[House Hearing, 113 Congress]
[From the U.S. Government Publishing Office]
WHO IS TOO BIG TO FAIL:
DOES TITLE II OF THE
DODD-FRANK ACT ENSHRINE
TAXPAYER-FUNDED BAILOUTS?
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON OVERSIGHT
AND INVESTIGATIONS
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED THIRTEENTH CONGRESS
FIRST SESSION
__________
MAY 15, 2013
__________
Printed for the use of the Committee on Financial Services
Serial No. 113-19
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
_____
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HOUSE COMMITTEE ON FINANCIAL SERVICES
JEB HENSARLING, Texas, Chairman
GARY G. MILLER, California, Vice MAXINE WATERS, California, Ranking
Chairman Member
SPENCER BACHUS, Alabama, Chairman CAROLYN B. MALONEY, New York
Emeritus NYDIA M. VELAZQUEZ, New York
PETER T. KING, New York MELVIN L. WATT, North Carolina
EDWARD R. ROYCE, California BRAD SHERMAN, California
FRANK D. LUCAS, Oklahoma GREGORY W. MEEKS, New York
SHELLEY MOORE CAPITO, West Virginia MICHAEL E. CAPUANO, Massachusetts
SCOTT GARRETT, New Jersey RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas WM. LACY CLAY, Missouri
PATRICK T. McHENRY, North Carolina CAROLYN McCARTHY, New York
JOHN CAMPBELL, California STEPHEN F. LYNCH, Massachusetts
MICHELE BACHMANN, Minnesota DAVID SCOTT, Georgia
KEVIN McCARTHY, California AL GREEN, Texas
STEVAN PEARCE, New Mexico EMANUEL CLEAVER, Missouri
BILL POSEY, Florida GWEN MOORE, Wisconsin
MICHAEL G. FITZPATRICK, KEITH ELLISON, Minnesota
Pennsylvania ED PERLMUTTER, Colorado
LYNN A. WESTMORELAND, Georgia JAMES A. HIMES, Connecticut
BLAINE LUETKEMEYER, Missouri GARY C. PETERS, Michigan
BILL HUIZENGA, Michigan JOHN C. CARNEY, Jr., Delaware
SEAN P. DUFFY, Wisconsin TERRI A. SEWELL, Alabama
ROBERT HURT, Virginia BILL FOSTER, Illinois
MICHAEL G. GRIMM, New York DANIEL T. KILDEE, Michigan
STEVE STIVERS, Ohio PATRICK MURPHY, Florida
STEPHEN LEE FINCHER, Tennessee JOHN K. DELANEY, Maryland
MARLIN A. STUTZMAN, Indiana KYRSTEN SINEMA, Arizona
MICK MULVANEY, South Carolina JOYCE BEATTY, Ohio
RANDY HULTGREN, Illinois DENNY HECK, Washington
DENNIS A. ROSS, Florida
ROBERT PITTENGER, North Carolina
ANN WAGNER, Missouri
ANDY BARR, Kentucky
TOM COTTON, Arkansas
Shannon McGahn, Staff Director
James H. Clinger, Chief Counsel
Subcommittee on Oversight and Investigations
PATRICK T. McHENRY, North Carolina, Chairman
MICHAEL G. FITZPATRICK, AL GREEN, Texas, Ranking Member
Pennsylvania, Vice Chairman EMANUEL CLEAVER, Missouri
PETER T. KING, New York KEITH ELLISON, Minnesota
MICHELE BACHMANN, Minnesota ED PERLMUTTER, Colorado
SEAN P. DUFFY, Wisconsin CAROLYN B. MALONEY, New York
MICHAEL G. GRIMM, New York JOHN K. DELANEY, Maryland
STEPHEN LEE FINCHER, Tennessee KYRSTEN SINEMA, Arizona
RANDY HULTGREN, Illinois JOYCE BEATTY, Ohio
DENNIS A. ROSS, Florida DENNY HECK, Washington
ANN WAGNER, Missouri
ANDY BARR, Kentucky
C O N T E N T S
----------
Page
Hearing held on:
May 15, 2013................................................. 1
Appendix:
May 15, 2013................................................. 41
WITNESSES
Wednesday, May 15, 2013
Krimminger, Michael H., Partner, Cleary Gottlieb................. 11
Rosner, Joshua, Managing Director, Graham Fisher & Co............ 9
Skeel, David A., Jr., S. Samuel Arsht Professor of Corporate Law,
University of Pennsylvania Law School.......................... 6
Taylor, John B., Mary and Robert Raymond Professor, Stanford
University, and George P. Schultz Senior Fellow in Economics,
Stanford's Hoover Institution.................................. 8
APPENDIX
Prepared statements:
King, Hon. Peter............................................. 42
Krimminger, Michael H........................................ 43
Rosner, Joshua............................................... 57
Skeel, David A., Jr.......................................... 66
Taylor, John B............................................... 70
WHO IS TOO BIG TO FAIL:
DOES TITLE II OF THE
DODD-FRANK ACT ENSHRINE
TAXPAYER-FUNDED BAILOUTS?
----------
Wednesday, May 15, 2013
U.S. House of Representatives,
Subcommittee on Oversight
and Investigations,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 10 a.m., in
room 2128, Rayburn House Office Building, Hon. Patrick T.
McHenry [chairman of the subcommittee] presiding.
Members present: Representatives McHenry, Fitzpatrick,
Duffy, Hultgren, Ross, Wagner, Barr; Green, Cleaver, Delaney,
Sinema, Beatty, and Heck.
Ex officio present: Representative Hensarling.
Also present: Representative Sherman.
Chairman McHenry. The Oversight and Investigations
Subcommittee of the Financial Services Committee will come to
order. We are pleased to begin a hearing entitled, ``Who Is Too
Big To Fail: Does Title II of the Dodd-Frank Act Enshrine
Taxpayer-Funded Bailouts?''
We have a distinguished panel composed of 4 witnesses.
Three of them are currently here, and one is en route.
