The Bailout Debate

President Obama Signs the Dodd-Frank Wall Stre...

President Obama Signs Dodd-Frank (Photo credit: Leader Nancy Pelosi)

Treasury Undersecretary Mary Miller and the House Financial Services Committee recently assessed the ongoing efforts designed to reduce the risk posed to the financial system by systemically-important companies and ensure that no institution is “too-big-to-fail.”

In remarks to the 22nd annual Hyman P. Minsky Conference, Undersecretary Miller suggested that “comprehensive reforms passed by Congress and signed into law by President Obama” ensure that “no financial institution, regardless of its size, will be bailed out by taxpayers again.”

“The too-big-to-fail catchphrase appears to mean different things to different people,” said Miller. Some believe it means “that the government will bail a company out if it is in danger of collapse because its failure would otherwise have too great a negative impact on the financial system or the broader economy. With respect to this understanding of too-big-to-fail, let me be very clear: it is wrong.”

As one of the lessons learned from the recent financial crisis, Miller said the Dodd-Frank Act “makes it very clear that the government cannot bail out a failing financial company.” Instead, she argues, a failing financial company will have “[its] shareholders…wiped out; creditors will absorb losses; culpable management will not be retained and may have their compensation clawed back; and any remaining costs associated with liquidating the company must be recovered from disposition of the company’s assets and, if necessary, from assessments on the financial sector, not taxpayers.”

Miller points to two new provisions contained in Dodd-Frank – the living wills requirement and orderly liquidation authority – that provide regulators with “important tools they lacked before the crisis to resolve a failing company while limiting the fallout to the rest of the financial system.” These provisions will require financial companies “to closely examine their structure and activities, determine what risks they might present, and how they could be resolved in an orderly manner should the need arise.”

Similarly, the House Financial Services Committee recently held a subcommittee hearing to explore the extent that Dodd-Frank authorizes the government to breakup financial institutions. Oversight and Investigations Subcommittee Chairman Patrick McHenry (R-NC) called for more clarity on specific aspects of the Act’s implementation, especially Sections 121 (grave threats) and 165 (living wills and orderly liquidation), which gives the Federal Reserve and FDIC authority to mitigate a financial company’s risk to the financial system.

The hearing examined how these regulators construed their power under Dodd-Frank. Scott Alvarez, the Federal Reserve’s general counsel, said “the perception that an institution is too-big-to-fail reduces the incentives of the firm and its shareholders, creditors and management to limit risk taking and distorts competition by enabling the firm to fund itself more cheaply than its competitors.” The Federal Reserve, working with other regulators and international parties, has produced “a well-integrated set of rules and supervisory practices that substantially reduces the probability of failure of our largest, most complex financial firms.” Chief among these practices are ensuring heightened capital requirements, which Alvarez calls “the cornerstone of prudential bank regulation” and have been monitored under the Fed’s supervisory stress tests.

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