There is one really good reason to ignore appointed Senator Dean Heller’s (R-NV) call for repealing the Dodd-Frank Act on financial regulation reform. [DB] In the simplest possible terms it’s called “Orderly Liquidation Authority.”
No bank (now known as Financial Holding Companies, or FHC’s) wants the term “bankruptcy” to slip through its lips. So, we don’t talk about the B-Word, instead we say “Orderly Liquidation.”
In order to see why “Orderly Liquidation” is an important process all we have to do is to look back at what happened to Lehman Brothers. Investopedia has a succinct summary. A year after the Lehman Brothers meltdown, Time published “Three Lessons of the Lehman Brothers Collapse,” which also describes that consummate mess. Indeed, the Lehman collapse earned the dubious honor of being on the top of Time’s “Top Ten Financial Collapses” for 2008.
If we can agree that the lessons of the financial market collapse, Lehman et alia, in late 2008 ought to be taken to heart, then we can more objectively analyze how the Dodd-Frank Act attempted to alleviate some of the problems — not the least of which was “Too Big Too Fail.”
The core of the new legislation on this topic is contained in Title 2 of the Dodd-Frank Act, which financialists decry as “The Government Take Over Of Banks!” The right wing Heritage Foundation moaned:
Title II of the Dodd–Frank Act, ominously captioned “Orderly Liquidation Authority,” provides for government takeovers of failing financial companies either by the consent of the company’s board of directors or, failing that, by court order. The purpose of Title II is “to provide the necessary authority to liquidate failing financial companies that pose a significant risk to the financial stability of the United States in a manner that mitigates such risk and minimizes moral hazard.”
More specifically, that “ominous” cloud would deprive corporate shareholders of their rightful place in the governance of their financial holding companies, constitute excessive intrusion into state and other federal regulatory authority over banking institutions, “trample” on the judicial branch, and deprive financial holding companies of their right to defend themselves in court.
Repealing the “ominous” cloud of Dodd-Frank would have the U.S. revert to a system such as existed in 2008 in which the government had only two choices when faced with a replication of the Lehman Etc. Debacle: (1) Bail out the banks; or, (2) Watch helplessly as the financial markets implode into oblivion.
Senator DeMint’s (R-SC) bill (S. 712), co-sponsored by Senator Heller would — in very simple terms — wipe out Title II of the Dodd-Frank Act: “The Dodd-Frank Wall Street Reform and Consumer Protection Act (Public Law 111-203) is repealed, and the provisions of law amended by such Act are revived or restored as if such Act had not been enacted.” And, there we are, without an Orderly Liquidation Authority to clean up any messes made by financial holding companies, AKA banks — with laws “revived or restored as if such Act had not been enacted” — so whatever it was that created the problems at Lehman Brothers, AIG, Bear Stearns, and Merrill Lynch, could be repeated.
Perhaps this is the point at which we want to remind ourselves that before the Dodd-Frank Act the government had only two choices (Bail/Collapse.) So, what improvements in the system were enacted so that we wouldn’t have to repeat this sordid bit of economic history?
Establish An Early Warning System
Title I of the legislation created the Financial Stability Oversight Council, composed of the Secretary of the Treasury, the Chair of the Federal Reserve System, the Comptroller of the Currency, the Director of the Bureau of Consumer Financial Protection, the chair of the SEC, the chair of the FDIC, the chair of the Commodities Futures Trading Commission, the director of the FHA, the chair of the National Credit Union Administration Board, and an independent member appointed by the President subject to confirmation by the Senate.
Require Advance Planning
Call it a “Living Will” or a “Funeral Plan,” or whatever title seems appropriate, the Dodd-Frank Act requires the financial holding institutions to plan for their own demise, and to provide some crucial information at hand in case the company veers into “resolution.” * It has been cogently argued that had Lehman (and the others) done some advance planning, and had they kept and shared vital information about their operations, that the reorganization of U.S. financial institutions would have been much less painful for all concerned. [EconCon]
Put Someone In Charge of Picking Up The Pieces
In the case of a financial holding company this agency would be the FDIC.