Without objection, the Chair is authorized to declare a
recess of the committee at any time, and the Chair would like
to announce that the intention is to adjourn this subcommittee
by noon today. We have one witness who has to depart by 11:45,
and that witness is Professor Skeel, who has to catch a flight.
So, with that, I recognize myself for 5 minutes for an
opening statement.
Two-and-a-half years ago, when the Dodd-Frank Act was
signed into law, President Obama declared that too-big-to-fail
had ended. Today, there seems to be much debate as to whether
that is true. Across the ideological spectrum, elected
officials, members of the media, Federal Reserve Presidents,
and even the Chairman of the Federal Reserve have acknowledged
that this problem still persists.
Just this past week, Chairman Bernanke, in his speech to
the Federal Reserve Bank of Chicago, said, ``I think that too-
big-to-fail is a very big issue and we will not have completed
the goals of financial regulatory reform unless we have
adequately addressed this issue.''
The Administration's Attorney General Eric Holder
highlighted the problem from the perspective of prosecuting
Federal crime. Testifying in front of the Senate he said, ``I
am concerned the size of some of these institutions has become
so large that it does become difficult for us to prosecute them
when we are hit with indications that if you do prosecute, it
will have a negative impact on the national economy, perhaps
even the world economy.''
The fact is that Dodd-Frank did not end too-big-to-fail but
instead enshrined it. Title II of Dodd-Frank, which created the
Orderly Liquidation Authority (OLA), made government guarantees
for Systemically Important Financial Institutions (SIFI)
explicit. The Orderly Liquidation Authority is less than
orderly. Liquidity is provided by the government, but it does
have enormous authorities within it. And it is this explicit
guarantee that not only provides an unfair advantage to the
biggest and most powerful companies and institutions, but in
doing so has the potential to seriously distort our
marketplace.
However, relatively little has been done in terms of the
halls of Congress and policymakers here in regard to the actual
process that takes place within the Orderly Liquidation
Authority (OLA). The competitive advantages that OLA provides
to large, troubled institutions are real, and whether these
advantages will be applied to save large, troubled financial
institutions while harming otherwise healthy competitors
remains to be seen, as well.
OLA imposes a bank restructuring process in lieu of
bankruptcy that is intended to allow troubled financial
institutions to continue operating while undergoing
recapitalization. The general idea is that the parent company
suffers equity in debt write-downs while the operating
subsidiary remains solvent and proceeds with business as usual.
The FDIC calls this the single point of entry process.
While this process provides attractive benefits such as
avoiding a loss of franchise value that often results from a
run on a failed bank, the benefits of continuity come with an
extraordinarily great price and a price to the taxpayers and to
those who bank with other institutions, potentially, as well.
Protecting the franchise value requires a bailout. While
the government provides liquidity to a bridge holding company
while exempting it from taxes and potentially exempting it from
capital requirements or other regulatory requirements, the cost
of these subsidies is ultimately backed by attacks on banks and
thereby attacks on those that utilize banking services, which,
as we know, is clearly passed on to customers in my district
and across the country.
The FDIC and Treasury--their discretion to provide these
advantages is paired with the political value of saving a
Systemically Important Financial Institution. When faced with a
failed institution, and an open wallet from the Treasury backed
by a bank tax, what do we expect the regulators to do? To
advantage these corporations, these new entities, or
disadvantage them?
These are the questions that we have today. As reflected in
the continued lower cost of borrowing available to Systemically
Important Financial Institutions, this bailout perpetuates too-
big-to-fail and the moral hazard associated with it.
I recognize that our witnesses have a variety of opinions
on this matter, and we look forward to their talking through
this process to policymakers here so that we can more deeply
understand the Orderly Liquidation Authority, what that bridge
holding company looks like, and the terms under which they will
operate, potentially operate, and what the letter of the law
actually says.
So, I look forward to your testimony. And I look forward to
Members' questions and getting to a deeper understanding of the
Orderly Liquidation Authority within Dodd-Frank.
With that, I now recognize the ranking member, Mr. Green,
for 5 minutes. Oh, the ranking member wishes Mr. Sherman to be
recognized first on his side.
Mr. Sherman is recognized for 3 minutes.
Mr. Sherman. I thank the ranking member.
Chairman McHenry. I'm sorry. Recognizing that you are not a
member of the subcommittee, we have to ask unanimous consent
for you to make a statement, since we allow subcommittee
members to speak first, but hearing no objection, we will
recognize you for 3 minutes for an opening statement.
Mr. Sherman. I thank both the ranking member and my
colleagues.
TARP stood for Troubled Asset Recovery Program. We put a
big light on it, we stopped it for a while, and in the end they
didn't dare buy a single toxic asset, a single bad bond from
the big banks. Instead, they bought preferred stock, and that
is why we are getting most of our money back, but it was still
a bailout.
The Orderly Liquidation Authority in Dodd-Frank has some
problems, but compare it the first four drafts of the bill,
which I described and it was quoted by a few on the other side
as TARP on steroids because it provided permanent unlimited
bailout authority. The current bill limits the amount of cash
the taxpayers put out to the value of the assets securing that
cash, and while that does provide some advantages, it certainly
is a pale shadow of what was intended by those who started that
legislation.
Ultimately, though, you don't need legislation to get a
bailout. They didn't have one in 2008. They were credibly able
to tell the country that if we didn't bail them out, they would
take us down with them, and as long as there are institutions
that can credibly make that claim, we have seen once that
Congress is willing to pass whatever statute eventually they
propose. So what we need to do is make sure that no private
entity can make the claim that they can pull down the entire
economy. We ought to break up those who are too-big-to-fail,
and as I think the chairman pointed out, too big to jail, no
institution should be so large that its creditors believe that
they will be bailed out and its executives believe that they
are immune from the criminal laws that affect us all.
So, I look forward to ending the--not just changing the
statute but changing the economic reality that we were
confronted with in 2008, and that I hope we are not confronted
with again.
I again thank the chairman, and I yield back.
