The biggest shortfall of the Dodd-Frank Act is its inability to remove incentives that encourage banks to misuse savings under an understanding that they are too big to fail, Former Federal Reserve Chairman Alan Greenspan has claimed.
Title II of Dodd-Frank addresses the risks of too-big-to-fail and intends to correct for them through the orderly liquidation authority (OLA) and resolution planning for systemically important financial institutions (sifis).
It remains unclear, however, whether the OLA and resolution planning will prevent bank savings from being misused as a result of bad incentives created by the 2008 troubled asset relief program.
Speaking at the Securities Industry and Financial Markets Association’s annual meeting on Tuesday, the former banking regulator said it would be best for distressed banks to go through a standard Chapter 11 plan and liquidate.
“The whole financial system essentially works best when it is able to move savings into profitable investment,” he said. “If, for example, there are many institutions which are labeled effectively too-big-to-fail, more likely than not they may be misusing the savings of the society.”
“Ordinarily, if they were not too big to fail they would go through Chapter 11 and get restructured and the whole system would start again,” said Greenspan.
As it stands, the Federal Deposit Insurance Corporation (FDIC) can be appointed a receiver of distressed member banks under the Federal Deposit Insurance Act of 1950. The OLA creates a similar process for sifis in which the Secretary of the Treasury appoints the FDIC as a receiver for the relevant institution’s top holding company. The FDIC is then to sell all the assets to a bridge holding company. The receivership retains all liabilities and the FDIC receives all equity interests.
The FDIC plans for such a bridge company to receive private financing that can be guaranteed by an orderly liquidation fund backed by the Treasury. The role of the FDIC as a guarantor of debt financing for distressed sifis has raised concerns too-big-to-fail still exists.
An assessment by Federal Financial Analytics published on October 22 sought to answer whether US sifis are still too-big-to-fail. The paper concluded US bank holding companies and other financial services firms, regardless of size or the nature of their operations, can no longer be rescued at long-term cost to the federal government or otherwise supported in ways that undermine market discipline.
Karen Shaw Petrou, managing partner of Federal Financial Analytics, said the assessment targeted the biggest confliction in financial regulation – the premises behind capital requirements and other stability provisions and the idea that banks are too big to fail.
“Right now, we’re regulating financial services institutions as if they’re too big to fail and just in case they are not, which is the worst of all possible worlds,” Petrou said
“The orderly liquidation authority is incomplete and untested, but when you look at the law, it is very straight forward - it says tax payers may not bail-out banks,” Petrou said. “Institutions are to be resolved under Chapter 11, except in the event of systemic risk which must be found under a series of very stringent conditions.”
The OLA bridge company strategy would consider liquidation plans, also called living wills, to guide the FDIC under such a scenario. The deadline for sifis to submit plans was October 1. The publicly disclosed sections of liquidation plans are available on the FDIC’s website.
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