ/bcbs165/cacomments.htm.
277
      Id.
278
    The Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System,
the Federal Deposit Insurance Corporation, The Office of Thrift Supervision, and the National Credit
Union Administration, Interagency Policy Statement on Funding and Liquidity Risk Management, March 4,
2010, available at http://www.occ.treas.gov/ftp/release/2010-27a.pdf.



                                                  74
public comment.279 The interagency policy statement emphasized the importance of cash

flow projections, diversified funding sources, stress testing, a cushion of liquid assets,

and a formal, well-developed contingency funding plan as primary tools for measuring

and managing liquidity risk.280

        Importantly, both the Basel proposal and the U.S. interagency policy statement

are “structure-neutral” in the sense that they propose liquidity standards and risk

management tools independent of the structure of a financial institution. They do not, for

example, proscribe different liquidity standards and risk management tools for cross-

border banks organized as subsidiaries in host countries, compared to cross-border banks

organized as branches in host countries. That said, some of the industry comments on

both the Basel proposal and the U.S. interagency policy statement expressed concerns

that the proposed liquidity standards and risk management tools would apply not only to

the parent of a consolidated financial institution, but also to the stand-alone affiliates,

potentially resulting in “trapped pools” of liquidity. For example, the Basel proposal

stated, under the section entitled “scope of application”:

                 133. The proposed standards and monitoring tools should
                 be applied to all internationally active banks on a
                 consolidated basis, but may be used for other banks and
                 on any subset of entities of internationally active banks
                 as well to ensure greater consistency and a level playing
                 field between domestic and cross-border banks. The
                 standards should be applied consistently wherever they are
                 applied. When applied on a legal entity basis, affiliated



279
    Comments on the draft interagency policy statement are available at
http://www.federalreserve.gov/generalinfo/foia/index.cfm?doc_id=OP-1362&doc_ver=1
280
   Joint Press Release, Federal Banking Agencies Issue Policy Statement on Funding and Liquidity Risk
Management, March 10, 2010, available at http://www.federalreserve.gov/newsevents/
press/bcreg/20100317a.htm.



                                                  75
                   entities should be treated no differently than unrelated
                   third party financial institutions. (emphasis added)281

            In its public comment on the Basel proposal, IIB expressed its concern with this

language. Specifically, IIB stated that “the proposal might be read as requiring the

maintenance of ring-fenced (or ‘trapped’) amounts of liquidity in certain entities or

jurisdictions, a result that would unduly restrict global banking institutions’

implementation of their overall risk management strategies.”282 In its public comment,

IIB also expressed the view that “local branches . . . should not be viewed as stand alone

entities for these purposes” and that cross-border banks “should have the freedom to

choose whether to conduct their wholesale banking operations outside their home country

through branches and/or through separately incorporated local subsidiaries.”283

            Essentially, the fear here is that new Basel liquidity standards would be applied to

branches of foreign banks on a stand-alone basis. If host countries are not convinced that

their taxpayers are adequately protected from the risks of illiquid branches, one would

imagine that host countries would be more likely to support stand-alone liquidity

standards for branches of foreign banks. Eliminating the possibility of host country

emergency liquidity assistance to branches of foreign banks will mitigate the potential

losses to taxpayers posed by illiquid branches of foreign banks. Therefore, under the

policy change suggested here, host countries would have reduced incentives to lobby for

the application of any new Basel liquidity standards to branches of foreign banks on a

stand-alone basis.

281
      Basel Proposal on Liquidity Risk Management, supra note 276, at 31.
282
   Comment of the Institute of International Bankers on Basel Proposals to Strengthen Global Capital and
Liquidity Regulations, April 16, 2010, at 7, available at http://www.bis.org/publ/bcbs165/cacomments.htm.
283
      Id. at 4.


                                                    76
           There are at least five potential arguments against this policy change. I will

address each in turn. First, one could argue, for example, that the U.S. is in a better

position to provide emergency liquidity assistance to branches of foreign banks because

the branches need liquidity in U.S. dollars. At one time, this may have been a serious

problem. The Federal Reserve’s recent success with foreign currency swaps, however,

shows that the U.S. could provide adequate dollar liquidity to home country central banks

to meet the dollar liquidity needs of U.S. branches of foreign banks.284 Under the swap

arrangements during the financial crisis, foreign central banks simply drew down dollar

accounts held at U.S. Federal Reserve Banks. In this way, the Federal Reserve would not

provide direct liquidity to branches, thereby taking on direct credit exposure to branches

(and therefore the entire global bank), but would deal only with the home country central

bank. The exposure to the home country central bank is obviously much less risky than

credit exposure to the branch itself. In a sense, the home country central bank would act

as an intermediary between the U.S. Federal Reserve, which would provide dollars, and

the U.S. branch of the foreign bank, which needs dollars. If the branch were to fail, the

home country central bank would absorb the entire loss.

           Second, one could argue that the U.S. is in a better position to provide emergency

liquidity assistance to branches of foreign banks because, as a result of time zone

differences, the home country central banks may literally be asleep as the branch crisis

emerges. One should first recognize that the liquidity crisis seen from 2007 to 2009 did

not occur overnight. The Federal Reserve opened up broad-based facilities to branches of

foreign banks over an extended period of time. There is little reason to believe that time

zone differences would have impeded the home country central banks from providing
284
      See Table 11.


                                                77
dollar liquidity to their branches in the U.S. Also, under the design of the foreign

currency swaps during the financial crisis, the foreign central banks actually held dollar

accounts at U.S. Federal Reserve Banks. Thus, there would be no need to activate all of

the personnel and technological systems of the home country central bank; all that would

be required is approval from key home country individuals, albeit late at night.

        Third, one could argue that there is little cost to U.S. taxpayers of emergency

liquidity assistance to branches of foreign banks and hence this change would not pack

much punch. In the event that the branch actually fails (which almost certainly implies

the failure of the parent too), this argument depends on the adequacy of the collateral that

the Federal Reserve holds on the loan. If the bank does not fail, then the Federal Reserve

will almost certainly be repaid, and the transaction imposes no cost on the U.S. taxpayer.

Moreover, in principle, the Federal Reserve does not lend to insolvent firms. Yet,

because the solvency of a U.S. branch of a foreign bank is essentially the same question

as the solvency of the parent bank, the Federal Reserve will be less confident about the

solvency of a U.S. branch of a foreign bank, compared to the solvency of a U.S. bank or a

U.S. subsidiary of a foreign bank. Thus, the collateral adequacy question is especially

important with respect to branches of foreign banks.