Chairman McHenry. The gentleman yields back. I now
recognize the vice chairman of the subcommittee, Mr.
Fitzpatrick, for 2 minutes.
Mr. Fitzpatrick. Thank you, Mr. Chairman, for holding this
important hearing. The Orderly Liquidation Authority, or the
OLA, provides an alternative to bankruptcy that will most
likely arise when a financial institution's failure threatens
the broader economy. The FDIC has decided to implement the OLA
through the single point of entry approach, or SPOE. The SPOE
approach is an attempt to reduce the complexity associated with
resolving massive and enormously complex financial
institutions. SPOE calls for the equity and debt issued at the
holding company level to be written down during the OLA process
as a means to convert a failed financial institution into a new
and stable financial institution, thereby imposing losses on
the former owners and unsecured creditors of the firm.
Due to the complexity of Systemically Important Financial
Institutions, the drafters of Dodd-Frank provided a great deal
of discretion to the FDIC and Treasury in how and whether to
recapitalize or liquidate a firm that is resolved under the
OLA. Ultimately, the vast discretion embeds a permanent level
of uncertainty.
Central to this point is the funding authority provided to
the FDIC through the Orderly Liquidation Fund, or the OLF. When
a troubled financial institution enters the OLA process, the
FDIC is authorized to provide funding up to 90 percent of total
consolidated assets in the financial institution. The FDIC
alternatively could provide 0 percent and instead maximize
capital via the write-down of debt. The difference between 90
percent of a trillion dollars and 0 percent of a trillion
dollars is enormous. How can creditors of Systemically
Important Financial Institutions accurately evaluate risk when
the FDIC holds so much discretion? This is only one component
of the vast discretion provided to the FDIC and to the
Treasury.
I look forward to the testimony of our witnesses, and I
yield back the balance of my time.
Chairman McHenry. I thank the vice chairman, and we will
now recognize the ranking member of the subcommittee, Mr.
Green, for 5 minutes.
Mr. Green. Thank you, Mr. Chairman. I thank you, and I want
to especially thank the staff, if I may take a moment to do so,
for the outstanding work that they have done in compiling
information for us for this hearing.
I think this hearing will provide us an opportunity to get
some answers to many questions that are being posed with
reference to Dodd-Frank, but I would like to take a moment and
deal with the issue that the hearing is designed to address:
Does Title II of Dodd-Frank Enshrine Taxpayer-Funded Bailouts?
Stated another way, does Title II of Dodd-Frank--which is the
law--enshrine--which is to legalize, memorialize, perpetuate--a
taxpayer-funded bailout? As you know, bailouts are monies that
go to these institutions to keep them afloat. That is the way
the public views this and that is the way I interpret what we
are talking about today, the proposition that is before us.
And the question is to be answered in the following manner,
pursuant to some of the material that the staff has given to
us, and I am proud of this material. We have Section 214 styled
``The Prohibition on Taxpayer Funding,'' which reads, ``Section
214(a) provides that no taxpayer funds may be used to prevent
the liquidation of any financial company under this title.
Section 214(b) requires that all funds expended in the
liquidation of a covered financial company be recovered from
the disposition of assets or through assessments on the
financial sector. Section 214(c) provides that the taxpayer
shall bear no losses from the exercise of any authority under
Title II.''
Now, that is pretty explicit in terms of taxpayers bailing
out an institution. I would also add, and I am pleased that my
friend Mr. Sherman is here, he was very vocal about Section
13(3) and pursuant to his request, and I thank him for making
these requests, we were able to prevent Section 13(3) funds
from being utilized to bail out these institutions in the
future. So we had this big debate about how we were going to
bail out companies, and we decided we wouldn't, and then the
debate became, how will the taxpayer dollars be used if they
are used, and we thought that they shouldn't be used at all.
That was the argument that was made in what is called an ex
ante fashion, meaning that we would use funds from the industry
to cover any losses the same way we use industry funds for
premiums for FDIC. If you like the way FDIC functions, you
should like the way Dodd-Frank and the Orderly Liquidation
Authority function because FDIC funds are used, these are
premiums, and these premiums are an ex ante premium. That means
they are paid before an event occurs.
Because we had a good many persons who--and by the way,
these were not persons, for the most part, on my side of the
aisle--felt that we ought to have an ex post process, meaning
that the funds, if they are to be collected from the industry,
would be collected after the event occurs, and that was made a
part of the bill, the ex post process.
Given that we now have this process of collecting after the
fact, we also have this language that protects taxpayer funds.
We can't use 13(3) funds. Taxpayers, while some of the funds
may be used, they are not given to the FDIC. It is a loan, and
the loan can carry with it an interest rate such that taxpayers
will never be on the hook for a company going out of business.
Finally, on this point, and I will make it quickly, in my
opinion, too-big-to-fail is the right size to regulate. That is
what Dodd-Frank does. It regulates too-big-to-fail, but it also
provides a means by which too-big-to-fail can be eliminated.
There is an Orderly Liquidation Authority, and this Orderly
Liquidation Authority has the means by which large mega
companies, the AIGs of the world, can be wound down and not
have an impact on the broader economy. That is what Dodd-Frank
is enshrined to do, that is what the law says, and in my
opinion, we have an opportunity to regulate and manage these
too-big-to-fail institutions.
Thank you, Mr. Chairman. I yield back.
Chairman McHenry. I thank the ranking member, and it is
healthy to have a debate, and that is good. So, with that, we
will now recognize Mrs. Wagner of Missouri for 2 minutes.
Mrs. Wagner. Thank you very much, Mr. Chairman. After our
country went through the financial crisis of 2008, there was
broad agreement on two very important issues: first, that
hardworking American taxpayers should never again be forced to
foot the bill for the failure of a financial institution; and
second, that government policy should not favor one particular
institution or class of institutions at the expense of the rest
of the market.
Unfortunately, it appears that the so-called Orderly
Liquidation Authority included in Dodd-Frank violates both of
these principles. At best, the new resolution authority is, as
former Democratic Senator Ted Kaufman recently put it, a
``paper tiger that will fall apart the minute it is tested in a
real life financial crisis.''
