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‘The Biggest Kiss’

Mitt Romney was right: Dodd-Frank is a gift to big banks

Oct 29, 2012, Vol. 18, No. 07 • By C. BOYDEN GRAY AND ADAM J. WHITE
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That has amounted to an immense subsidy, worth “about $4 billion per year before the crisis, increasing to $60 billion during the crisis, topping $84 billion in 2008,” according to a recent paper by the World Bank’s Deniz Anginer and Syracuse University’s A. Joseph Warburton. Other studies, including one by the Bank of England, presented similar findings. 

Instead of ending that subsidy to big banks, Dodd-Frank intensifies it in at least three ways. First, by officially designating SIFIs, Dodd-Frank eliminates any uncertainty as to whether a bank is actually considered too big to fail. Second, by lowering the asset threshold from $100 billion to $50 billion, it increases the number of likely SIFIs. And third, by including not just banks but also nonbank financial companies, Dodd-Frank further expands the universe of possible SIFIs.

President Obama, former FDIC director Bair, and -others suggest that these SIFI designations are something that financial companies will want to avoid, not obtain, because SIFIs will face stricter oversight by federal regulators. Dodd-Frank’s regulators will put SIFIs into “a penalty box,” said Bair: Big banks might “try to spin it like it’s a good thing” to receive the government’s SIFI designation, “but it’s a bad thing.”

Such predictions reflect the triumph of hope over experience. If unofficial too-big-to-fail status was worth billions before Dodd-Frank, then official SIFI status will be worth even more today. One management consulting firm, Deloitte, went so far as to predict that banks falling short of the $50 billion threshold “are likely to face a strategic decision”: Either forgo SIFI status or “aim to become SIFIs to take advantage of possible perceived funding and other advantages, from being seen as having implicit government guarantees from being too big to fail.”

The Washington Post was blunter in its assessment: “Get ready for Too-Big-to-Fail envy,” it warned readers last year.

To the extent that Dodd-Frank’s proponents ever acknowledge this problem, they tend to fall back on a second defense: that Dodd-Frank’s Title II ensures that troubled SIFIs will be “liquidated,” not rescued, and that “taxpayers shall bear no losses from the exercise of” that liquidation authority. President Obama pressed this point when he signed Dodd-Frank: “Because of this law, the American people will never again be asked to foot the bill for Wall Street’s mistakes. There will be no more tax-funded bailouts—period. If a large financial institution should ever fail, this reform gives us the ability to wind it down without endangering the broader economy.”

That is wishful thinking. Title II does not actually require the government to “wind down” a troubled SIFI. Under Dodd-Frank, “liquidation” can consist of the government keeping the company alive and restructuring it by use of an FDIC-created “bridge financial company.” 

In fact, that is the approach endorsed by the FDIC’s acting chairman, Martin J. Gruenberg. The FDIC will not wind down troubled SIFIs, as President Obama promised; instead, as Gruenberg explained in a May 10 speech, the FDIC’s “most promising resolution strategy” will be to take the SIFI parent company into receivership, transfer its assets to a bridge company, operate its subsidiary banking units, and ultimately keep the SIFI alive—an outcome that, Gruenberg suggested, will not just “mitigate systemic consequences” but also “preserve the franchise value of the firm.” 

And in that process, the FDIC will be able to exploit a section in Dodd-Frank that gives regulators extraordinary power to ignore the rules of bankruptcy and favor certain creditors over others. The transparency of normal bankruptcy is replaced with a black-box process that empowers regulators and favors the most influential stakeholders, including, most likely, other government-designated SIFIs.

In short, Dodd-Frank’s “liquidation” provisions will not actually end too big to fail—they will sustain it. Dodd-Frank has “ended” too big to fail only in the same sense that the 1928 Kellogg-Briand Pact “ended” war.

Nor can it truthfully be said that “taxpayers” will not fund the liquidation process. Under Dodd-Frank, the Treasury Department and FDIC can fund liquidations by imposing fees on financial institutions—fees that ultimately are passed through to the taxpayers and others who own the stock of those fee-paying companies or who are the companies’ customers.

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