        Unfortunately, the Federal Reserve has refused to disclose sufficient information

about the collateral it accepted during the financial crisis to analyze whether its lending

was adequately collateralized.285 I would not, however, be alone in questioning the




285
   See, e.g., David Glovin and Thom Weidlich, Federal Reserve Seeks to Protect U.S. Bailout Secrets,
BLOOMBERG NEWS, Jan. 11, 2010.



                                                  78
adequacy of the collateral that the Federal Reserve accepted during the financial crisis.286

And, although the Federal Reserve actually made substantial profits during the financial

crisis and has defended its collateral practices, there is simply not enough public

information to evaluate the risks to the U.S. taxpayer going forward.287 In any event, the

cost to U.S. taxpayers of emergency liquidity assistance to branches of foreign banks

depends on whether the Federal Reserve is likely to suffer losses on these loans.

Although that question is outside the scope of this paper, suffice it so say that there is an

active debate, and that branches of foreign banks put the Federal Reserve at

comparatively higher risk than subsidiaries of foreign banks, because the solvency of the

branch is inextricable from the solvency of the parent, and the Federal Reserve is not in

an adequate position to assess the solvency of the parent.

        Fourth, one could argue that ending host country emergency liquidity assistance

to branches of foreign banks fails to address the important problem of cross-border bank

re-capitalization. That is true. Yet, a politically feasible system of burden sharing—the

only theoretically satisfying way to solve the problem of cross-border bank

recapitalization—currently appears far afield. Perhaps more importantly, a leading policy

alternative to true burden sharing, especially in Europe, is subsidiarization. Yet,

subsidiarization is a deeply flawed policy solution. Subsidiarization, moreover, is no

panacea to the issue of cross-border bank re-capitalization. As the financial crisis

showed, host countries are likely to exclude even subsidiaries of foreign banks from their

286
   See, e.g., John Thorton, Glenn Hubbard, and Hal Scott, The Federal Reserve's Independence Is at Risk,
THE BROOKINGS INSTITUTION, Aug. 20, 2009.
287
   See, e.g., Vivien Lou Chen, Fed’s Kohn Says Emergency Lending Isn’t Creating Taxpayer Risk,
BLOOMBERG NEWS, April 18, 2010 (“‘We are not taking significant credit risk that might end up being
absorbed by the taxpayer,’ [Federal Reserve Vice Chairman] Kohn said in a speech at a conference at
Vanderbilt University. ‘For almost all the loans made by the Federal Reserve, we look first to sound
borrowers for repayment and then to underlying collateral . . . .’”).


                                                   79
bank re-capitalization programs. The U.S. excluded subsidiaries of foreign banks, and an

initial review of the bank rescues in the major banking countries indicates that

subsidiaries of foreign banks were generally excluded from bank re-capitalization

programs. In any event, the argument here is that, even with subsidiaries, home and host

countries may still face intense conflicts in crisis situations.

        Fifth, my proposal does not address the depository insurance problem with respect

to branches of foreign banks. This problem is best illustrated by the UK and Dutch

experience with local branches of a failed Icelandic bank. I would first note that there is

no depository insurance problem in the U.S. with respect to branches of foreign banks,

because branches cannot accept U.S. deposits less than $250,000, and the FDIC does not

insure deposits in excess of $250,000. That said, the depository insurance question is a

potential area for reform in Europe. Before resorting to subsidiarization, European

policymakers would benefit from considering whether changes to the depository

insurance scheme would satisfy host country concerns.

VI. CONCLUSION

        By and large, U.S. branches and subsidiaries of foreign banks were eligible to

participate in the stabilization measures undertaken by the U.S. government in response

to the financial crisis of 2007-2009. The key exception was the Capital Purchase

Program, the U.S. program to re-capitalize banks; even U.S. subsidiaries of foreign banks

were excluded from that program. Actions taken during the financial crisis illustrated the

more general question of how to allocate the burden of rescuing cross-border banks

between the home and host countries. I showed that ex ante burden sharing agreements

between home and host countries are theoretically desirable but not politically feasible,



                                               80
especially in the absence of a supra-national banking supervisor. Although living will-

based burden sharing agreements for particular banks are more realistic, their

effectiveness is questionable in the absence of a single resolution procedure for cross-

border banks. Unfortunately, a leading policy alternative to more effective international

burden sharing is subsidiarization, a process through which branches of foreign banks are

converted into subsidiaries. Although subsidiarization would better align ex ante

supervision and regulation with ex post responsibility to rescue a cross-border bank, it

would lead to the fragmentation of global banking, result in trapped pools of capital and

liquidity, and may slow economic growth.

       Next, I suggested that one way to clarify the division of responsibilities between

home and host countries in the event of a liquidity crisis is to eliminate the possibility of

host country emergency liquidity assistance to branches of foreign banks. Because global

banks manage the liquidity of their branch networks on a consolidated basis, it makes

more sense, I argued, for the home country both to supervise the worldwide liquidity of

global branch networks, and to be responsible for all emergency liquidity assistance to

the branch network. If a branch of a foreign bank needs liquidity in the host country

currency, the host country central bank can enter into currency swap arrangements with

the home country central bank. The Federal Reserve’s success with foreign currency

swaps during the financial crisis shows that this arrangement could be viable. Finally, I

argued that this change would reduce the risk to host country taxpayers posed by

branches of foreign banks, which I suggested may weaken the political case for

subsidiarization.




                                              81
                                                   Table 1
                            Legal Structure of U.S. Operations of Foreign Banks1
                                         December 2009 ($ millions)

                                                             Number of            Total                Percentage of
                    Legal Structure                           Banks             U.S. Assets            Total Assets

    Uninsured State Branch                                        134            $1,642,498                 55%
    Uninsured Federal Branch                                       44              $120,031                  4%
    Uninsured State Agency                                         57             $123,892                   4%
    Insured State Branch                                            6               $14,901                  0%
    Insured Federal Branch                                          4                $9,858                  0%
    Uninsured Federal Agency                                        2                $1,094                  0%
    Total Branch or Agency Share                                  247            $1,912,274                 64%

    National Bank                                                  23               $594,226                20%
    State Member Bank                                               7               $210,269                 7%
    State Non-Member Bank                                          23               $154,520                 5%
    Total Subsidiary Share                                         53               $959,015                32%

    Federal Savings Bank                                            1                $73,840                 2%
    State Savings Bank                                              1                $32,464                 1%
    Edge Corp (Banking)                                             5                $10,036                 0%
    Non-Depository Trust Co-Member                                  4                  $493                  0%
    Non-Depository Trust Co-Non-Member                              9                  $192                  0%
    Agreement Corp (Banking)                                        1                   $341                 0%
    Agreement Corp (Investment)                                     2                   $343                 0%
    New York Investment Company                                     2                     $0                 0%
    Representative Office                                         136                     $0                 0%
    Edge Corp (Investment)                                          3                     $4                 0%
    Total Other Share                                             164               $117,713                 4%


    TOTAL ACROSS ALL CATEGORIES                                   464            $2,989,002               100%

Notes and Sources
1
    Data obtained from Federal Reserve Table Entitled "Structure and Share Data for the U.S. Offices
    Of Foreign Banks," available at http://www.federalreserve.gov/releases/iba/200912/default.htm.