And at worst, the OLA is a mechanism which makes taxpayer
bailouts the official law of the land, and at the same time
undermines basic principles of our free market economy. Either
way, I hope today's hearing will make clear that Dodd-Frank and
the OLA did not end too-big-to-fail and in many ways have
actually made the problem worse.
I look forward to hearing from our witnesses on this very
important topic.
Chairman McHenry. I thank the Members. With no other
Members seeking recognition for opening statements, we will now
move to the panel's oral presentation of their written
testimony. Without objection, all of the witnesses' written
statements will be made a part of the record.
On your table, there is a light. All four of you are savvy
to hearings on Capitol Hill, and you know the process: green
means go; yellow means hurry up; and red means stop. So with
that, let me introduce our distinguished panel today.
We have Professor David A. Skeel, who is the Samuel Arsht
Professor of Corporate Law at the University of Pennsylvania
Law School. Among a number of his scholarly publications, he
authored a book entitled, ``The New Financial Deal:
Understanding the Dodd-Frank Act and Its Unintended
Consequences.''
Professor John B. Taylor is the Mary and Robert Raymond
Professor of Economics at Stanford University. He has also
authored a number of scholarly publications, including a well-
regarded book entitled, ``First Principles: Five Keys to
Restoring America's Prosperity.'' For Fed watchers, he is the
originator of the Taylor rule, inventively entitled the
``Taylor Rule,'' which is important.
We have Mr. Josh Rosner, the managing director at Graham
Fischer & Company. He recently co-authored a book entitled,
``Reckless Endangerment,'' which the Economist Magazine
recognized as one of its 2011 books of the year and a ``must
read.'' The ``must read'' part was my addition to the
Economist's recommendations. I think others will note the
Economist's recommendations more than mine.
Mr. Michael Krimminger is a partner at the law firm of
Cleary Gottlieb. He recently joined the firm in 2012 after a
long and distinguished career serving government with the
Federal Deposit Insurance Corporation, where he most recently
was the General Counsel.
Each of you will be recognized for 5 minutes, and as I
mentioned, your written statements will be included in the
record, so you can summarize. We will begin with Professor
Skeel.
STATEMENT OF DAVID A. SKEEL, JR., S. SAMUEL ARSHT PROFESSOR OF
CORPORATE LAW, UNIVERSITY OF PENNSYLVANIA LAW SCHOOL
Mr. Skeel. Thank you all for the opportunity to testify on
this important issue. It is a great honor to appear before you
all today. What I would like to do in my brief opening remarks
is two things: first, I will describe several very problematic
features of Title II as it is written, as it is on the statute
books; and second, I will focus for a minute or two on the
single point of entry strategy that the FDIC has developed over
the past year or so for implementing Title II.
I will argue that Title II needs serious amendments and
also that the too-big-to-fail issue is not solved, not resolved
by a long shot by Title II and should be addressed in other
ways such as by changes to the bankruptcy laws.
I should perhaps start by noting that it is quite possible
that regulators would simply bail out another giant financial
institution that threatened to fail rather than ever invoke the
rules in Title II. Although the Dodd-Frank Act tries to make
bailouts more difficult, as has already been alluded to several
times, it certainly hasn't at all eliminated the possibility of
a bailout. With the six biggest institutions in particular,
there is a very good chance that regulators would never turn to
Title II, particularly if more than one of them were in trouble
at the same time.
If regulators did invoke Title II, they would probably
transfer some or all of the assets and liabilities of the
holding company, the top corporation in the enterprise, to a
newly created bridge financial institution. Title II authorizes
the FDIC to create a bridge institution like this and permits
the FDIC to keep it going for up to 5 years. For this 5-year or
up to 5-year period, the bridge institution has major
competitive advantages as compared to other financial
institutions.
One benefit is access to copious amounts of funding from
the United States Treasury, potentially at below market rates.
Bridge institutions also are given a sweeping exemption from
taxes. While the bridge is in existence, it is not required to
pay any taxes on the value of its franchise, property, or
income. This tax-free status gives the bridge institution an
enormous advantage over other financial institutions. In my
view, there is simply no justification for this special
treatment.
For more than a year, the FDIC has been developing a
strategy it refers to as a single point of entry strategy for
invoking and using Title II. After establishing a new bridge
institution, the FDIC would transfer all of the holding
company's assets and all of its short-term liabilities to a new
bridge institution, leaving its long-term debt, primarily its
bonds, and its stock, behind in the old institution.
Although I think this is a very clever strategy for
resolving a large bank's financial distress, it seems to me to
raise three very important concerns. First, the single point of
entry strategy assumes that all the derivatives contracts and
other short-term obligations of the troubled financial
institution will be bailed out. This will encourage the big
banks to use even more of the derivatives and other complex
financial contracts that caused so much trouble 5 years ago.
Second, although Title II explicitly requires that its
provisions be used for liquidation, single point of entry is
essentially a reorganization. It thus stands in tension with
the explicit requirements of Title II.
Finally, the single point of entry strategy won't end too-
big-to-fail at all. It will essentially rescue the troubled
financial institution and is designed to ensure that the
institution retains just as dominant a position after a
financial crisis as before it.
Let me suggest three implications of these comments about
the likely effect of Dodd-Frank's resolution rules. First, I
think it is very, very important to amend Title II to fix these
problems, particularly the exemption from taxes that the bridge
institution has.
Second, Title II is not a solution to the too-big-to-fail
problem. The largest financial institutions have, as they had,
a dominant position in American finance in no small part due to
the too-big-to-fail subsidy they enjoy when they borrow money.
I think it is very important to do something directly about the
too-big-to-fail problem.
Finally, I believe it is important to recognize that
bankruptcy is a very effective alternative to Title II for
addressing the financial distress of large financial
institutions. John Taylor and I are both involved in a project
at the Hoover Institution that tries to suggest some ways to
make bankruptcy even better.
