WASHINGTON The House Financial Services Committee wrestled with concerns over "too big to fail" on Wednesday, pressing current and former regulators on how the Dodd-Frank Act could be improved to prevent future bank bailouts.
Lawmakers on both sides of the political aisle delved into the nitty-gritty details of how regulators would wind down a large, failing institution under Dodd-Frank, with many raising questions about how those efforts could fall short.
Regulators on the panel have all been outspoken in their concerns about "too big to fail," though they were divided in their level of support for the crisis-era law and in the solutions they offered to improve the system. Two of the panelists, Sheila Bair, former chairman of the Federal Deposit Insurance Corporation, and Thomas Hoenig, vice chairman at the FDIC, argued that Dodd-Frank at least has the "tools" to end "too big to fail," while the others, Richard Fisher, president and chief executive of the Federal Reserve Bank of Dallas, and Jeffrey Lacker, president and CEO of the Federal Reserve Bank of Richmond, said it doesn't solve the problem.
Below are some key highlights from Wednesday's hearing:
Some warned that regulators still have too much discretion.
A big problem for regulators and investors during the financial crisis was the lack of certainty around the fate of a troubled bank some institutions were allowed to fail, while others were acquired or bailed out. That's an issue that Dodd-Frank attempts to solve, but some lawmakers and panelists at Wednesday's hearing warned the law doesn't go far enough in tying regulators' hands from bailing out another big bank.
"I think that discretion traps policymakers in a crisis," Lacker. "Expectations build up that they may use that discretion to rescue creditors and let them escape losses. And given that expectation, policymakers feel compelled to fulfill the expectation in order to avoid the disruption of markets pulling away from who they've lent to on the basis of that expected support."
Fisher raised a similar point as he detailed his plan to end "too big to fail," which would attempt to shift market expectations by restricting deposit insurance to commercial banks and requiring others to sign a contract explicitly stating there will not be another government bailout.
"When you have discretion, you have room for powerful lobbies to influence decision making. When you have a strict rule of law, as long as it's a good rule of law, I believe is the simple proposal we've made from the Dallas Fed, then you remove that possibility for folks to work on the regulators, massage the regulators, lobby the regulators and so on," he said. "And you have a greater chance of discipline. So this is all about the rule of law."
But Bair argued that there are "substantial limitations" on regulators' discretion already in place, particularly when it comes to their ability to differentiate among creditors.
"They can't differentiate among creditors except under two conditions," said Bair. "One, you're going to maximize recovery. Two, you're going to maintain essential operations. You've got to pay your employees. You've got to pay your IT people. You've got to pay the people who've been mowing the lawn. And that's true in bankruptcy. Those people are paid in full bankruptcy. Those creditors are differentiated."
She added: "I think Dodd-Frank what was trying to say is, 'This is the process going forward. Here's how the government is going to do this. These are the limits on their discretion.' I think there are very meaningful limits there."
There are widely different views of the impact of SIFI designations.
Panelists at the hearing were also split over the effects of being designated a "systemically important financial institution."
"This designation is not a badge of honor, but a scarlet letter," said Bair. "It includes no benefits from the government. It only heightens the firm's required capital and supervision. It does not mean the firm will be resolved under OLA, rather than bankruptcy. In fact, Section 165 requirements for resolutions are aimed at ensuring an orderly resolution under the bankruptcy code, not orders of liquidation."
But others argued that SIFIs actually benefit from the designation, because the market understands that those institutions would be the first to be saved in the event of another major crisis.
"Based on my experience of working in the financial markets since 1975, as soon as a financial institution is designated systemically important as required under Title I of the Dodd-Frank Act and becomes known by the acronym SIFI, it is viewed by the market as being the first to be saved by the first responders in a financial crisis," said Fisher. "In other words, the SIFIs occupy a privileged position in the financial system. One [pundit] refers to the acronym SIFI as meaning 'save if failure impending.'"
There is unanimous support for higher capital requirements.
All of the regulators on the panel expressed ongoing concern with the amount of capital that financial institutions hold today.
"More capital would be a real plus for the industry," said Hoenig. "Right now, the largest institutions have actually less capital than the regional and the community banks by a substantial margin. So, they should increase their capital."
The FDIC official has advocated in the past for capital requirements as high as 10% across institutions of all sizes, higher than some of his fellow panelists. Bair has argued that a minimum of 8% might be sufficient, though Fisher noted at the hearing that community banks have expressed concern with that number too.
"Your first strategy is always to try to prevent a failure or reduce the probability of it. And that can only be done with high-quality capital," Bair said on Wednesday.
The two Fed presidents, Lacker and Fisher, also suggested that banks need to hold more capital, though they emphasized higher requirements must be paired with structural changes to the financial system and wouldn't be sufficient on their own.