                                                                                                            Page 1 of 23
                                                                             Table 2
                                                                    Total U.S. Banking Assets
                                                                    December 2009 ($ millions)

                              Branches           Other U.S.           Total U.S.            All U.S.        Percentages of Total U.S. Banking Assets Held By
                          And Agencies of       Operations of       Operations of          Banking            Branches               Other            Total
                                          1                     2                                      3                   1                   2
         Asset            Foreign Banks        Foreign Banks        Foreign Banks        Operations         And Agencies       Foreign Bank        Foreign Bank
          (1)                   (2)                  (3)                  (4)               (5)                  (6)                (7)                 (8)
                                                                       (2) + (3)                              (2) / (5)           (3) / (5)           (4) / (5)


    Commercial and             $278,962           unknown 4           unknown 4            $1,317,400            21%              unknown 4         unknown 4
    Industrial Loans


    Total Assets             $1,912,274          $1,076,728          $2,989,002          $11,804,800             16%                   9%              25%




Notes and Sources
1
    Corresponds to the "Branch or Agency" data in Table 1. Data obtained from Federal Reserve table entitled "Assets and Liabilities of U.S.
    Branches and Agencies of Foreign Banks," available at http://www.federalreserve.gov/econresdata/releases/assetliab/current.htm.
2
    Corresponds to the "Subsidiary" and "Other" data in Table 1.
3
    Data obtained from Federal Reserve table entitled "Assets and Liabilities of Commercial Banks in the U.S.," available at
    http://www.federalreserve.gov/releases/h8/current/. Seasonally-unadjusted figures are presented here.
4
    Unfortunately, the Federal Reserve only breaks out Commercial and Industrial Loans for branches and agencies of foreign banks.
    There is no publicly available Federal Reserve data on Commercial and Industrial Loans made by subsidiaries of foreign banks.




                                                                                                                                                      Page 2 of 23
                                                   Table 3
                            Legal Structure of U.S. Operations of Foreign Banks1
                                           June 2008 ($ millions)

                                                             Number of            Total                Percentage of
                    Legal Structure                           Banks             U.S. Assets            Total Assets

    Uninsured State Branch                                        130           $1,796,515                  57%
    Uninsured Federal Branch                                       43             $186,531                   6%
    Uninsured State Agency                                         63              $68,822                   2%
    Insured State Branch                                            8              $23,683                   1%
    Insured Federal Branch                                          4               $5,372                   0%
    Uninsured Federal Agency                                        1                 $432                   0%
    Total Branch or Agency Share                                  249           $2,081,355                  66%

    National Bank                                                  23              $552,963                 18%
    State Member Bank                                               8              $207,733                  7%
    State Non-Member Bank                                          25              $147,668                  5%
    Total Subsidiary Share                                         56              $908,364                 29%

    Federal Savings Bank                                            1               $79,189                  3%
    State Savings Bank                                              1               $38,175                  1%
    Edge Corp (Banking)                                             5               $11,216                  0%
    Non-Depository Trust Co-Member                                  5                $2,263                  0%
    Non-Depository Trust Co-Non-Member                              9                 $123                   0%
    Agreement Corp (Banking)                                        1               $14,342                  0%
    Agreement Corp (Investment)                                     3                  $350                  0%
    New York Investment Company                                     2                  $850                  0%
    Representative Office                                         150                    $0                  0%
    Edge Corp (Investment)                                          3                    $4                  0%
    Total Other Share                                             180              $146,512                  5%


    TOTAL ACROSS ALL CATEGORIES                                   485           $3,136,231                100%

Notes and Sources
1
    Data obtained from Federal Reserve Table Entitled "Structure and Share Data for the U.S. Offices
    Of Foreign Banks," available at http://www.federalreserve.gov/releases/iba/200806/default.htm.




                                                                                                             Page 3 of 23
                                                                              Table 4
                                                                     Total U.S. Banking Assets
                                                                      June 2008 ($ millions)

                              Branches           Other U.S.           Total U.S.           All U.S.          Percentages of Total U.S. Banking Assets Held By
                          And Agencies of       Operations of       Operations of          Banking             Branches              Other            Total
                                          1                     2                                     3                     1                  2
          Asset            Foreign Banks       Foreign Banks        Foreign Banks        Operations          And Agencies       Foreign Bank       Foreign Bank
           (1)                   (2)                 (3)                  (4)               (5)                   (6)                (7)                (8)
                                                                       (2) + (3)                               (2) / (5)           (3) / (5)          (4) / (5)


    Commercial and             $321,921           unknown 4           unknown 4           $1,495,300             22%              unknown 4         unknown 4
    Industrial Loans


    Total Assets             $2,081,359           $1,054,876         $3,136,235          $11,002,400             19%                  10%              29%




Notes and Sources
1
    Corresponds to the "Branch or Agency" data in Table 3. Data obtained from Federal Reserve table entitled "Assets and Liabilities of U.S.
    Branches and Agencies of Foreign Banks," available at http://www.federalreserve.gov/pubs/supplement/2008/11/table4_30p1.htm.
2
    Corresponds to the "Subsidiary" and "Other" data in Table 3.
3
    Data obtained from Federal Reserve table entitled "Assets and Liabilities of Commercial Banks in the U.S.," available at
    http://www.federalreserve.gov/releases/h8/20080627/. Seasonally-unadjusted figures are presented here.
4
    Unfortunately, the Federal Reserve only breaks out Commercial and Industrial Loans for branches and agencies of foreign banks.
    There is no publicly available Federal Reserve data on Commercial and Industrial Loans made by subsidiaries of foreign banks.