[The prepared statement of Professor Skeel can be found on
page 66 of the appendix.]
Chairman McHenry. Thank you for your testimony.
We will now recognize Dr. Taylor.
STATEMENT OF JOHN B. TAYLOR, MARY AND ROBERT RAYMOND PROFESSOR,
STANFORD UNIVERSITY, AND GEORGE P. SCHULTZ SENIOR FELLOW IN
ECONOMICS, STANFORD'S HOOVER INSTITUTION
Mr. Taylor. Thank you, Mr. Chairman, and Ranking Member
Green for inviting me to testify on this important topic of
bailouts, too-big-to-fail, and Title II of Dodd-Frank.
In my view, too-big-to-fail, and the concern about bailouts
is very much alive even with Title II of Dodd-Frank. I know
there is disagreement about that. The Chairman of the Federal
Reserve says that expectations of bailouts aren't there because
of Title II. A couple of his colleagues take different
viewpoints. Jeff Lacker of the Richmond Fed says we haven't
dealt with the too-big-to-fail problem. Charlie Rosner at the
Philadelphia Fed says in particular, Title II resolution is
likely to be biased toward bailouts.
When you look at OLA and how it might operate in practice,
it seems to me there are serious reasons for concern. The FDIC
will have an enormous amount of discretion about how to
implement its difficult task of resolving a large financial
institution. It is hard to specify what exactly they will do.
There is a great deal of uncertainty about that, and a great
deal of concern about transparency.
My sense is given this, and given the heat of a crisis, it
is quite likely the top policymakers will go right around Title
II. They may have to change the law to do so. That is quite
possible. So that will involve the same kind of bailouts we saw
in 2008. It is not enough of an alternative to bailouts, if you
like.
But even if Title II is used, it seems to me the bailout
problem is still there. There will be every incentive for the
FDIC to provide additional funds to some creditors, additional
funds over and above what they would get under a normal
bankruptcy or in the marketplace. This is, by definition, to me
a bailout. It really doesn't matter whether the funds come
directly from the taxpayers or they come indirectly from the
taxpayers through an assessment of financial institutions and
higher prices to consumers of financial institutions, or for
that matter, it doesn't matter if it comes from other creditors
less favored. Money is taken away from the less favored to the
more favored creditors. All the problems of lower interest
rates that the large firms might get, the problem is the moral
hazard exists with this form of a bailout. Yes, there is
removal of the protection of the shareholders, but the
protection of large important creditors is still there, and the
determination of that will be through discretion, not through
the law.
I think there are some other problems with Title II. David
Skeel mentioned some of these. But more basically, under a
bankruptcy, the new firm would be motivated by profit and loss
considerations, the decisions to be made as we are familiar in
our economy. Under Title II, the new firm, for as long as 5
years, is going to be run by the government, so all the
concerns that this committee, in particular, would have about
the pressures put on government agencies for favors, for
example, for different kinds of treatment, will most likely
exist for this kind of a firm.
In addition, as David said, there are very particular
advantages. The lower borrowing cost because of the access to
the Treasury, the exemption from taxes, and the lower capital
requirements are enormous advantages this firm will have, and
you can understand why the FDIC would like to nurse this firm
for a while with those special advantages. But the truth is,
they are so huge, and for a 5-year period, the firm will most
likely have those unfair advantages, and I could see very well
the government agencies would want to take account of that.
So I think a better approach is to reform the Bankruptcy
Code. There is a lot of work done on that. David Skeel
mentioned that. The idea is to have even a large financial firm
go through an orderly bankruptcy without spillovers, according
to the rule of law, without all the discretion that the current
Title II entails. I think it is possible. I write about this in
detail in my testimony. I will be happy to answer any questions
you may have about it.
Thank you, Mr. Chairman.
[The prepared statement of Dr. Taylor may be found on page
70 of the appendix.]
Chairman McHenry. Thank you, Dr. Taylor.
I now recognize Mr. Rosner.
STATEMENT OF JOSHUA ROSNER, MANAGING DIRECTOR, GRAHAM FISHER &
CO.
Mr. Rosner. Chairman McHenry, Ranking Member Green, and
members of the subcommittee, thank you for inviting me to
testify on this important subject.
I should express my concern that the criticisms of Title II
will be used as an argument for repeal of a flawed rule before
a workable replacement or fix is created. That is not my
intent. Before addressing Title II, I want to highlight the key
problem with Title I. Congressional intent was to ensure all
too-big-to-fail firms would be unwound through bankruptcy. If
the Fed adhered to the intent of Title I, then Title II would
be unnecessary.
Instead, Title I and Title II create a special class of
GSE-like companies that benefit from implied government
guarantee. Title II's liquidation authority was designed to
protect from the disorderly failure of firms that cannot be
resolved under bankruptcy. Because of the explicit and implicit
subsidies it offers, the industry prefers it to bankruptcy.
While a traditional liquidation would result in replacement of
management, under the FDIC's proposed regime, key management of
failed operating subsidiaries could continue to manage the
newly recapitalized firm. It remains unclear what if any
benefit will accrue to the public from OLA. By contrast, the
measurable benefits will flow to those creditors that benefit
from disparate treatment and bonuses will be paid to retain
highly paid employees deemed essential to keeping the
enterprise functioning.
The FDIC's approach requires an enormous amount of taxpayer
subsidized debtor-in-possession financing from Treasury. It
supports an ``all animals are created equal but some animals
are more equal than others'' banking system. These companies
are far too large. Markets simply can't fund them in
bankruptcy.
Under Section 210(n)(5), bridge funding from Treasury is
priced at Treasury rates plus the spread for average corporate
bond yields, but Dodd-Frank does not state which corporate
index should be used. If the FDIC indexes to a Triple A
corporate average, funding may by at rates the market confers
on only the healthiest institution. That subsidy has value not
just in failure.
Additionally, the government has the authority to leave
behind as much debt as it wants, another subsidy. Potential
needs of the largest companies could reach to close to $100
billion, straining even Treasury's ability to access funds.
