Does Dodd-Frank Have Teeth After All?

August 6, 2014 at 8:49 am Leave a comment

Just how big a deal is the announcement late yesterday afternoon that the Federal Reserve Board and the FDIC have rejected the so-called “living wills” drawn up by the nation’s 11 largest financial institutions as inadequate to ensure that they can be liquidated in a cost effective manner? Depending on what happens next it could be like Vladimir Putin saying “I’m sorry” to the Ukrainians and giving them back Crimea, Tiger Woods suddenly getting healthy and winning the next five majors, or Congress actually passing meaningful legislation.

Dodd-Frank required systemically important banks to submit bankruptcy plans that explain to the Federal Reserve and the FDIC how their liquidation can be executed in bankruptcy court in the event they fail. Previous submissions have been accepted by regulators without amendment.  But, yesterday, the Fed and FDIC told the 11 largest banks, each with more than $250 billion in assets, to go back to the drawing board and credibly demonstrate how they can fail without putting the American taxpayer on the hook.

The ostensible Dodd-Frank logic is that these plans will prevent the American public from extending an implicit guarantee to the behemoths that they are too big to fail. The statute provides that, in the event these plans are deficient, regulators can order these institutions to sell some of their assets and adhere to higher capital standards. But, as this recent exchange between Fed Chairman Yellen and Massachusetts Senator Warren demonstrates, it didn’t seem that regulators was taking these living wills seriously. Now they are or at least pretending like they are. The real test will be when the adjusted plans are resubmitted. If they don’t include asset divestitures than they aren’t serious proposals. But, the banks involved may be willing to gamble that, despite yesterday’s announcement, regulators will never force them to restructure their monstrosities.  Time will tell.

Why does it matter? Because if credit unions have to comply with Dodd-Frank it isn’t asking too much for a financial system to be put in place that prevents the banking system from getting sucked down another sinkhole anytime soon and taking credit unions down with it.

The eight largest banks hold assets equal to 65% of the nation’s GDP.  In addition, these banks are given a competitive advantage by virtue of the fact that the Government has to bail them out, or so it believes. As I said before – and I know this is hardly an original thought – Dodd-Frank does too little to reign in the biggest banks. After all, next week’s crisis may not be triggered by mortgages but as long as a handful of institutions are allowed to suck up a disproportionate amount of the nations’ economy something bad is bound to happen, right? Maybe, just maybe, the Fed will prove me wrong.

What is so fascinating about the Fed’s announcement is that it is ordering the behemoths not to simply write up better contingency plans, but to restructure their operations to accommodate a liquidation. In its own words, by July 2015 they all must:

  • Establish a rational and less complex legal structure that would take into account the best alignment of legal entities and business lines to improve the firm’s resolvability;
  • Develop a holding company structure that supports resolvability;
  • Amend, on an industry-wide and firm-specific basis, financial contracts to provide for a stay of certain early termination rights of external counterparties triggered by insolvency proceedings;
  • Ensure the continuity of shared services that support critical operations and core business lines throughout the resolution process; and
  • Demonstrate operational capabilities for resolution preparedness, such as the ability to produce reliable information in a timely manner.

In addition, look at the language used by the members of the FDIC, and it’s clear that there are regulators annoyed that too little has been done to prevent another disaster. For instance, in supporting yesterday’s decision FDIC board member Jeremiah O. Norton argued that “achieving a credible and workable framework for resolving large and complex financial institutions would be the pinnacle accomplishment in the wake of the 2008 financial crisis.“

And Vice Chairman Thomas M. Hoenig, who has long been a vocal critic of too big to fail banks, pointed out that the economy today is more, not less dependent on these institutions which are still highly leveraged and noted:

“Some parties nurture the view that bankruptcy for the largest firms is impractical because current bankruptcy laws won’t work given the issues just noted. This view contends that rather than require that these most complicated firms make themselves bankruptcy compliant, the Government should rely on other means to resolve systemically important firms that fail. This view serves us poorly by delaying changes needed to assert market discipline and reduce systemic risk, and it undermines bankruptcy as a viable option for resolving these firms. These alternative approaches only perpetuate “too big to fail.”

Maybe real banking reform isn’t just a blogger’s pipe dream after all.






Entry filed under: Compliance, Regulatory. Tags: , , , .

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Authored By:

Henry Meier, Esq., General Counsel, New York Credit Union Association.

The views Henry expresses are Henry’s alone and do not necessarily reflect the views of the Association.

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