                                                                                                                                                      Page 4 of 23
                                     Table 5
                 Location of Uninsured Branches of Foreign Banks1
                             December 2009 ($ millions)

                                   Number of           Total                Percentage of
         Home State                 Banks            U.S. Assets            Total Assets

                                                                      2
    New York                              84          $1,453,116                      88%
    Connecticut                             4           $107,989                      7%
    Illinois                              10              $55,726                     3%
    California                            25              $19,793                     1%
    Florida                                 6              $5,393                     0%
    Washington                              2                 $481                    0%
    Texas                                   0                    $0                   0%
    Oregon                                  3                    $0                   0%

    Total                                134          $1,642,498                 100%

Notes and Sources
1
    Data obtained from Federal Reserve table entitled "Structure and Share Data for
    the U.S. Offices Of Foreign Banks," available at http://www.federalreserve.gov/
    releases/iba/200912/default.htm.

2
    This figure amounts to approximately 49% of the total U.S. assets held by U.S.
    operations of foreign banks ($2.99 trillion).




                                                                                            Page 5 of 23
                                                 Table 6
          Branches and Subsidiaries of Foreign Banks With More Than $50 Billion in U.S. Assets 1
                                        December 2009 ($ millions)

                                                                        Home                                      U.S.
            Name of Bank                           Parent                State           Legal Form           Office Assets

Branches
    Deutsche BK AG NY BR                  Deutsche Bank                 NY           Uninsured State Branch      $96,908
    Norinchukin BK NY BR                  Norinchukin                   NY           Uninsured State Branch      $90,950
    Rabobank Nederland NY BR              Rabobank                      NY           Uninsured State Branch      $90,000
    BNP Paribas Equitable Tower BR        BNP Paribas                   NY           Uninsured State Branch      $86,967
    Societe Generale NY BR                Societe Generale              NY           Uninsured State Branch      $81,967
    Calyon NY BR                          Calyon                        NY           Uninsured State Branch      $80,896
    Bank Tok-Mit UFJ NY BR                Bank of Tokyo-Mitsubishi      NY           Uninsured State Branch      $65,345
    Barclays BK PLC Park Ave BR           Barclays                      NY           Uninsured State Branch      $63,559
    Mizuho Corporate NY BR                Mizuho Corporate Bank         NY           Uninsured State Branch      $59,221

    Total (9)                                                                                                   $715,813

Subsidiaries
    HSBC BK USA NA                        HSBC                          VA           National Bank              $167,165
    T D BK NA                             Toronto-Dominion Bank         DE           National Bank              $140,039
    RBS Citizens NA                       RBS Group                     RI           National Bank              $116,921
    Union BK NA                           Bank of Tokyo-Mitsubishi      CA           National Bank               $85,196
    Manufacturers & Traders TC            Allied Irish Banks            NY           State Member Bank           $67,860
    Compass BK                            BBVA                          AL           State Member Bank           $64,608
    Bank of the West                      BNP Paribas                   CA           State Non-Member Bank       $60,001

    Total (7)                                                                                                   $701,790




Notes and Sources
1
    Data obtained from Federal Reserve table entitled "Structure and Share Data for the U.S. Offices
    of Foreign Banks," available at http://www.federalreserve.gov/releases/iba/200912/default.htm.




                                                                                                               Page 6 of 23
                                                      Table 7
                                                                                                          1
              Foreign Banks With More Than $50 Billion in U.S. Assets Across All of Their U.S. Operations
                                                     December 2009 ($ millions)
                                                             Total              Branch or
         Parent Bank               Home Country            U.S. Assets           Agency              Subsidiary     Other

  Toronto-Dominion Bank             Canada                   $182,133              $32,031           $150,102.00         $0
  BNP Paribas                       France                   $179,381             $105,675            $73,706.00         $0
  HSBC                              United Kingdom           $169,142                   $0           $169,142.00         $0
  Bank of Tokyo-Mitsubishi          Japan                    $161,372              $70,926            $90,103.00       $343
  RBS Group                         United Kingdom           $149,385                   $0           $116,921.00    $32,464
  Deutsche Bank                     Germany                  $143,631              $96,908            $46,345.00       $378
  BBVA                              Spain                    $107,198              $42,590            $64,608.00         $0
  Rabobank                          Netherlands               $99,434              $90,000             $9,434.00         $0
  Banco Santander                   Spain                     $96,659              $15,518                 $0.00    $81,141
  Norinchukin                       Japan                     $90,950              $90,950                 $0.00         $0
  UBS                               Switzerland               $86,259              $56,085            $30,066.00       $108
  Bank of Montreal                  Canada                    $82,737              $38,075            $44,662.00         $0
  Bank of Nova Scotia               Canada                    $82,226              $82,226                 $0.00         $0
  Societe Generale                  France                    $82,160              $81,968                 $0.00       $192
  Calyon                            France                    $81,430              $81,430                 $0.00         $0
  Allied Irish Banks                Ireland                   $79,582              $10,814            $68,768.00         $0
  Barclays                          United Kingdom            $78,518              $65,904            $12,614.00         $0
  RBS PLC                           United Kingdom            $69,786              $69,786                 $0.00         $0
  Mizuho Corporate Bank             Japan                     $65,165              $61,395             $3,770.00         $0
  Sumimoto                          Japan                     $51,512              $49,547             $1,965.00         $0
  Royal Bank of Canada              Canada                    $51,499              $23,832            $27,667.00         $0

  TOTAL (21)                                               $2,190,159            $1,165,660            $909,873    $114,626
                                                             100%                   53%                 42%          5%
Notes and Sources
1
  Data obtained from Federal Reserve table entitled "Structure and Share Data for the U.S. Offices
  of Foreign Banks," available at http://www.federalreserve.gov/releases/iba/200912/default.htm.
  U.S. Office Assets were aggregated across all operations of the Parent Bank.