This is the easiest way to understand that these companies are
far too large. Markets simply can't fund them in bankruptcy.
Under the FDIC's approach, a failing firm's operating
subsidiaries remain open and operating while the holding
company would be subject to OLA. Thus, subsidiary creditors
face greatly diminished chances of loss. After all, the FDIC
has declared that these subsidiary banks and broker dealers
will probably never face insolvency. Counterparties will be
less prudent if they think creditors of the holding company are
on the hook.
If the government stands behind the holding company, market
monitoring will go down, leading to further problems. Why would
creditors choose to do business with companies that face normal
market discipline in bankruptcy when they could deal with the
company that offers subsidized pricing and assurances from the
FDIC that it would never fail? The FDIC's approach also create
incentives for management and creditors to starve the holding
company of funding and to instead raise capital at the
operating company, weakening the holding company's ability to
act as a source of strength.
It is very problematic if the same institution has the
possibility of going through two different insolvency regimes,
depending on the whim of regulators. Returns to creditors are
different under each regime and are somewhat unknowable in the
Title II regime, making it difficult for creditors to make
investment decisions. More disturbing is the FDIC's decision to
justify dissimilar treatment of similarly situated creditors
under the guise of protecting critical functions. As market
participants become concerned about the potential failure of a
too-big-to-fail firm, they will exacerbate problems and
increase systemic risk by selling their holdings into an
increasingly illiquid market. It paradoxically provides
benefits to any claimant that can convince regulators of its
systemic importance.
As a restructure regime, Title II levies no cost of failure
and provides no clear process to move assets from weak hands to
strong hands. The proper approach to ending the too-big-to-fail
problem would be to consider fairness, which is at the core of
the too-big-to-fail problem. It is essential that large firms
be subject to the same insolvency regime that smaller firms
are: the Bankruptcy Code. Making these firms small and simple
enough to fail through standard bankruptcy is clearly the best
path forward. It would eliminate the Orwellian approach to
equality, reduce risk of capital market flight, and support the
FDIC's mission as deposit insurer to the narrow banking system.
There is obviously far more detail in my written testimony,
and I would hope that you would take the time to read that.
Thank you.
[The prepared statement of Mr. Rosner can be found on page
57 of the appendix.]
Chairman McHenry. Thank you, Mr. Rosner.
And finally, I recognize Mr. Krimminger.
STATEMENT OF MICHAEL H. KRIMMINGER, PARTNER, CLEARY GOTTLIEB
Mr. Krimminger. Chairman McHenry, Ranking Member Green, and
members of the subcommittee, thank you for the opportunity to
testify today.
Too-big-to-fail did not begin with the recent financial
crisis or with Dodd-Frank. It has been the long-term
expectation by the market that some institutions are so
critical to the functioning of the financial system that the
government will act to prevent their insolvency. Over many
years, this has distorted market pricing for debt and equity
and limited the incentives that should be provided by market
discipline. Unfortunately, the recent financial crisis proved
the expectation of too-big-to-fail to be true.
Why? Because faced with the massive disruptions in the
market in the fall of 2008, regulators had no other option than
the Bankruptcy Code to resolve the largest non-bank financial
companies. After the turmoil following the Lehman bankruptcy,
this was not viewed as a reasonable choice, and as a result,
the regulators had to take several difficult steps to prevent
greater chaos.
To be succinct in response to the question posed for
today's hearing, Title II of Dodd-Frank does not enshrine too-
big-to-fail. Title II simply provides an alternative to the
Bankruptcy Code to ensure that the tools are available in a
crisis to close the largest financial companies and to impose
the losses on their shareholders and creditors while mitigating
the potential for more widespread dislocations in the financial
system and economy.
Any consideration of Title II has to examine why it was
created. In a properly functioning market economy, there will
be winners and losers, and some firms will become insolvent and
should fail. Actions that prevent them from failing ultimately
distort market mechanisms, including the market incentive to
monitor the actions of similarly situated firms.
Title II is a reaction to the fact that in 2008, the
regulators did not have an adequate legal framework to close
and resolve the largest companies. This was the reason that
Title II was created, to address limitations of the then-
current Bankruptcy Code. Title II is simply an adaptation of
the rules the FDIC has long used to resolve banks. It is
important to note also that the authorities in Title II are now
the international standard because regulators everywhere
recognize the need for tools adapted from those previously used
by the FDIC. The G20 heads of state and the Financial Stability
Board have endorsed them, and countries are putting those tools
into place.
Let me be clear, however, that bankruptcy has a long and
honored history under U.S. law. For the vast majority of the
business bankruptcies in the United States, the current system
has worked very well. In extraordinary circumstances, the
limitations of normal bankruptcy can impair its ability to
resolve the most complex financial companies. Improvements can
and should be made to the bankruptcy process to make it more
effective for such insolvency.
I have long recommended several improvements such as better
capabilities to continue businesses under first day orders,
changes to address financial contracts, and the ability to act
immediately under broader mandates for designated trustees or
debtors in possession. The recommendations made yesterday by
the Bipartisan Policy Center and others offer valuable
additional suggestions.
However, Title II does provide a critical backup resolution
structure for extraordinary cases, and I think we need both.
While Title II is a vital foundation, it is not sufficient to
end too-big-to-fail. The expectation of a government bailout
will end only when the market fully incorporates into its
pricing and other interactions an expectation that in the next
crisis, the largest institutions will be closed and resolved.
While Title II provides the legal framework, more must be done.
We must continue ongoing efforts to achieve even a greater
international coordination and we must continue the ongoing
resolution planning.
The FDIC has done an admirable job of explaining its plans,
but the job is not complete, because questions and doubts
remain. To complete the job, the FDIC must be much more
explicit about how it will conduct any Title II process. I
understand it will shortly be issuing a policy statement about
that process. I will say that this statement needs to lay out
very clearly the expected process under Title II and the
limitations of its discretion.
Too-big-to-fail should be eliminated because of its
distortion of market discipline and market practices and
ultimately its negative consequences for the real economy.
