House and Senate Subcommittees Spar Over TBTF Resolution Rules — Part II

Friday, 17 May 2013 01:33 PM

By Robert Feinberg

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On May 15, the Senate Banking Committee's Subcommittee on National Security and International Trade and Finance (too many "ands"), chaired by Mark Warner, D-Va., held a hearing titled "Improving Cross Border Resolution to Better Protect Taxpayers and the Economy." Warner was the only senator present, and this gave him, as he said, an hour and a half to ask all the questions he could muster of several banking agency witnesses regarding how the implementation of the resolution provisions of the Dodd-Frank Act is working.

It should be noted at the outset that the cross-border issues considered at this hearing are different from those raised in the controversy over competing regulations under Title VII of Dodd-Frank, which would regulate derivatives transactions conducted overseas by "U.S. persons." The cross-border issues discussed at this hearing are those of Title II of Dodd-Frank, which would apply to the resolution of too big to fail financial institutions with global operations, so that any resolution of failed institutions would require both a workable legal and legislative framework and extensive coordination among international financial regulators.

Unlike the House hearing, the Senate hearing represented only one side of the argument, unless you count Warner, who got a bit caught up in his own misgivings about what the FDIC and the Federal Reserve might be doing.

The three panelists were functionaries of the FDIC, the Fed and the Treasury in charge of various aspects of the resolution program, such as it is. Jim Wigand, director of the FDIC's Office of Complex Financial Institutions, is the genius behind the resolution plans being devised at the FDIC. To hear his full presentation, rather than just the five-minute version presented at the hearing is a painful ordeal.

Michael Gibson, director of the Fed's Division of Banking Supervision and Regulation, is in charge of the aspects of the plan that pertain to bank holding companies, which fall under the jurisdiction of the Fed, and William Murden, director of the Treasury's Office of International Banking and Securities Markets, has the thankless task of trying to coordinate the U.S. program with those of the major trading partners represented in the G20.

Especially in the case of Wigand, nearly every statement they make contains a hidden premise, a contingency or some other form of weasel wording, so that it becomes a game, although not an enjoyable one, to parse the statements and try to figure out what they are trying to say, then compare it with one's view of reality.

In an amusing interlude, Warner got caught in this predicament as he tried to elicit from the panel assurances that they were prepared to confront the vulnerability of the U.S. financial system to shocks that might come from Europe or elsewhere at any time. After several efforts produced only verbal fog, Warner gave up. The dialog was becoming embarrassing to him, if not to the witnesses.

Readers trying to figure out whether the resolution policy embodied in Title II is a hit or a myth might be interested in the latest piece by Simon Johnson of MIT, a leader in the debate, titled, "The Myth of a Perfect Orderly Liquidation Authority for Big Banks," published Thursday in The New York Times. Johnson dissects a paper issued by the so-called Bipartisan Policy Center (BPC) that touts the virtues of Title II.

Conservatives would be interested to know that the principals of the BPC are the eminences grises George Mitchell, Tom Daschle, Bob Dole and Howard Baker. The motto of this group should be "No special interest left behind." The group is evidently aimed at those who think, or are susceptible to the argument that, there's just too much partisanship in Washington. However, in the financial arena, the issues tend not to be partisan, so this group becomes another convenient purveyor of what this writer refers to as "bank propaganda."

Johnson's main point, offered from the left of center, is similar to that of the Republican witnesses at the House hearing, that to provide special treatment for banks, even through the mechanism of a new bankruptcy code chapter, exacerbates market uncertainty and devalues the rule of law.

I would add the following points, all of which tend to get totally lost in the debate:

1. Faulty bank model. The business model of the banking industry is fundamentally flawed, because it has been overtaken by the progression of the U.S. economy to one primarily based on agriculture to an industrial and later to a service economy. True enough, the banking industry can present itself as a segment of the service economy, but there isn't any real money in it; the industry is almost totally dependent on government support.

2. Culpable managers. Title II provides that as part of the so-called resolution process, managers found to be culpable (rather than capable) are to be removed. This is a flawed socialist concept. In a competitive marketplace, managers of enterprises should expect to get weeded out if they are corrupt, incompetent or merely unlucky. Lloyd Blankfein, CEO of Goldman Sachs, one of the failed zombie banks that the government rescued famously, said that he was "doing the Lord's work." But in a competitive market, even if that's true, it's not enough. If you don't do the Lord's work well enough, without imposing the costs of your hobby on the larger society, you should be out on your keister (a word for which we have Ronald Reagan to thank).

3. Conceit of industry funding.
Title II provides that if a failing institution has to be rescued because of its systemic significance, the group of too big to fail institutions will be assessed the cost after the fact. Conferees on Dodd-Frank faced a quandary. If they established a fund for bailouts, that would be ridiculed, as it was, as setting the stage for more bailouts. In order to preserve deniability, it was necessary to make a plausible claim that no public money will be spent. However, the FDIC is already busted and dependent on Treasury credit to operate, and its plan to recapitalize doesn't even take effect until near the end of this decade. Republican conferees complained loudly about this during the conference on Dodd-Frank.

In conclusion, the administration's narrative that the 2008 episode was unpredictable and that the authorities lacked the tools to avoid a bailout is fantasy, and so is the so-called resolution plan. It is just as fantastic as the claim that policymakers are determined to make sure that a crisis resulting in a federal bailout will "never happen again."

One is reminded of the claims of the television huckster Joe Isuzu, who might have said, "Five giraffes can fit in the back seat, with plenty of head room." Title II is just a figment of the industry's PR machine, backed by compliant legislators and so-called regulators. No one really believes this, either; rather, the exponents of this message hope that when this elaborate construct ultimately blows up, they will be comfortably ensconced in gated communities far away from the wreckage.

The Oversight Subcommittee of the House Financial Services Committee has schedule a hearing for May 22 to look at the immunity from prosecution that the zombie banks enjoy under Justice Department policy. It will be interesting to see whether anyone is bold enough to argue that an institution that is capable of bringing down the nation's financial system and the global economy should be subject to stricter, not more lenient, compliance standards.

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