Tags: House | too big to fail | FDIC | Fed

House Subcommittee Looks at ‘Too Big to Fail’ Authority

By    |   Wednesday, 17 Apr 2013 02:53 PM

The House Financial Services Committee (HFSC)’s Oversight and Investigations Subcommittee, chaired by Patrick McHenry, R-N.C., who has close ties to the mortgage banking industry and once took a $5,000 contribution from Countrywide Financial, held a hearing on April 16 to consider the authority that federal banking regulators have to determine that some financial institutions pose risk to the financial system and that, in order to contain this risk, measures can be taken to require the institutions to divest themselves of such activities, perhaps to such an extent as to break up the “too big to fail” banks, as some commentators, senators and even former Citigroup CEO Sandy Weill have advocated.

On that same day, the House Financial Services Committee's Financial Institutions and Consumer Credit Subcommittee held a hearing on the complaints of community bankers.

The Oversight and Investigations hearing provides an opportunity to introduce readers to what will be a new tool to use in conjunction with hearings of HFSC. While as a general proposition, it is fair to criticize the committee for being too close to the financial services industry and for choosing to help the industry portray itself as the victim of the financial crisis rather than the cause of it, thus perpetuating the very flaws in the financial system that prevent the crisis from ever being contained or reversed, the committee should be commended for providing a link to a copy of the memorandum provided to committee members for each hearing so that viewers can have access to the same briefing material the members received from the committee.

They do this even though the memos don’t always portray the committee in the most favorable light, perhaps because they don’t realize how far off course they are.

For example, in this instance, the committee appears to be asking the wrong question — whether the regulators have the authority to deal with too big to fail, a question the staff answered with the appropriate citations to the Dodd-Frank language, rather than whether the regulators have the motivation to use this authority and avoid succumbing to the blandishments of industry trade associations and lawyers.

The memorandum misses the point for another reason. History shows that the regulators tend to respond to the demands of key clients. Once they determine what policy they want to pursue, they then find the authority, creating it out of whole cloth if necessary.

On the other hand, sometimes they already have authority to take action but do not want to exercise it, perhaps because the interests of a key client or clients would suffer, and the employment prospects of regulators might suffer along with those of the clients.

At this hearing, the three witnesses represented the agencies charged with administering the powers conferred on them by the Dodd-Frank Act supposedly to deal with the problem of too big to fail. However, these very powers are also part of the narrative that the reason the 2008 episode of the ongoing financial crisis occurred was that the regulators did not have these authorities.

In making this argument, the administration chooses to ignore the fact that throughout the 40 or 50 years of the ongoing financial crisis, the administration and the regulators were empowered many times to take action to halt the buildup of exposure to enormous losses due to the recklessness of bankers and the fecklessness of their regulators, losses that are compounded every day.

The first witness was Scott Alvarez, who has been the general counsel of the Federal Reserve for many years. Unlike the FDIC, where general counsels rotate through the revolving door every few years and the job is now filled by Richard Osterman, Jr., an acting appointee and the second witness, Fed general counsels tend to serve for an extended period.

The third witness, James Wigand, director of the FDIC’s Office of Complex Financial Institutions, the entity within the FDIC that is supposed to deal most directly with the issue of too big to fail.

Witnesses at committee hearings are generally given five minutes to present the highlights of their testimony. With respect to Wigand, I have been subjected to the whole megillah at a public conference and found it to be the most unpleasant, narcissistic, incredible ordeal of any of the hundreds, maybe thousands, of speeches and presentations heard during this protracted financial crisis.

Readers can judge for themselves, but the pronouncements of Wigand are worthy of attention because he appears to be one of the most influential bureaucrat/regulators administering policy regarding too big to fail.

In Alvarez’s testimony, he decried the effects of too big to fail as creating incentives for institutions to take undue risk and inhibiting competition. But he also cited efforts to strengthen the capital of the industry, along with the new Orderly Liquidation Authority, as measures that could stave off the likelihood that a too big to fail institution would fail and the Dodd-Frank powers would be tested.

The best advice here is not to look to the Federal Reserve as a bulwark against too big to fail. Recently, Fed Governor Dan Tarullo acknowledged earlier this month that the regulators have not yet eliminated too big to fail and that the project is still “work in progress.”

In their joint testimony, Wigand and Osterman asserted their intention to make the process that requires banks to submit “living wills” to facilitate their breakup under a bankruptcy-like process “both timely and meaningful.” I would suggest, first of all, that there is no way the living will process can be timely, because the time to break up these institutions was back in 1981, when they had already become huge, highly leveraged and risky.

In the intervening decades, Congress has repeatedly adopted legislation that was supposed to give the regulators new tools to combat the financial crisis, but none of these tools was ever implemented. Therefore, the default assumption, so to speak, must be that the new tools are essentially cosmetic and are unlikely to reverse the established policy of allowing the too big to fail institutions to continue to grow and to add new institutions to their number.

At the same time, it is fair to say that the new powers could conceivably be meaningful if the process and the public debate lead the institutions to voluntarily decide, perhaps at the prodding of outside directors, that it is in their best interest to act proactively to scale back the threats they pose to the U.S. and global financial systems.

Perhaps the most instructive analogy is the case of the housing government-sponsored enterprises Fannie Mae and Freddie Mac, which have been operating for six years under a government conservatorship, with policymakers proclaiming that they must be reformed in some manner at some indefinite time in the future.

Meanwhile, after the expenditure of at least $300 billion in public support, the enterprises have muddled through and are reporting profits. Another too big to fail institution, Wells Fargo, appears to have joined the party, and industry lobbies are calling for the industry to be restructured in the interest of preserving the 30-year, fixed-rate mortgage, this time with an explicit government guarantee.

So this is another direction policy can take, and participants who for whatever reason are prone to declare “Mission Accomplished” might be a bit premature.

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Robert-Feinberg
The House Financial Services Committee’s Oversight and Investigations Subcommittee held a hearing on April 16 to consider the authority that federal banking regulators have to determine that some financial institutions pose risk to the financial system.
House,too big to fail,FDIC,Fed
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Wednesday, 17 Apr 2013 02:53 PM
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