However, too-big-to-fail is not created or enshrined by the
Dodd-Frank Act. We need to support market discipline by
ensuring that we have insolvency procedures that are effective
for all scenarios. Market discipline, if allowed to act, can
prevent failures by incentivizing action by management and
creditors alike.
Thank you, and I would be pleased to answer any questions.
[The prepared statement of Mr. Krimminger can be found on
page 43 of the appendix.]
Chairman McHenry. I thank the witnesses.
Under Section 210 of the Dodd-Frank Act, the FDIC is
authorized to borrow from the Treasury, ``all purchases and
sales by the Secretary of such obligations under this paragraph
shall be treated as public debt transactions of the United
States.''
It is clear that the Orderly Liquidation Authority
authorizes the FDIC to tap the Treasury, the Treasury to tap
the public markets, and the taxpayers are on the hook for that
debt that the Treasury lets, just as they are today for
Treasury auctions in our current market.
Now, I bring this up, Professor Skeel, to understand this
process, what dollar percentage cap within the Act is provided
as a limitation on what the FDIC can loan a bridge corporation?
Mr. Skeel. The Act has two different dollar limitations,
and limitations almost isn't the right word because they are
not very limiting. At the time a Title II resolution starts,
the FDIC can borrow up to 10 percent of the consolidated asset
value of the institution, which if you take JPMorgan Chase as
your example, that is 10 percent of $2 trillion in consolidated
assets, more or less. That is $200 billion at the start of the
case.
Chairman McHenry. And then, thereafter?
Mr. Skeel. And then, thereafter, after 30 days the FDIC can
borrow up to 90 percent of the fair value of the assets. So if
the asset--
Chairman McHenry. So 90 percent.
Mr. Skeel. --is in that same range, we would be talking
about $1.8 trillion.
Chairman McHenry. Okay. So Dr. Taylor, Mr. Rosner, can you
put that in context for this last crisis? Perhaps, let's walk
through the scenario. If you had multiple firms going through
the Orderly Liquidation Authority, had it been in place in
2008, what would that look like?
Mr. Rosner. I think it is fair to say that Title I and
Title II were created under the premise of single institutions
failing. I think if we ended up with the contagion and multiple
large institutions failing at the same time, unfortunately we
would likely see the Treasury, the Fed back up here before all
of you arguing as to the reasons that we are going down the
same path and need to do another TARP-like bailout.
Chairman McHenry. That is not a great answer. Dr. Taylor?
Mr. Taylor. I think your question really was addressing
within Title II. There is the concern about going around it as
well, but even within it, of course, that is a huge subsidy.
The access to the Treasury borrowing is lower interest rates;
also, the rate at which the FDIC would be able to translate
that into its own loans is pretty much discretionary at this
point as well.
Chairman McHenry. You have a bridge company, it is funded,
getting liquidity support from the Treasury, lending enormous
sums to this company. You have the FDIC that is in charge of
managing this government bank, let's call it, so you have
ongoing operations managed by the FDIC, while at the same time
the FDIC and the Treasury are making decisions on how to value
the assets, and is there enormous discretion there, Professor
Skeel?
Mr. Skeel. Absolutely.
Chairman McHenry. So you have enormous discretion on
valuing those assets. Describe this conflict within the FDIC
and Treasury on making a wise decision for taxpayer dollars
while at the same time making wise decisions to get a firm back
on a healthy basis making a nice profit.
Mr. Skeel. Obviously, the FDIC has an incentive to make
valuation decisions that support its goal of preserving this
giant financial institution, so there is a direct conflict of
interest, and the FDIC has almost complete discretion. It is
very, very difficult to challenge its decisions
Chairman McHenry. So that discretion, Mr. Rosner, in terms
of valuation, is there any check within the Act on that?
Mr. Rosner. No, there isn't a check. First of all, I think
it is also worth pointing out that there is no obligation or
mechanism within Title II to price the credit risk that is
being taken on, and I think that is an important part of a
subsidy as well, but beyond that, I think the point that was
made is really important to emphasize, which is the conflict,
the internal and inherent conflict between the role as
balancing the public interest with the interest of creditors--
let's not think about it as the institution--as creditors of
that institution, are really unbridgeable
Chairman McHenry. So unbridgeable, why?
Mr. Rosner. Because at the end of the day, there is a
political reality where they are going to have to show, just as
we have seen claimed over and over since the crisis, that they
have made all of the taxpayers' money back, and if that comes
at the cost of unfair disadvantaging of certain creditors, that
is an internal conflict which really needs to be addressed.
Chairman McHenry. I thank the witnesses. We will now
recognize the ranking member for 5 minutes. I am sorry. The
ranking member is asking me to recognize Mr. Cleaver. Mr.
Cleaver is recognized for 5 minutes.
Mr. Cleaver. Thank you, Mr. Chairman.
Dr. Taylor, would you agree that unless it is curtailed,
too-big-to-fail will continue to place the taxpayers in a
position of blackmail? You might want to substitute a word for
``blackmail,'' it probably won't rhyme, but you get the premise
of my question?
Mr. Taylor. I am not sure I do. I think the concern of too-
big-to-fail and the bailout tendency is multifold. Part of it
is the distortions it creates in the market and it encourages
risk-taking. It leads to the crisis we are trying to avoid.
That is probably the biggest concern I would have.
In terms of the taxpayers, absolutely. Using taxpayers'
money like this is inexcusable, but I think the too-big-to-fail
problem goes beyond that, because if, for example, through an
assessment, you charge a broad group of financial institutions,
they are going to charge higher prices on their customer, so it
is going to be paid elsewhere. Or if the bailout of certain
creditors occurs at the expense of other creditors, that is
also a problem because it is going against the direction of the
rule of law which we have in the country. So there is a whole
set of ramifications that I am concerned about here.