                                                                                                                              Page 7 of 23
                                              Table 8
                             Banks With Assets Greater Than $50 Billion 1
                                    December 2009 ($ millions)

                                         U.S.      Foreign-Owned            Domestic     Consolidated
Rank              Bank                   Bank    Subsidiary Branch           Assets2       Assets2
  1    Bank of Amer NA                    X                                 $1,389,723     $1,465,221
  2    JPMorgan Chase BK NA               X                                 $1,063,827     $1,627,684
  3    Wells Fargo BK NA                  X                                   $608,657       $608,778
  4    Citibank NA                        X                                   $602,869     $1,161,361
  5    Wachovia BK NA                     X                                   $487,276       $510,083
  6    U S BK NA                          X                                   $275,348       $276,376
  7    PNC BK NA                          X                                   $258,452       $260,310
  8    Suntrust BK                        X                                   $164,341       $164,341
  9    Branch BKG&TC                      X                                   $159,412       $159,676
 10    HSBC BK USA NA                                X                        $151,831       $167,165
 11    T D BK NA                                     X                        $140,039       $140,039
 12    Regions BK                         X                                   $132,998       $138,007
 13    FIA Card SVC NA                    X                                   $132,479       $145,366
 14    Capital One NA                     X                                   $127,276       $127,360
 15    RBS Citizens NA                               X                        $116,921       $116,921
 16    Fifth Third BK                     X                                   $112,182       $112,736
 17    State Street B&TC                  X                                   $106,213       $153,741
 18    Citibank SD NA                     X                                    $97,969        $97,969
 19    Deutsche BK AG NY BR                                     X              $96,908             n/a
 20    Chase BK USA NA                    X                                    $91,043        $91,043
 21    Goldman Sachs BK USA               X                                    $91,014        $91,016
 22    Norinchukin BK NY BR                                     X              $90,950             n/a
 23    Rabobank Nederland NY BR                                 X              $90,000             n/a
 24    Keybank NA                         X                                    $88,692        $90,179
 25    BNP Paribas Equitable Tower BR                           X              $86,967             n/a
 26    Bank of NY Mellon                  X                                    $86,135       $164,275
 27    Union BK NA                                   X                         $84,249        $85,196
 28    Societe Generale NY BR                                   X              $81,967             n/a
 29    Calyon NY BR                                             X              $80,896             n/a
 30    Manufacturers & Traders TC                    X                         $67,860        $67,860
 31    Morgan Stanley BK NA               X                                    $66,159        $66,159
 32    Discover BK                        X                                    $65,845        $65,845
 33    Bank Tok-Mit UFJ NY BR                                   X              $65,345             n/a
 34    Compass BK                                    X                         $64,608        $64,608
 35    Barclays BK PLC Park Ave BR                              X              $63,559             n/a
 36    Bank of the West                              X                         $60,001        $60,001
 37    Mizuho Corporate NY BR                                   X              $59,221             n/a
 38    Comerica BK                        X                                    $58,165        $59,144
 39    Northern TC                        X                                    $56,991        $68,809
 40    Ally BK                            X                                    $55,303        $55,303
 41    Huntington NB                      X                                    $51,111        $51,111
 42    M&I Marshall & Ilsley BK           X                                    $50,254        $50,254
       TOTAL (42)                         26         7           9          $7,881,056     $8,563,937




                                                                                              Page 8 of 23
                                                         Table 8
                                        Banks With Assets Greater Than $50 Billion 1
                                               December 2009 ($ millions)

Notes and Sources

 1
     Data for branches of foreign banks obtained from Federal Reserve table entitled "Structure and Share Data for the U.S.
     Offices of Foreign Banks," available at http://www.federalreserve.gov/releases/iba/200912/default.htm. Data for
     U.S. subsidiaires of foreign banks, and for U.S. Banks, obtained from Federal Reserve table entitled "Insured U.S.-
     Chartered Commercial Banks That Have Consolidated Assets of $300 Million or More, Ranked by Consolidated
     Assets," available at http://www.federalreserve.gov/releases/lbr/current/default.htm.

 2
     Assets for branches of foreign banks correspond to "U.S. Office Assets" shown in "Structure and Share Data for the U.S.
     Offices of Foreign Banks." Assets for U.S. subsidiaries of foreign banks and for U.S. Banks correspond to "Domestic
     Assets" shown in "Insured U.S.-Chartered Commercial Banks That Have Consolidated Assets of $300 Million or More,
     Ranked by Consolidated Assets." The reason for the difference is that the Federal Reserve only reports total U.S. Office
     Assets for branches of foreign banks, but distinguishes between Consolidated Assets and Domestic Assets for
     subsidiaries of foreign banks and U.S. Banks. The only subsidiaries of foreign banks for which Domestic Assets differed
     from Consolidated Assets were HSBC BK USA NA (which had Consolidated Assets of $167,165 but Domestic Assets of
     $151,831) and Union BK NA (which had Consolidated Assets of $85,196 but Domestic Assets of $84,249). Note that the
     number of U.S. banks with Consolidated Assets greater than $50 billion (26) is the same as the number of U.S. banks with
     Domestic Assets greater than $50 billion (26).




                                                                                                                                Page 9 of 23
                                                 Table 9
                 Legal Structure of U.S. Operations of Foreign Banks by Home Country1
                                       December 2009 ($ millions)

                                       Allocation of Country Exposure      Share of Total Assets Across All Countries
                   Total            Branch or                               Branch or
  Home Country   U.S. Assets         Agency       Subsidiary     Other        Agency       Subsidiary       Other

United Kingdom     $556,407            40%          54%            6%           12%           31%            29%
France             $435,704            83%          17%            0%           19%             8%            0%
Canada             $427,748            48%          52%            0%           11%           23%             0%
Japan              $393,240            75%          25%            0%           15%           10%             0%
Germany            $287,794            84%          16%            0%           13%             5%            0%
Spain              $216,991            30%          33%           37%            3%             7%           69%
Ireland            $105,586            35%          65%            0%            2%             7%            0%
Netherlands        $109,266            91%            9%           0%            5%             1%            0%
Switzerland        $110,676            73%          27%            0%            4%             3%            0%
Italy               $48,272           100%            0%           0%            3%             0%            0%
Australia           $50,815            90%          10%            0%            2%             1%            0%
Sweden              $34,140           100%            0%           0%            2%             0%            0%
Belgium             $23,321           100%            0%           0%            1%             0%            0%
Taiwan              $25,154            79%          21%            0%            1%             1%            0%
Israel              $23,128            37%          63%            0%            0%             2%            0%
Finland             $34,174           100%            0%           0%            2%             0%            0%
Norway              $11,732           100%            0%           0%            1%             0%            0%
Brazil              $14,139           100%            0%           0%            1%             0%            0%
                                                                                                          Page 10 of 23
                                                             Table 9
                             Legal Structure of U.S. Operations of Foreign Banks by Home Country1
                                                   December 2009 ($ millions)

