June 6, 2017
The Brookings Institution Event: Is Dodd-Frank’s Failure Resolution Regime Failing?
Key Topics & Takeaways
- Orderly Liquidation Authority: The discussion focused on the effectiveness of Orderly Liquidation Authority (OLA) as compared to a hypothetical bankruptcy option. The moderator, David Wessel, noted that the Financial CHOICE Act repeals OLA, which was established by Title II of Dodd-Frank, and replaces it with a bankruptcy option specifically for large financial institutions. Most panelists supported retaining OLA, with modifications, arguing that bankruptcy courts are a) not fast enough to resolve institutions, and b) will not account for systemic financial stability issues that can arise from the failure of large institutions.
- Regulatory Discretion: A key issue discussed by the panel is whether OLA grants regulators too much discretion when resolving financial institutions. Ben Bernanke argued that it did not, as regulators need wide discretion to resolve large, failing financial institutions. Bernanke said that during the 2008 Financial Crisis, regulators had to rely on ad hoc resolution mechanisms, such as brokering the sale of distressed institutions to healthier banks, and that this process created instability in the market and was of questionable legality.
- International Resolution Issues: Panelists also discussed the ability of OLA to resolve large US institutions with substantial overseas operations. The panelists that defended OLA said that one of OLA’s biggest advantages over bankruptcy is that regulators could coordinate with their international counterparts to address market stability, which bankruptcy courts cannot do.
- David Wessel, Director, the Hutchins Center on Fiscal and Monetary Policy (Moderator)
- David Skeel, Professor, University of Pennsylvania Law Scool
- H. Rodgin Cohen, Senior Chairman, Sullivan & Cromwell LLP
- Ben S. Bernanke, former Chairman, Federal Reserve Board of Governors
- Hester Peirce, Director, Financial Markets Working Group, Mercatus Center
David Wessel opened the discussion by providing the historical context for the creation of the Orderly Liquidation Authority (OLA), noting that the provision passed the Senate with near unanimity. Wessel began with a generic question for all participants, soliciting their views on OLA repeal (which is in the CHOICE Act) compared to its retention and/or possible modification.
Skeel said that OLA should be used infrequently but should not be repealed. Bernanke expressed full-throated support for OLA, saying that financial regulators have the requisite background knowledge to resolve failing, large institutions while minimizing the broader economic fallout. Bernanke said that bankruptcy should be the norm but that in financial crises, like the one in 2008, bankruptcy is an “unrealistic” option. Bernanke also said that the Federal Reserve (the “Fed”) and the Federal Deposit Insurance Corporation (FDIC) will take steps to protect the stability of the financial system broadly when resolving an institution, which is critical to ending a crisis, while bankruptcy courts would not.
Cohen expressed support for OLA, saying that it is a “logical extension” of the FDIC’s ability to resolve failing banks generally and that the measure is not a radical departure from policymaking precedent. Peirce was generally hostile to OLA, pointing out that the difficulties in resolving a large financial institution are not ameliorated by OLA, which also sacrifices the transparency of bankruptcy courts. Peirce dismissed the idea that the emergency liquidity infusions that OLA authorizes regulators to make would be paid back in the short term, and called for OLA’s replacement with new bankruptcy code provisions tailored for large financial institutions.
Participants then discussed the ability of OLA to deal with moral hazard problems within the financial sector. Bernanke said that dangerous externalities can arise if many firms engage in systemically risky behavior, which OLA handles forcing institutions to take losses in senior debt at the Bank Holding Company (BHC) level, and by levying assessments on the whole industry to pay for emergency liquidity accessed during the resolution of a large financial institution. Skeel agreed that the risk of OLA creating moral hazard are “pretty low” as OLA is not an attractive option to major banks given the authority regulators are granted to impose losses. Skeel also provided a brief overview of the single-point of entry (SPOE) mechanism for administering OLA, and said that this simplifies the process of resolving a financial institution.
The discussion then pivoted briefly to the risks that clearinghouses pose to the financial system, and Wessel asked panelists for their thoughts on how clearinghouses fit in to the OLA conversation. Peirce said that OLA could not be applied to clearinghouses, which are structured differently from banks. Cohen said that the Basel Committee should explore regulations and capital requirements for clearinghouses, which Skeel agreed with. Skeel said that using SPOE on clearinghouses would be impossible given their lack of bond debt at the holding company level. Skeel suggested that the Fed be granted the authority for resolving a clearinghouse.
Wessel then asked the panel if the Dodd-Frank Act gave regulators too much discretion to resolve financial institutions. Bernanke argued that discretion is critical, but that it should be tempered by giving regulators a “clear set of goals.” Bernanke also noted that large parts of the regulatory architecture for resolving financial institutions is outdated, with some important laws governing the industry now decades old. Bernanke said that this outdated structure is why the Fed and the Treasury had to rely on ad hoc measures of questionable legality during the 2008 crisis. Furthermore, most of that regulatory architecture was built to deal with depository institutions, and not newer financial institutions.
The discussion then returned to OLA’s effectiveness as a resolution method compared to bankruptcy. Peirce said that OLA adds to instability and fails to discipline financial institutions lending practices. Skeel took an opposite view, saying that a total reliance on bankruptcy will “put bailouts back on the table” as regulators will be reluctant to hand over resolution authority to bankruptcy courts. Cohen argued that bankruptcy and OLA are not incompatible, and that having two reliable resolution mechanisms will give the system more flexibility.
Skeel then addressed the relative speeds of OLA compared to bankruptcy, and said that it is a misconception that bankruptcy courts are too slow to resolve large failing institutions. Skeel noted that while litigation has continued for years, the main Lehman bankruptcy case and asset sale was completed in less than a week. Cohen responded to this by noting that the mechanisms federal regulators used to broker the Lehman bankruptcy and asset sale to Barclays will likely be unavailable in future crises, as regulators later fined and sued firms that bought distressed banks during the crisis.
During the question and answer portion, an audience member asked the panel if the FDIC could manage multiple large institutions simultaneous failure with OLA. Bernanke said that while handling multiple SIFI’s simultaneous failure would be incredibly difficult, the country is better off in that scenario with OLA, as opposed to without it.
Another audience member then asked about the 10% leverage ratio and accompanying regulatory off-ramp included in the CHOICE Act, and if this provision would make OLA irrelevant. Skeel said he thought this was an “excellent idea” while Bernanke disagreed. Bernanke noted that the CHOICE Act creates only a raw leverage ratio and does not risk-weight assets, which will encourage banks to meet their leverage ratio with the highest-yield and hence the riskiest assets.
An audience member noted that OLA is supposed to be used on any firm designated as a SIFI, but that the FSOC has only designated three insurers – AIG, Prudential, and MetLife – as SIFIs. The audience member asked if OLA would work for insurers. Peirce and Skeel both expressed skepticism about the viability of OLA to resolve large, systemically-important insurers.
The last question fielded by the panel concerned the viability of OLA to resolve large, international financial institutions. Bernanke said that one of OLA’s strengths was that it encouraged cross-border regulatory coordination, and was aimed at protecting the financial system generally (as opposed to just the creditors of a failing institution, which is bankruptcy’s focus). Bernanke also said that by concentrating all losses at the BHC level, foreign regulators are less likely to panic about losses at the foreign subsidiaries of US companies. Cohen also noted that foreign regulators are unlikely to trust the bankruptcy process.
For more information on this event, please click here.