Republican politicians have launched a full-scale attack on the “orderly liquidation authority,” the provision in Title II of the Dodd-Frank Act that empowers the Federal Deposit Insurance Corp. to unwind a failing financial conglomerate in a manner that avoids chaos in the financial system. But the effort to unwind this authority is unfortunate.
In the last couple of weeks, the White House issued an order to review the OLA and the House Financial Services Committee released the Financial Choice Act, a proposed replacement to Dodd-Frank, which calls for the OLA’s elimination.
Critics of the FDIC’s resolution authority charge that the agency’s access to a Treasury Department liquidity facility — the Orderly Liquidation Fund — is akin to bailout authority. They instead favor reforms to the bankruptcy code to deal with the failure of large firms. But this ignores the point behind creating the OLA.
One of the primary drivers behind the failure provision was the Lehman Brothers bankruptcy in the crisis. At that time, there was no regulator legally empowered to guide a behemoth through the liquidation process with the aim to prevent market panic. The only other legal choice besides letting Lehman go bankrupt was for a government bailout. So the Lehman estate was left up to the bankruptcy courts.
But in a bankruptcy, lawyers have the incentive merely to rescue as much as possible for their clients. In contrast, under the OLA, the FDIC’s objective is to help unwind a bank while trying to protect the safety and soundness of the American financial system and economy. Without such a regime in place, the financial system and economy would fall victim to the competing interests of various individual parties, none of whom would be focused on the big picture.
Opponents of the OLA idea seem to ignore that a failed large bank is not just a domestic problem, but rather an international one. Partly for this reason, other countries have followed the U.S. lead in crafting resolution regimes. In 2014, the Financial Stability Board published its “key attributes” framework for G-20 countries developing systems for winding down failed companies.
International coordination in the establishment of laws and institutions to resolve global banks is crucial. Precisely because the biggest U.S. banks have legal entities in foreign jurisdictions, the FDIC has spent the last seven years working with G-20 countries to establish memorandums of understanding to coordinate how they would work together in the event that a U.S. behemoth with overseas affiliates failed. In contrast, relying on a bankruptcy judge to handle a cross-border resolution is dangerous because she would only have authority in the U.S., without the ability to coordinate on a bilateral or global basis.
During last week’s House Financial Service Committee’s hearing on the Financial Choice Act, Republican lawmakers argued that the OLA needed to be eliminated because it enshrines “too big to fail.” But these critics completely mischaracterize the FDIC’s strategy. They would be well served to visit the FDIC’s site on bank recovery and resolution plans, and the OLA, where they might be surprised to discover that the FDIC’s position on a failed bank is that “bankruptcy is the statutory first option.”
I find it disturbing that the OLA is being incorrectly labeled as a means for the FDIC to pick any bank randomly and unwind it. That is simply not the case.
Under Dodd-Frank, the FDIC and the Federal Reserve together must make a recommendation to the Treasury secretary to activate a Title II receivership.
Two-thirds of the boards of both the FDIC and the Fed must approve the recommendation. But it is then up to the Treasury secretary, in consultation with the president, whether to make the final determination. In other words, our current sitting president and his Treasury secretary, Steven Mnuchin, hold considerable sway in the process.
But this is all beside the point. Much of Dodd-Frank — including Title II — was written in order to mitigate the significant human and financial costs of financial crises. But that goal seems to be forgotten by the authors and supporters of the Financial Choice Act.
William Dudley, president and CEO of the Federal Reserve Bank of New York reminded us of this in a recent speech he delivered at the Princeton Club in which he stated that “the harm the crisis caused Americans can only be described as catastrophic.”
Dudley noted that in the six months following November 2008, the nation lost an average of 700,000 jobs per month. He also pointed to a broad-based decline in home prices, leading to nearly eight million foreclosures. And the damage wasn’t just limited to the U.S. Millions of jobs were also lost in the U.K. and Europe due to the financial crisis.
While regulators’ and politicians’ focus should be to create laws and rules to keep banks from failing in the first place, no law can prevent failure 100% of the time. Hence, the OLA is a safeguard against the dire consequences of a systemically important firm failing. Assuming that the bankruptcy process is enough to resolve a failed bank is very shortsighted and would likely increase the chance that American taxpayers would again have to rescue big banks.