Tags: Senate | bank | subsidy | Dodd-Frank

Senate Banking Subcommittee Looks at Big Bank Subsidies

By    |   Wednesday, 13 Aug 2014 07:48 AM

The Senate Banking Committee's Subcommittee on Financial Services and Consumer Protection, chaired by Sen. Sherrod Brown, D-Ohio, held a hearing July 31 titled "Examining the GAO Report on Expectations of Government Support for Bank Holding Companies" (BHCs).

Witnesses represented the group at the Government Accountability Office that conducted the study, as well as three academic critics and one K Street public policy shop.

The hearing generated enough controversy to merit a rating of 3 gavels as political theater, and it would have score 3.5 or more if Sen. Elizabeth Warren, D-Mass., had attended and asked one of her usual provocative questions on this subject. Last year Warren jousted with Treasury Secretary Jack Lew over what it would take to establish "with a straight face" that the policy of supporting "too big to fail" had really ended as supporters of Dodd-Frank contend.

The report was requested by Sen. David Vitter, R-La., who along with Brown and Warren has been a leading proponent of legislation to break up the banks that are too big to fail and were bailed out during the 2008 episode of the ongoing, permanent financial crisis in order to reduce the likelihood of another costly bailout in the next crisis, which even the strongest supporters of the Dodd-Frank Act acknowledge is virtually inevitable.

Brown began his opening statement by complaining that the leader of the study, Lawrence Evans, director of financial markets and community investment at GAO, built the study around interviews with corporate treasurers who were recommended to him by the U.S. Chamber of Commerce, a lobby group that has opposed breaking up the too big to fail banks.

Evans, in turn, complained that his most vocal critic on the panel, Edward Kane, a finance professor at Boston College, had misunderstood the study in asserting that the GAO had "bungled the assignment" to determine the extent of the subsidy because he used the wrong methodology.

However, Vitter credited the study for advancing the debate and helping to lead the committee toward a consensus on the proposed legislation.

Kane argued that Evans took too narrow a view of the subsidies BHCs enjoy by treating them as "bond insurance" and ignoring the effect of the ability of BHCs to issue virtually unlimited debt to finance excessive risk taking, by virtue of the willingness of investors to assume that the debt is backed by the government.

Anat Admati, a professor of finance and economics at Stanford's Graduate School of Business and co-author of The Emperor's New Clothes, argues that BHCs are able to maintain themselves in a permanent state of distress by virtue of a free government subsidy.

Deniz Anginer, assistant professor of finance as the Virginia Tech Business School, and Douglas Holtz-Eakin, former director of the Congressional Budget Office, were more willing than Kane and Admati were to credit the reforms of Dodd-Frank for containing the extent of the subsidy.

Finally, despite the reference of Vitter to a growing consensus, the witnesses differed significantly in the remedies they propose. Kane proposes stronger corporate governance and law enforcement, while Admati would employ Prompt Corrective Action to require BHCs to raise enough capital to absorb the losses entailed by their risky activities.

Anginer proposes more transparent tracking of the subsidy as it changes during time, and Holtz-Eakin backs the proposal by Sen. Pat Toomey, R-Pa., and some other Republicans to write a new chapter of the bankruptcy code to clarify the extent to which creditors would be bailed out.

(Archived video can be found here.)

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Robert-Feinberg
The Senate Banking Committee's Subcommittee on Financial Services and Consumer Protection, chaired by Sen. Sherrod Brown, D-Ohio, held a hearing July 31 titled "Examining the GAO Report on Expectations of Government Support for Bank Holding Companies" (BHCs).
Senate, bank, subsidy, Dodd-Frank
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2014-48-13
Wednesday, 13 Aug 2014 07:48 AM
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