How Dodd-Frank’s ‘orderly liquidiation authority’ could lead to bailouts and zombie banks

Image Credit: Shutterstock

Image Credit: Shutterstock

If a megabank becomes insolvent under Dodd-Frank, regulators have the means and authority to wind them down. At least on paper. Dallas Fed President Richard Fisher has his doubts whether things will work so neatly in reality:

In reality, rather than fulfill Dodd–Frank’s promise of “no more taxpayer-funded bailouts,” the U.S. Treasury will likely provide, through the FDIC, debtor-in-possession financing to the failed companies’ artificially-kept-alive operating subsidiaries for up to five years, but perhaps longer.

Under the single point of entry method, the operating subsidiaries remain protected as the holding company is restructured. So if a company does business with the operating subsidiaries, say, through derivatives transactions, then this company is even more confident that their counterparty is TBTF. Some officials refer to this procedure as a “liquidity provision” rather than a bailout. Call it whatever you wish, but this is taxpayer funding at far-below-market rates.

At the Dallas Fed, we would call this form of “liquidation” a nationalized financial institution. During the five-year resolution period, this nationalized institution does not have to pay any taxes of any kind to any government entity. To us, this looks, sounds, and tastes like a taxpayer bailout, just hidden behind different language. If it waddles like a duck and quacks like a duck, it’s a duck. …

Title II promotes and sustains an unnatural longevity for zombie financial institutions—and this is an acute issue in other financial systems, including parts of Europe today. Title II imposes a competitive disadvantage onto small- and medium-size financial institutions, and it does so for potentially several years at taxpayer expense. It is these smaller financial institutions that, by the way, provide the primary financial lifeline so vital to the small- and medium-size businesses in your Congressional districts that, in turn, provide the bulk of innovation and job creation in the United States.

What’s more, OLA depends on the biggest banks providing “living wills” that would instruct regulators how to safely wind them down. But recall that the Federal Deposit Insurance Corporation official responsible for dealing with megabank bankruptcy recently told Bloomberg Businessweek that none of the biggest banks have yet been able to devise credible plans. And it’s an “open question” whether the wind-down process is viable. Maybe Too Big To Fail, or TBTF, should be TBTFF — Too Big To Fail Forever.

One thought on “How Dodd-Frank’s ‘orderly liquidiation authority’ could lead to bailouts and zombie banks

  1. they will be bailouts and, on cspan I watched both christopher dodd say “bailouts, I mean ‘winding’ downs” …and barbara boxer in duet on the senate floor speak of

    THESE TYPES OF BAILOUTS………i kid you not. They really think everyone is just a dumb as a box of rocks.

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