So the House Republicans on the Financial Services Committee just voted to repeal “resolution authority.” What does this mean, and how can we compare it to previous actions by House Republicans?
A useful way of understanding both the financial crisis of 2008 and Dodd-Frank’s response to it is through the idea of a “shadow banking system.” We have a set of regulatory rules, laws, practices and institutions from the New Deal that does well with the regular banking sector. Over the past thirty years, a set of institutions started acting like banks without calling themselves banks, and thus did not have the same set of rules, laws and practices in place to regulate them as such. Dodd-Frank’s goal was to extend this regulatory framework to all “systemically risky financial institutions,” or shadow banking institutions.
One of the main pillars of this is “resolution authority,” which allows FDIC to takeover and wind-down a failing shadow bank. Since the New Deal the FDIC can wind down a failing commercial bank without the system collapsing. We found that putting commercial banks through bankruptcy was a disaster, so we created FDIC to allow a firm to fail and allocate losses in a way that mitigated panics and contagion. Now the FDIC can use those powers on firms acting like banks but that are not hanging a “bank” sign on their window. These powers include the ability to force big financial firms to write “living wills” to help with taking them down.
The FDIC has been making progress in formulating these powers. They released a major report, The Orderly Liquidation of Lehman Brothers Holdings under the Dodd-Frank Act, which walks through how they would have handled 2008. They’ve also answered conservative think tank critiques of resolution authority in what I think are correct and persuasive.
So when you hear people, especially on the right, criticizing Dodd-Frank’s resolution authority your first step should be to analyze what they think of the FDIC more broadly. Do they view it as a statist boot stamping on a human face forever? Here’s a Cato Handbook for Congress from 1997 arguing for the privatization of FDIC and mandating banks purchase private deposit insurance (perhaps from an exchange?). Cato’s 2001 call for privatizing FDIC is amazing for how disastrous every one of their assumptions and calls turned out to be in light of the financial crisis. But, as they say, at least it’s an ethos.
Representative Spencer Bachus (R – AL) is the current Chairman of the House Financial Services Committee, and just lead the Committee in a vote that, among many other things, repealed this resolution authority powers. Bachus has argued “This authority is not a death panel for failed institutions…It is taxpayer-funded support for their creditors and counterparties.”
So where does Bachus stand on FDIC more broadly? Here’s the fascinating part: he lead a major 2002 move that expanded deposit insurance. Bachus was the chief sponsor of the Federal Deposit Insurance Reform Act of 2002 which increased “the standard maximum amount of deposit insurance coverage from $100,000 to $130,000” and also adjusted it for inflation.
It’s not clear why he supports FDIC when it comes to commercial banks but not shadow banks. It’s also not clear why, if he is so concerned about even the potential for moral hazard and taxpayer-funding being at risk (remember: FDIC recoups any expenses from fees on shadow banks, so taxpayers are always paid back), he took the bizarre step of expanding the amount of coverage FDIC gives to depositors (or the “creditors and counterparties” he rails about). Did he feel creditors in the form of depositors weren’t protected enough?
I’ve been reading about this 2002 bill, and if Bachus showed any concern about FDIC as an institution and a preference for putting commercial banks through bankruptcy instead of an orderly winddown I can’t find it. I’m trying to get a comment from the House Financial Services Committee on this but it certainly seems like a complete about face. So one has to ask – if FDIC is a useful and appropriate way of allowing firms that hang a “bank” sign on the window to fail, why isn’t it appropriate when a firm functions exactly like a bank?
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