POLITICS: PennAve

Two Fed presidents: Dodd-Frank will not prevent bank bailouts

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Beltway Confidential,Finance and Banking,Fiscal Policy,Federal Bailouts,PennAve,Joseph Lawler,Federal Reserve,Dodd Frank

Two presidents of regional Federal Reserve banks warned Wednesday that the 2010 financial regulation overhaul known as Dodd-Frank does not solve the problem of too-big-to-fail banks and will not prevent taxpayer bailouts of banks in the future.

Richard Fisher, the president of the Dallas Fed, said the law’s “stated promise to end too big to fail rings hollow,” and that one of the law’s provisions for winding down insolvent banks would result in a “’Rob Peter to pay Paul’ chain of events, with the taxpayers playing the role of Peter.”

The law also “replicated the … mutually reinforcing expectations” of bailouts “that defined too-big-to-fail” before the 2008 financial crisis, according to Philadelphia Fed President Jeffrey Lacker.

Fisher and Lacker testified at a House Financial Services Committee hearing called to examine whether Dodd-Frank had effectively ended government bailouts of banks. The committee’s chairman, Texas Republican Jeb Hensarling, said in his opening remarks that “Dodd-Frank not only fails to end too big to fail and its attendant taxpayer bailouts – it actually codifies them into law.”

The Dodd-Frank financial regulation reform effort was taken up in 2010 as a response to outrage over the financial crisis and the ensuing bailout of Wall Street. The legislation was designed to another prevent another event like the bankruptcy of Lehman Brothers in September 2008, when the firm’s failure led to a widespread banking panic and eventually the passage of the law that included the TARP bailout.

Critics of the Dodd-Frank law, however, believe the measure would not avert such a scenario in the future. The law’s requirement that regulators use their own discretion to determine when a bank should be taken into receivership by the Federal Deposit Insurance Corporation, Lacker suggested, “traps policymakers in a crisis.” He predicted that regulators would feel compelled to provide support to financial firms during a panic to meet banks’ expectations of government intervention.

Dodd-Frank defines financial institutions with assets over $50 billion as “systemically important financial institutions,” or SIFIs, and subjects them to added regulation. Fisher said banks with that designation would be “viewed by the market as being the first to be saved by the first responders in a financial crisis.” The perception that they occupy a “privileged space in the financial system,” according to Fisher, means they would enjoy an implicit subsidy through cheaper financing.

Fisher also said that the Dodd-Frank liquidation process “sounds, and tastes like a taxpayer bailout” because the subsidiaries of a failed bank holding company would be allowed to operate after the company entered FDIC receivership, providing them with a guarantee against failure. Fisher noted that, although costs to the government of resolving a SIFI are charged to other SIFIs under Dodd-Frank, those charges can be written off as tax-deductible business expenses, resulting in taxpayer losses either way.

To end the phenomenon of too big to fail, Fisher proposed limiting the access to the Fed’s discount window to FDIC insurance to commercial banks only. Lacker suggested that banks be required to write “living wills” that would clearly spell out a strategy for quick and orderly resolution without taxpayer assistance in the case of failure.

The Dodd-Frank law did have defenders at the hearing. Sheila Bair, the former head of the FDIC who played a key role in drafting Dodd-Frank’s provision for resolving failed banks, objected to Fisher’s description of the SIFI designation as a privilege, saying it was “not a badge of honor but a scarlet letter” and that banks try to avoid it rather than seek it out. Bair, with current FDIC Vice President Thomas Hoenig, maintained that the Dodd-Frank law “provides the tools” necessary for regulators to liquidate distressed firms without relying on taxpayer bailouts or risking a financial system-wide crash.

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