At a hearing examining Titles I and II of the Dodd-Frank Act
and the attendant orderly liquidation authority for systemically important
financial institutions, House Financial Services Committee Chair Jeb Hensarling
(R-TX) said that there is a growing consensus that Dodd-Frank did not end too
big to fail (TBTF) as applied to large, complex financial firms. Indeed, he noted
that the Dodd-Frank Act codifies the TBTF doctrine. In this regard, he pointed
to Section 113 of Dodd-Frank, which authorizes the Financial Stability
Oversight Council to designate financial firms as systemically important
financial institutions. In essence,
said Chairman Hensarling, by designating a financial firm as a systemically
important financial institution, the FSOC is designating the firm as TBTF.
The Committee’s Ranking Member, Rep. Maxine Waters
(D-CA), noted that Title II of Dodd-Frank includes provisions that are supposed
to prevent taxpayer-funded bail-outs. She pointed to Section 214(a), which provides
that no taxpayer funds may be used to prevent the liquidation of any financial
company under Title II. Section 214(b) requires that all funds expended in the
liquidation of a covered financial company be recovered from the disposition of
assets or through assessments on the financial sector. Section 214(c) provides
that taxpayers shall bear no losses from the exercise of any authority under
Title II.
Rep. Mick Mulvaney (R-SC) said that, despite Section 214,
it appears that taxpayer funds could still be used in a Title II orderly
liquidation. Asked by Rep. Mulvaney for his view, Dallas Fed President Richard
Fisher noted that, if the reorganized firm cannot repay the Treasury for
its debtor-in-possession financing, Section 214 says that the repayment should
be clawed back via a special assessment on the company’s SIFI competitors.
Since that assessment is then written off as a tax-deductible business expense
by the assessed firm, thereby reducing revenue to the Treasury, Mr. Fisher
contends that it is at taxpayer expense.
Rep. Patrick McHenry
(R-NC) flatly stated that the Dodd-Frank Act did not end TBTF. He also noted
that the FSOC has not identified new risks to the economy and the Federal
Reserve Board has not made public how it would employ its new authorities to
prevent a financial crisis. He also pointed out that the DOJ is reluctant to
prosecute large financial institutions.
Rep. Carolyn Maloney
(D-NY) emphasized that Dodd-Frank properly gave regulators a third option
outside the previous binary choice for a failed financial firm of bankruptcy or
a taxpayer bailout. This third option is the orderly liquidation authority in
Title II, allowing the FDIC to wind down large financial firms.
In
his testimony, Mr.
Fisher argued that the Dodd–Frank Act, despite its best intentions, imposes a
prohibitive cost burden on the non-TBTF financial institutions and needs to be
amended. As soon as a financial institution is designated systemically
important as required under Title I of Dodd–Frank, he noted, it is viewed by
the market as being the first to be saved by the first responders in a
financial crisis. In other words, said the Dallas Fed leader, these SIFIs occupy a
privileged space in the financial system
In reality, rather than fulfill Dodd–Frank’s promise of no
more taxpayer-funded bailouts, the Treasury will likely provide, through the
FDIC, debtor-in-possession financing to the failed companies, he continued,
thereby artificially keeping alive operating subsidiaries for up to five years,
and perhaps longer. Under the single point of entry method being espoused by
Treasury, the operating subsidiaries remain protected as the holding company is
restructured. President Fisher described Title II of Dodd–Frank as a disguised
form of taxpayer bailout that promotes and sustains an unnatural longevity for
zombie financial institutions.
The Dallas Fed
has a three-prong reform proposal to address the situation. First, roll back the federal safety net of deposit
insurance and the Federal Reserve’s discount window to where it was always
intended to be, that is, to traditional commercial bank deposit and lending
intermediation and payment system functions. Thus, the safety net would only be
available to traditional commercial banks and not to the nonbank affiliates of
bank holding companies or the parent companies themselves.
Second, customers, creditors and counterparties of all
nonbank affiliates and the parent holding companies would sign a simple, legally
binding, unambiguous disclosure acknowledging and accepting that there is no
government guarantee backstopping their investment. Third, the largest
financial holding companies would be restructured so that every one of their
corporate entities is subject to a speedy bankruptcy process.
In her testimony, former FDIC Chair Shelia Bair strongly disagreed with the notion that Title
II’s orderly liquidation authority enshrines the government bailout policies of
2008 and 2009. Dodd-Frank has abolished the implicit and explicit TBTF policies
that were in effect before its enactment. To the extent that TBTF remains, she
noted, it is because regulators have more work to do to ensure that financial
firms go into orderly liquidation if they do fail and because markets continue
to question whether government will follow through on Title II and allow a
systemically important firm to fail.
There are some things that could be done to improve the
orderly liquidation process, said the former FDIC Chair. For example,
regulators should ensure that large, complex financial institutions have
sufficient long-term debt at the holding company level. The success of an
orderly liquidation authority using the Treasury’s single point of entry
approach depends on the top level holding company’s ability to absorb losses
and fund recapitalization of the surviving operating entities, reasoned the former FDIC head. Currently,
nothing requires that firms hold sufficient senior debt to meet this need.