                                                   Allocation of Country Exposure      Share of Total Assets Across All Countries
                               Total            Branch or                               Branch or
  Home Country               U.S. Assets         Agency       Subsidiary     Other        Agency       Subsidiary       Other

China, Peoples Republic Of      $12,828           100%            0%           0%            1%             0%            0%
India                            $9,654            91%            9%           0%            0%             0%            0%
Mexico                           $3,800            44%          56%            0%            0%             0%            0%
Portugal                         $7,367            60%          19%           21%            0%             0%            1%
Venezuela                        $6,504             8%          92%            0%            0%             1%            0%
Korea, South                     $6,036            66%          34%            0%            0%             0%            0%
Bahrain                          $2,012           100%            0%           0%            0%             0%            0%
Singapore                        $6,738           100%            0%           0%            0%             0%            0%
Austria                          $3,376           100%            0%           0%            0%             0%            0%
Hong Kong                        $3,544            80%          20%            0%            0%             0%            0%
Chile                            $3,465           100%            0%           0%            0%             0%            0%
Turkey                           $2,193           100%            0%           0%            0%             0%            0%
Colombia                         $1,323            92%            0%           8%            0%             0%            0%
Uruguay                          $1,736           100%            0%           0%            0%             0%            0%
Malaysia                           $868           100%            0%           0%            0%             0%            0%
Greece                             $832             0%         100%            0%            0%             0%            0%
Panama                             $822           100%            0%           0%            0%             0%            0%
Egypt                              $727           100%            0%           0%            0%             0%            0%
                                                                                                                      Page 11 of 23
                                                        Table 9
                        Legal Structure of U.S. Operations of Foreign Banks by Home Country1
                                              December 2009 ($ millions)

                                              Allocation of Country Exposure      Share of Total Assets Across All Countries
                          Total            Branch or                               Branch or
  Home Country          U.S. Assets         Agency       Subsidiary     Other        Agency       Subsidiary       Other

Kuwait                      $1,913           100%            0%           0%            0%             0%            0%
Ecuador                       $573            31%          69%            0%            0%             0%            0%
Dominican Republic            $443             0%         100%            0%            0%             0%            0%
United Arab Emirates          $504           100%            0%           0%            0%             0%            0%
Jordan                        $437           100%            0%           0%            0%             0%            0%
Nigeria                       $413           100%            0%           0%            0%             0%            0%
Argentina                     $449           100%            0%           0%            0%             0%            0%
Peru                          $517           100%            0%           0%            0%             0%            0%
Indonesia                     $377           100%            0%           0%            0%             0%            0%
Thailand                      $283           100%            0%           0%            0%             0%            0%
Pakistan                      $356           100%            0%           0%            0%             0%            0%
Philippines                   $289            34%          66%            0%            0%             0%            0%
Curacao, Bonaire, Sab         $139           100%            0%           0%            0%             0%            0%
Saudi Arabia                   $98           100%            0%           0%            0%             0%            0%
Qatar                          $87           100%            0%           0%            0%             0%            0%
El Salvador                    $12           100%            0%           0%            0%             0%            0%
Honduras                        $0             0%            0%           0%            0%             0%            0%
Luxembourg                      $0             0%            0%           0%            0%             0%            0%
                                                                                                                 Page 12 of 23
                                                                     Table 9
                                     Legal Structure of U.S. Operations of Foreign Banks by Home Country1
                                                           December 2009 ($ millions)

                                                                  Allocation of Country Exposure            Share of Total Assets Across All Countries
                                        Total                  Branch or                                     Branch or
      Home Country                    U.S. Assets               Agency       Subsidiary     Other              Agency       Subsidiary       Other

    Azerbaijan                                  $0                   0%               0%               0%         0%             0%            0%
    Jamaica                                     $0                   0%               0%               0%         0%             0%            0%
    Ukraine                                     $0                   0%               0%               0%         0%             0%            0%
    Channel Islands                             $0                   0%               0%               0%         0%             0%            0%
    South Africa                                $0                   0%               0%               0%         0%             0%            0%

    TOTAL                              $2,989,002                                                               100%          100%          100%

Notes and Sources
1
    Data obtained from Federal Reserve Table Entitled "Structure and Share Data for the U.S. Offices
    Of Foreign Banks," available at http://www.federalreserve.gov/releases/iba/200912/default.htm.




                                                                                                                                           Page 13 of 23
                                                                                                 Table 10
                                                                                    Federal Reserve Liquidity Programs
                                                                      For Which Branches and Subsidiaries of Foreign Banks Were Eligible
                    $1,000
                                                                                                                                              AIG Loan (included due to foreign
                                                                                                                                                   CDS counterparties)
                               $900
                                               Asset-Backed Commercial Paper Money
                                               Market Mutual Fund Liquidity Facility
                               $800



                               $700
                                                            Discount Window
Federal Reserve Assets ($bb)




                                                (includes Primary and Secondary Credit)
                               $600                                                                           Commercial Paper
                                                                                                               Funding Facility
                A




                               $500
                                                                                                                                                               Term Asset-Backed Securities
                                                                                                                                                                    Lending Facility
                               $400



                               $300



                               $200
                                                                                                                     Term Auction Facility


                               $100



                                 $0
                                 11/28/07         2/28/08           5/28/08          8/28/08          11/28/08          2/28/09          5/28/09          8/28/09          11/28/09

                                                                                                                 Date
                               Source: Data obtained from the Federal Reserve Historical Data on Factors Affecting Reserve Balances, available at http://www.federalreserve.gov/Releases/H41/hist/.
                                                                                                                                                                                     Page 14 of 23
                                                                                               Table 11
                                                                                Federal Reserve Liquidity Programs
                                                     For Which Branches and Subsidiaries of Foreign Banks Were Eligible (Showing Total Fed Assets)
                       $2,500



                                                        Total Federal Reserve Assets



                       $2,000
                                                      On November 19, 2008, these assets
                                                      accounted for 67% of the Federal
                                                      Reserve's Total Assets.
Federal Reserve Assets ($bb)




                       $1,500
                                                      On March 11, 2009, these assets                                                           Federal Reserve Liquidity Programs
                A




                                                            t d for       f the Federal
                                                      accounted f 44% of th F d l                                                              F Which Branches and Subsidiaries of
                                                                                                                                               For Whi h B      h    d S b idi i   f
                                                      Reserve's Total Assets.                                                                       Foreign Banks Were Eligible
                                                                                                                                                     (Including FX Swap Lines)

