Title: A proposal for efficiently resolving out-of-the-money swap positions at large insolvent banks
First published: 2003
Description: "Recent evidence suggests that bank regulators appear to be able to resolve insolvent large banks efficiently without either protecting uninsured deposits through invoking 'too-big-to-fail' or causing serious harm to other banks or financial markets.  But resolving swap positions at insolvent banks, particularly a bank's out-of- the-money positions, has received less attention.  The FDIC can now either repudiate these contracts and treat the in-the-money counterparties as at-risk general creditors or transfer the contracts to a solvent bank.  Both options have major drawbacks.  Terminating contracts abruptly may result in large- fire sale losses and ignite defaults in other swap contracts.  Transferring the contracts both is costly to the FDIC and protects the counterparties, who would otherwise be at-risk and monitor their banks.  This paper proposes a third option that keeps the benefits of both options but eliminates the undesirable costs.  It permits the contracts to be transferred, thus avoiding the potential for fire-sale losses and adverse spillover, but keeps the insolvent bank's in-the-money counterparties at-risk, thus maintaining discipline on banks by large and sophisticated creditors"--Federal Reserve Bank of Chicago web site.
LC classification: HG2401