“Title II of the Dodd-Frank Act (entitled “Orderly Liquidation Authority”) also defines the policy goals of the liquidation proceedings and provides the powers and duties of the FDIC as receiver for a covered financial company. Section 204(a)  succinctly summarizes those policy goals as the liquidation of “failing financial companies that pose a significant risk to the financial stability of the United States in a manner that mitigates such risk and minimizes moral hazard.” The statute goes on to say that “creditors and shareholders will bear the losses of the financial company” and the FDIC is instructed to liquidate the covered financial company in a manner that maximizes the value of the company’s assets, minimizes losses, mitigates risk, and minimizes moral hazard.” [FedRegister](emphasis added)
This sounds effective, especially the part underlined in which all is made right without too much “collateral damage,” but how might this work in the real world? [EconCon] If the clean up process is merely a matter of Purchase and Assumption (a company buys the failing one lock, stock and barrel) the FDIC has plenty of experience at this. There’s nothing new here, just the FDIC finding buyers for a failed bank — as it has done for decades. However, what happens if one part of the bank is “good” and it has another part that is still “toxic?”
The following may be an over-simplification of the options, but the FDIC could (1) agree to having some other institution buy the assets, and the FDIC could retain the losses; (2) create a financial “bridge company”(explained below); (3)start moving to minimize the mess by ” allowing prime brokerage customers to transfer their accounts to other brokers, and allowing derivatives counterparties to novate trades to other dealers. If a deal is struck, however, the bridge companies would transfer the assets being acquired to the buyer, and sell whatever is left back to the receivership.” [EconCon] (4) Let The Liquidation Begin if the FDIC finds there isn’t a buyer for anything.
For the third time, with even more feeling — without the Dodd-Frank Act the government has only two options to deal with a financial meltdown such as we saw in 2008: (1) Bail out the bankers; or, (2) Watch the financial system collapse. What DeMint and Heller are proposing is that we revert to The Bad Old Days, and that we (1) Dispense with any early warning system; (2) Require banks to do NO advance planning and share no vital information; (3) Put no one in charge of picking up the pieces and trying to fix the system before it melts down.
The bill Wall Street Warriors DeMint and Heller are presenting isn’t really about corporate or individual “freedom,” and “respecting the rights of the shareholders,” it’s altogether more about giving Wall Street financial institutions the LICENSE to return to the “Casino Days” of pre-2008 and the Jungle Ethics of financialism run rampant.
* (1) “full descriptions of the ownership structure, assets, liabilities, and contractual obligations of the company; (2) identification of the cross-guarantees tied to different securities, identification of major counterparties, and a process for determining to whom the collateral of the company is pledged; and (3) any other information that the Board of Governors and the Corporation jointly require by rule or order.” [EconCon]
** “Section 210(h) of Dodd-Frank authorizes the FDIC to create a “bridge financial company” — a temporary, pop-up financial institution that automatically has all the necessary charters and licenses, and is run by the FDIC — to purchase selected assets and liabilities of the entities in receivership. Crucially, before a broker-dealer is handed over to the Securities Investor Protection Corporation to resolve, the OLA allows the FDIC to transfer assets and customer accounts from the broker-dealer to a bridge financial company. This will allow the FDIC to ensure that the full suite of key services can continue uninterrupted: depositors can have uninterrupted access to their bank accounts, prime brokerage clients can have uninterrupted access to their cash and securities, etc.” [EconCon]
See Also: Singh & Chandi, “Dissection of Title II – Dodd-Frank Act,” PLAWG, January 7, 2011. “In defense of Dodd-Frank Resolution Authority Title I, Economics of Contempt, December 28, 2010. Federal Register: Orderly Liquidation Authority, Dodd-Frank Act, January 25, 2011. Morrison and Foerster, “The Dodd-Frank Act: A Cheat Sheet,” (pdf). FDIC, “Selections from the Dodd-Frank Act” link page to specific provisions. Congressional Research Service, “The Dodd-Frank Act: Systemic Risk and the Federal Reserve,” August 27, 2010. National Mortgage Professional, “FDIC Chair Bair Comments on Dodd-Frank Act’s Notice of Proposed Rulemaking,” September 27, 2010.