                       $1,000

                                               Federal Reserve Liquidity Programs
                                              For Which Branches and Subsidiaries of
                                                    Foreign Banks Were Eligible
                                                     (Excluding FX Swap Lines)
                                                  (Same Programs as in Table 10)
                               $500




                                 $0
                                 11/28/07          2/28/08          5/28/08          8/28/08          11/28/08          2/28/09          5/28/09          8/28/09          11/28/09

                                                                                                                 Date
                               Source: Data obtained from the Federal Reserve Historical Data on Factors Affecting Reserve Balances, available at http://www.federalreserve.gov/Releases/H41/hist/.
                                                                                                                                                                                     Page 15 of 23
                   Table 12
  Reproduction of AIG Schedule A: Collateral
    Postings Under AIGFP CDS (Top 20)1
                                         Collateral
         Counterparty                  Posted ($ mm)

Foreign Banks
      Societe Generale                     $4,100
      Deutsche Bank                        $2,600
      Calyon                               $1,100
      Barclays                               $900
      UBS                                   $800
      DZ Bank                                $700
      Rabobank                               $500
      KFW                                   $500
      Banco Santander                        $300
      Danske                                $200
      Reconstruction Finance Corp.           $200
      HSBC Bank                             $200
      Bank of Montreal                       $200
      RBS                                   $200
      Total                               $12,500
                                              68%
Domestic Banks
      Goldman Sachs                         $2,500
      Merrill Lynch                         $1,800
      Wachovia                                $700
      JP Morgan                              $400
      Morgan Stanley                          $200
      Bank of America                         $200
      Total                                 $5,800
                                               32%


      Grand Total                         $18,300

Notes
  1
      Data available at:
      http://www.aig.com/aigweb/internet/en/files/
      CounterpartyAttachments031809_tcm385-155645.pdf


                                                        Page 16 of 23
                                                        Table 13
                           Selected Quotations from House of Representatives Debate Regarding
                              The Emergency Economic Stabilization Act of 2008 (HR 3997) 1
                                                   September 29, 2008

 Representative                                                                Quote

Mr. Culberson     We're essentially creating a King Henry here who is going to be able to buy any type of financial instrument he wants from
(R-TX)            any financial institution anywhere in the world, anywhere in the world owned by anybody , the Secretary can step in
                  using his authority to buy any troubled asset he wishes— not just limited to residential mortgage- backed securities—any
                  financial instrument owned by any foreign entity, any American entity anywhere in the world and, quote, the Secretary
                  is authorized to take such actions as the Secretary deems necessary to carry out this act.

Mr. Doggett       Like the Iraq war and the PATRIOT Act, this bill is fueled by fear and hinges on haste. So much is missing. There is: . . . No
(D-TX)            complete bar on American taxpayers having to bail out the Bank of China—and the entire world.


Mr. Visclosky     Now we are being asked to solve this crisis that has been building for most of the last decade in 7 days. But is the solution
(D-IN)            being foisted on us really going to help Main Street? Or is it simply meant to clean up Wall Street’s mess, cloak the Bush
                  Administration’s abysmal failure to protect the people of this country from financial predators, and further enrich those
                  whose covetousness has caused this problem? Is it going to help the people we represent, or is it going simply add to the
                  profits of foreign banks? . . . Why are we leaving our smaller banks to fend for themselves, while bailing out foreign
                  banks? Why does the Royal Bank of Scotland, with $3.5 trillion in assets, need welfare from the American taxpayer?



Mr. Broun         This is probably the most important vote that Members of Congress are going to take this year and for many, many years.
(R-GA)            Unfortunately, this bill is not going to solve the problem. This bill is going to bail out foreign banks. It’s going to bail out
                  Wall Street. But it’s not going to bail out banks, and it’s going to hurt the taxpayer.

Mr. Sherman       Now, we know that this bill will allow million-dollar-a-month salaries to executives at bailed out firms, and it allows
(D-CA)            hundreds of billions of dollars to be used to buy the toxic assets currently held by foreign investors.




                                                                                                                                        Page 17 of 23
                                                                     Table 13
                                        Selected Quotations from House of Representatives Debate Regarding
                                           The Emergency Economic Stabilization Act of 2008 (HR 3997) 1
                                                                September 29, 2008

      Representative                                                                        Quote

    Ms. Ginny-Brown            If you aren’t angry enough about this bailout, foreign banks get special treatment right there in section 112. The
    -Waite                     Treasury Secretary has the discretion to bail out foreign banks at the expense of the American taxpayer, no
    (R-FL)                     restrictions and no guarantees.

    Mr. Udall                  In addition, at a time when America’s middle class is severely stretched to make ends meet, this $700 billion bailout not
    (D-CO)                     only seeks to rescue our taxpayer dollars to bail out foreign companies. We must protect American taxpayers before
                               we seek to rescue foreign companies while their governments do nothing.


    Mr. Stearns                Even more troubling than the cost of this bailout is a provision that allows foreign banks to participate in the
    (R-FL)                     Treasury’s purchase plan. Under this bill, a foreign bank, such as the Bank of China, could sell a portfolio of toxic assets to
                               a U.S.-headquartered investment bank and then that bank could sell those same assets to the Treasury Department.


Notes
  1 The four most important provisions of the bill with respect to the eligibility foreign banks are the Section 101 provision regarding the purchase of

    troubled assets from financial institutions, the definitions of "Financial Institutions" and "Troubled Assets," and the Section 112 provision concerning
    coordination with foreign central banks:

    Section 101                "SEC. 101. PURCHASES OF TROUBLED ASSETS.
                               (a) OFFICES; AUTHORITY.—
                               (1) AUTHORITY.—The Secretary is authorized to establish the Troubled Asset Relief Program (or ‘‘TARP’’) to purchase,
                               and to make and fund commitments to purchase, troubled assets from any financial institution, on such terms and conditions
                               as are determined by the Secretary, and in accordance with this Act and the policies and procedures developed and published
                               by the Secretary."


                                                                                                                                                   Page 18 of 23
                                                                Table 13
                                   Selected Quotations from House of Representatives Debate Regarding
                                      The Emergency Economic Stabilization Act of 2008 (HR 3997) 1
                                                           September 29, 2008

 Representative                                                                       Quote


"Financial Institution" "(5) FINANCIAL INSTITUTION.—The term ‘‘financial institution’’ means any institution, including, but not limited to,
                        any bank, savings association, credit union, security broker or dealer, or insurance company, established and regulated under
                        the laws of the United States or any State, territory, or possession of the United States, the District of Columbia,
                        Commonwealth of Puerto Rico, Commonwealth of Northern Mariana Islands, Guam, American Samoa, or the United States
                        Virgin Islands, and having significant operations in the United States, but excluding any central bank of, or institution owned
                        by, a foreign government."


