The House Committee on Financial Services published a report by the Republican staff on the Committee, titled “Failing to End ‘Too Big to Fail,'” which assesses the Dodd-Frank Act’s “too big to fail” provisions.
The report reviewed factors that led to the financial crisis in 2008 and the conduct of the government in alleviating the crisis, including the steps that it took to “bail out” various financial institutions. According to the report, financial experts, regulators and market participants now agree that Dodd-Frank failed to accomplish its goals, particularly the goal of eliminating “too big to fail.”
With regard to Title I, the report found that: (i) FSOC is inefficient and a source of systemic risk; (ii) the Office of Financial Research has failed to identify or mitigate risks to the financial system, and failed its first high-profile test; and (iii) living wills do not solve the problem of “too big to fail” and may not be effective if used during a financial crisis.
With regard to Title II, the report found that: (i) the “Orderly Liquidation Authority” makes bailouts more likely in the future; (ii) the means by which the “Orderly Liquidation Authority” would prevent bailouts have never been explained and their effectiveness is in serious doubt; and (iii) the “Single Point of Entry” potentially could institutionalize AIG-style bailouts and encourage recklessness.
On July 23, 2014, the House Financial Services Committee is scheduled to hold a hearing, titled “Assessing the Impact of the Dodd-Frank Act Four Years Later,” regarding the findings outlined in the Report. The following witnesses are scheduled to testify:
- Barney Frank, former Chairman, House Committee on Financial Services;
- Anthony J. Carfang, Partner, Treasury Strategies, Inc.;
- Thomas C. Deas, Vice President and Treasurer, FMC Corporation, on behalf of the Coalition for Derivatives End Users;
- Paul H. Kupiec, Resident Scholar, American Enterprise Institute; and
- Dale K. Wilson, Chairman, President and Chief Executive Officer, First State Bank.
Lofchie Comment: The report is effectively divided into three parts. The first part asks whether “deregulation” of financial markets caused the financial crisis. The second part asks whether the U.S. government acted wisely in “bailing out” various financial institutions, or whether these institutions should have been left to fail. The third part asks whether particular institutions and procedures created by Dodd-Frank (the Financial Stability Oversight Council, the Office of Financial Research and the creation of living wills) have been successful to date.
The first section of the report provides a brief assessment of the causes of the financial crisis (which differs from the view of the Congress that adopted Dodd-Frank). In particular, the report disputes the notion that deregulation caused the crisis. Speaking as a financial regulatory lawyer, I think that the House report has a far stronger position than the adherents to the view that deregulation caused the crisis. During my entire career as a financial regulatory lawyer, the amount of financial regulation has steadily increased (which the report demonstrates). (A number of commenters and politicians have suggested that the repeal of the Glass-Steagall Act was deregulatory in that it allowed the combined operation of banks and securities firms. In fact, banks and securities firms were affiliated long before Glass-Steagall was repealed, and the repeal was not necessary for their affiliation.)
Arguably, this first section of the report is also critical of the regulators for failing to anticipate the financial crisis. Perhaps a gentler reading of the report would be that the regulators should concede they were not successful in anticipating the prior financial crisis. (On one issue, I am going to defend the regulators: I don’t think it is fair to criticize the SEC for failure to regulate the capital of holding companies of broker-dealers properly before the financial crisis. The SEC’s authority in this regard was extremely limited; it was more akin to a right to observe and was not at all comparable to the authority that the Federal Reserve has and maintains over bank-holding companies).
The second section of the report essentially argues that the U.S. government should not have “bailed out” Bear Stearns or other financial institutions during the crisis. Obviously, there is no way to prove that, in retrospect, one course of action would have been preferable to another. That said, my personal belief is that the bailout was the correct course of action. Had the government not stepped in to provide liquidity and support of various kinds, an extremely high number of financial institutions in the United States (and abroad) would (or perhaps would) have failed. The problem was not that some particular entity was “too big to fail.” It was that the value of assets (particularly real estate assets) crashed and no liquidity was available for financing. Had a few more financial institutions failed, asset values would have crashed further and liquidity may have stopped entirely – i.e., creating systemic shocks beyond even the dramatic ones we saw during the crisis.
The third section of the report provides forceful criticism by the Republican majority staff of the Financial Services Committee on FSOC, OFR and living wills. While I will not summarize these criticisms, my view has been that (i) these provisions are not well-founded, (ii) that these Dodd-Frank-created entities are not off to a good start, and (iii) their structure and purposes should be subject to reconsideration.
See: Report: Filing to End “Too Big to Fail”; Report: Dodd-Frank Does Not End Too Big to Fail; Hearing Announcement and Witness List.
See also: Financial Services Committee to Hear from Main Street Economy Voices at Dodd-Frank Anniversary Hearing; Rep. Jeb Hensarling Article, “Derailing the American Dream Since 2010: Thanks a lot, Dodd-Frank.”