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April 20, 2016

Financial Reform Newsletter: April 20, 2016

Breathing life into living wills, the FDIC and Fed determined that five of the nation’s largest banks’ resolution plans are “not credible”: The FDIC and Fed released their much anticipated evaluation of the resolution plans (so called “living wills”) that the country’s most dangerous too-big-to-fail banks were required by the Dodd-Frank Act to submit. The results were mixed:  five flunked, two had serious shortcomings and one passed with reservations.  Given that last time they all flunked, this actually constitutes progress on the part of these banking conglomerates.  Moreover, equally important, it was yet another sign that the regulators were serious about their mandate to end too-big-to-fail by requiring these most dangerous banks to have credible plans to be resolved in bankruptcy like every other corporation in America .
However, FDIC Vice Chair Thomas Hoenig was also right when he said that “the goal to end too-big to-fail and protect the American taxpayer by ending bailouts remains just that: only a goal.”  The fact remains that the most dangerous too-big-to-fail banks are still alive and well and will be bailed out by taxpayers if they fail again just as they were in 2008.  The choice remains letting them fail, causing financial and economic chaos, or bailing them out to prevent a financial collapse and a possible second Great Depression.  That’s why they must be made to have credible living wills, even though they will try for as long as possible to remain too-big-to-fail:  after all, who wouldn’t prefer to be bailed out by taxpayers rather than going into bankruptcy, losing your job, wealth, reputation and your stockholders losing all their money?  As intelligent profit maximizers, they will all choose the former unless forced to do otherwise.
Importantly, it now appears this can be done if these handful of dangerous banks genuinely want to do it: the regulators found that Citigroup did submit a credible living wills.  The regulators have given the others until October 1st to resubmit plans that are credible.  If they do not, the time for warnings is over.  By then, more than six years after the financial reform law was passed and eight years since the 2008 collapse, the regulators must directly and decisively use their authority and order these gigantic banking corporations to divest or otherwise dispose of any part of their businesses that prevent them from being resolved in bankruptcy.  They have been given more than enough time to do it themselves.  It will then be time for regulators to order them to do what they should have done – and could have done — years ago.
Moreover, regulators must require the banks to publicly release much more of their living will plans and the regulators themselves must release much more information about their evaluation and conclusions regarding each of the plans.  As we have detailed, such disclosure is essential for market discipline as well as public accountability, for the banks and the regulators.  True, this requires balancing competing interests, but maximum disclosure must be the guidepost. 

An overwhelmingly important Senate hearing on liquidity, fixed income and the industry’s M.O. making unsupported claims and disregarding contrary evidence: One of the most remarkable things about the debate over financial reform and the rules to implement it is how often the industry makes unsupported doom and gloom claims about it.  That is all the more remarkable because often the industry is in unique possession of the data and has a serious self-interest in making it available.  After all, if the data supports their position, then it would win the argument for them.  But, time and time again, they don’t provide the data or, too often, claim to provide it to a hired gun “consulting firm” that then produces a “report” remarkably agreeing with the paymasters’ claims, but again not providing the data for anyone independent to determine the accuracy or robustness of the claims. (We have argued for years to regulators and other policymakers that these circumstances should give rise to a presumption that the data does not support their claims.)
A version of this was on display last week at a very important, but very sparsely attended, hearing held by two subcommittees of the Senate Banking Committee.  It was innocuously titled “Examining Current Trends and Changes in the Fixed-Income Markets,” but don’t let that title fool you:  fixed income markets are incredibly important to the real economy and how businesses, in particular, fund their growth and operations. 
This was merely the latest event where unsupported industry claims that financial reform, especially the Volcker Rule, are supposedly “hurting” the fixed income markets and reducing liquidity while impairing capital formation and market functioning overall.  There were two senior, highly experienced government and markets experts testifying:  Antonio Weiss, Counselor to the Treasury Secretary, and Jay Powell, a Governor of the Federal Reserve System.  If you care about these issues and the war against financial reform, you really should read their testimony.  It is data driven, thoughtful and well presented.  Mr. Weiss’ written testimony in particular was comprehensive and is a must-read.
The upshot?  There is no evidence in the data (and, while more is needed and being gathered,  there is lots of it, including a comprehensive study by Treasury), that shows financial regulation is impairing the fixed income markets or reducing liquidity.  In fact, the evidence is the opposite.  Nevertheless, there were members of the Subcommittee that kept saying “but I keep hearing from industry participants” that financial reform is having a negative effect.  No matter how many times the witnesses referred back to the data and study showing no such evidence or basis for such unsupported claims, the questioners were not satisfied and kept rephrasing their questions hoping for a different answer.  This sadly encapsulates much of what happens regarding financial reform not only in Congress, but also at the regulatory agencies, the Executive Branch, so-called think-tanks and in the media:  unsupported industry claims being repeated over and over, arguing with, disregarding or often just denying evidence and data. You can watch the hearing here.  You can also see our presentation on the debate over liquidity and fixed income at a recent Brookings event here.  
Fact sheet on the District Court decision in MetLife lawsuit against FSOC shows the Court relying on a false premise while also ignoring Supreme Court and D.C. Circuit precedent:  It must first be remembered that the Financial Stability Oversight Council (FSOC) is the only governmental body with the power, authority and responsibly for identifying, investigating, and designating possible systemic threats from nonbank financial institutions, commonly referred to as the “shadow banking system.”  
If FSOC isn’t allowed to fulfill its statutory mandate to do that, then no one will and, like before the crash in 2008, systemic risk will move unseen from the regulated banking sector to the unregulated shadow banking sector. 
That’s what is at stake in the district court decision to rescind FSOC’s designation of MetLife, finding that it was arbitrary and capricious.  However, the Court’s analysis was deeply flawed: the Court misread the plain language of the statute; overlooked entirely or misapplied U.S. Supreme Court and D.C. Circuit precedent; and imposed on FSOC a legal requirement to conduct cost-benefit analysis where none exists.
As further detailed in this fact sheet, the Court went far beyond the appropriate limited, deferential review and improperly substituted its own judgments for those of the financial regulators and experts on FSOC and the people’s elected representatives in Congress.


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