"Troubled Assets"         "(9) TROUBLED ASSETS.—The term ‘‘troubled assets’’ means—
                          (A) residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to
                          such mortgages, that in each case was originated or issued on or before March 14, 2008, the purchase of which the Secretary
                          determines promotes financial market stability; and

                          (B) any other financial instrument that the Secretary, after consultation with the Chairman of the Board of Governors of the
                          Federal Reserve System, determines the purchase of which is necessary to promote financial market stability, but only upon
                          transmittal of such determination, in writing, to the appropriate committees of Congress."



Section 112               "SEC. 112. COORDINATION WITH FOREIGN AUTHORITIES AND CENTRAL BANKS. The Secretary shall coordinate,
                          as appropriate, with foreign financial authorities and central banks to work toward the establishment of similar programs by
                          such authorities and central banks. To the extent that such foreign financial authorities or banks hold troubled assets as a
                          result of extending financing to financial institutions that have failed or defaulted on such financing, such troubled assets
                          qualify for purchase under section 101."



                                                                                                                                            Page 19 of 23
                                                        Table 14
                           Selected Quotations from House of Representatives Debate Regarding
                               The Emergency Economic Stabilization Act of 2008 (HR 1424)
                                                     October 3, 2008

 Representative                                                                Quote

Mr. Blunt         I’d like to put in the RECORD, Madam Speaker, a letter I received from the Secretary of the Treasury talking about the rules
(R-MO)            and regulations that they will pursue that will assure that eligible financial institutions must be established and regulated to
                  have significant operations in the United States. It’s not talking about foreign banks. Also requiring that—in the letter that
                  they will set up rules and regulations so that people participating in this program won’t benefit from this program.

                  [TEXT OF THE LETTER FROM SECRETARY PAULSON:]

                  DEPARTMENT OF THE TREASURY,
                  Washington, DC, October 2, 2008.
                  Hon. ROY BLUNT,
                  House of Representatives,
                  Washington, DC.

                  DEAR MR. BLUNT: I am writing regarding the Emergency Economic Stabilization Act of 2008.

                     The Act requires that eligible financial institutions must be established and regulated and have significant operations in
                  the United States. Furthermore, it is the intention of the Department of the Treasury that all mortgages or mortgage-related
                  assets purchased in the Troubled Asset Relief Program will be based on or related to properties in the United States.




                                                                                                                                       Page 20 of 23
                                                        Table 14
                           Selected Quotations from House of Representatives Debate Regarding
                               The Emergency Economic Stabilization Act of 2008 (HR 1424)
                                                     October 3, 2008

 Representative                                                                 Quote

                     The Act requires the Department of the Treasury to prevent unjust enrichment of financial institutions selling troubled
                  assets into the Troubled Asset Relief Program, including preventing the sale of a troubled asset to the Treasury at a higher
                  price than what the seller paid to purchase the asset. The Act specifies a single exemption for troubled assets acquired in a
                  merger or acquisition or a purchase of assets from a financial institution that is established and regulated in the United States
                  and that is in conservatorship, receivership or bankruptcy. The Department of the Treasury believes this exemption is
                  important to encouraging healthy institutions to pursue acquisitions of struggling institutions. Such acquisitions help to
                  protect depositors, taxpayers and the financial system.

                     The Department of the Treasury will issue regulations or guidelines necessary to address and manage or to prohibit
                  conflicts of interest that may arise in connection with the administration and execution of the authorities provided under the
                  Act as soon as practicable after the date of enactment.

                         Sincerely,
                                               HENRY M. PAULSON, Jr.

Ms. Ginny-Brown   However, what we have before us today is the bill that the Senate sent to us. They sent us the same exact bill that the House
-Waite            rejected, but they added another $150 billion. It still bails out foreign banks and raises the debt limit $1 trillion.
(R-FL)

Mr. Tiahrt        What it comes down to is that a $700 or $800 billion bailout with voluntary reforms was not a plan I could support. Worse
(R-KA)            yet, Sec. 112 of the Senate bill, allows foreign financial institutions who hold troubled assets as a result of extending
                  financing to financial institutions that have failed or defaulted on such financing to participate in this massive Government
                  bail-out. What does this mean? Simply, the Federal Government has invited foreign financiers to participate in this
                  bailout on behalf of every American.




                                                                                                                                        Page 21 of 23
                                                       Table 14
                          Selected Quotations from House of Representatives Debate Regarding
                              The Emergency Economic Stabilization Act of 2008 (HR 1424)
                                                    October 3, 2008

 Representative                                                          Quote

Mr. Udall         And I said that while American taxpayers continue to struggle we should not bail out foreign companies whose
(D-NM)            governments are doing nothing. Again, this bill still falls short.




                                                                                                                           Page 22 of 23
                                                        Table 15
                       Eligibility of Branches and Subsidiaries of Foreign Banks in U.S. Financial
                               Stabilization Programs For Which U.S. Banks Were Eligible
                                                                                                       Must       Foreign
                                                     Program         Foreign Bank Eligibility        Hold Fed       Asset
                 Program                            Management   Subsidiaries?     Branches?         Reserves?   Screening?


Term Auction Facility (TAF)                          Fed             YES          YES                    YES       YES
Asset-Backed Commercial Paper Money Market
Mutual Fund (AMLF)                                   Fed             YES          YES                    NO        YES

Commercial Paper Funding Facility (CPFF)             Fed             YES          YES                    NO         YES

Term Asset-Backed Securities Loan Facility (TALF)    Fed             YES          YES                    YES        YES

Capital Purchase Program (CPP)                       Treasury        NO           NO                     n/a        n/a

Asset Guarantee Programs (AGP)                       Treasury        n/a          n/a                    n/a        YES

Legacy Securities Program (PPIF)                     Treasury        YES          YES                    n/a        YES

Increase in FDIC Deposit Insurance                   FDIC            YES          YES                    n/a        n/a
                                                                                  (only grandfathered)

TLGP Debt Guarantee Program                          FDIC            YES          NO                     n/a        NO

TLGP Transaction Account Guarantee Program           FDIC            YES          YES                    n/a        n/a
                                                                                  (only grandfathered)




                                                                                                                   Page 23 of 23

				
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