Mr. Cleaver. You mention rule of law. I was sitting right
here when Secretary Paulson was sitting right there telling us
that we have to take some action, that President Bush had sent
him over to tell us the situation that we were in, and then I
was really unhappy later when I read his comment that he did
not have the authority to do what he did, and so my question
is, in an economic crisis, do you think that we will discard
again the rule of law? Mr. Rosner?
Mr. Rosner. The answer, unfortunately, I think is yes, if
we continue down the path that we are heading down. The thing
that I found interesting is there does seem to be unanimity of
view among the Members that too-big-to-fail is an intolerable
situation for us to accept, which really says two things: one,
we either have to make these companies small enough and
manageable enough that they can be treated like every other
corporation; or two, they have to have sufficient amounts of
capital, real capital to be able to avoid that crisis. Those
are the outcomes. Those are the opportunities. And I don't
think Title I or Title II address those, and I think that
really is the task before you.
Mr. Cleaver. Yes, Mr. Krimminger?
Mr. Krimminger. I thought I would note one thing. One of
the things I would note about the criticisms of Title II as
well, as I think as I noted in my testimony, is you have to
look at the realistic alternatives we have had in the past. I
don't think it is realistic to go back and discard Title II and
have the Bankruptcy Code that was in existence in the past and
expect to the situation to be different than it was in the
past.
We certainly need to make improvements to the Bankruptcy
Code. I think everyone, and I believe even including the FDIC,
certainly when I was there, would have been wholeheartedly in
support of making Title II a less-likely-to-be-used
alternative, but to eliminate the alternative, even with an
improved Bankruptcy Code, I think is in some ways potentially
sending the message that in the next crisis, they are much more
likely to come back and sit at these desks and ask for more
money in the future.
Mr. Cleaver. Do you believe that the economies of scale in
banks and other certain businesses are worth preserving as long
as they are regulated in proportion to their impact on the
economy?
Mr. Krimminger. I think it is always very difficult to come
up with a metric, if you will, or an analysis that it concludes
at what size institutions should be. So, certainly there are
economies of scale. Certainly, there is a need for a global
financial system and financial institutions that can provide
credit for that financial system. Certainly, there is
regulation, additional regulation in Title I, and I think you
have to look at Title I, Title II, and other parts of the Dodd-
Frank Act as a combined whole and what effect they will have.
Are there changes that may be necessary at times? Yes. But
Title I and Title II, I think, are designed to kind of work in
tandem, and that is part of the issue.
Mr. Cleaver. We still have banks behaving badly, and I
think something needs to be done about it. I appreciate the
hearing, but I think we need to tweak Title II if it is not
strong enough and tough enough. I think the American people
would support that.
I think that my time has run out, Mr. Chairman.
Chairman McHenry. I thank the gentleman, and I would
certainly like to work with him on a process that will actually
work, and I think this hearing is bringing to light that the
current process doesn't. So I am encouraged by your comments,
and I appreciate that.
We will now recognize Mr. Ross of Florida for 5 minutes.
Mr. Ross. Thank you, Mr. Chairman. It is interesting that
three of our witnesses talked about an amendment to the
Bankruptcy Code, and one says that the Bankruptcy Code would
not have helped.
In my experience in my practice, which has been very
limited in bankruptcy, at least allowed for due process, notice
to creditors, notice to debtors, and in fact put them on notice
that they may only receive pennies on the dollar of what may be
owed them, and yet underneath Title II it appears as though we
are creating a situation where those creditors, even those
shareholders have no risk if a bridge holding company takes
over.
Is that your understanding, Mr. Skeel?
Mr. Skeel. That is absolutely my understanding. And as I
said earlier, the creditors that are most guaranteed to be
protected are the fancy financial contracts, the derivatives
that caused problems in 2008.
Mr. Ross. With the obvious competitive advantage that a
bridge holding company has, you also have a situation that is
so contrary to market forces that says where you have increased
risk, you may have increased return, and so if I am a
shareholder in a company that is now part of a bridge holding
company, my risk is almost eliminated; is that not true?
Mr. Skeel. Absolutely, for up to 5 years. As long as that
bridge company is going, it is a protected entity.
Mr. Ross. And Mr. Krimminger, let me ask you this: Under
Title II, is there any due process for these companies?
Mr. Krimminger. Absolutely, there is due process.
Mr. Ross. And what would that be? Obviously, it is not a
full due process as the law allowed under the Bankruptcy Code.
Mr. Krimminger. There is due process. In fact, the
Bankruptcy Code provides for ex ante due process and a hearing
before a judge. Part of the reason Title II has an ex post, in
other words, you have a right to file suit against the FDIC for
making errors or doing something to with your credit that is
inappropriate after the fact, is because of the need for speed
and financial insolvency.
And let me, if I may, just clarify one thing. I may have
been misinterpreted. I absolutely believe that improvements to
the Bankruptcy Code should be done and will be very helpful.
Mr. Ross. And I think they should be, too, because not only
are we talking about financial institutions. There are some
financial institutions that are too-big-to-fail under some
people's interpretation, but what about non-financial
institutions? If we are allowing now for this process to go
through that totally ignores our bankruptcy, what about Wal-
Mart? What is to prevent them from having some regulatory
reform system in place to keep them from going for bankruptcy?
My point is that we are taking traditional due process methods
and not allowing companies that have created a high risk, poor
performance and allowing them to succeed to a market
disadvantage.
Dr. Taylor, you talked about three of the disadvantages,
one of which is the lack of having to be liable for taxes at
every level. Do we know what the cost of that is?
Mr. Taylor. I don't think it has been estimated,
unfortunately. Maybe that is something you could request.
Mr. Ross. I think I will. Quite frankly, I think that the
cost of tax exemption will probably outweigh the benefits, if
any at all, in saving these companies.
Now, let me ask you this: The risk-based assessment, the
last step in the event that we have to now repay FDIC, and we
go to the good players, and we assess them their share, if you
will, what happens if you have a mutual company, a savings and
loan insurance company, that now has to be assessed. It has
done everything right. Are they able to recapture the cost of
this assessment in their rate-making process with their
consumers? Does anybody have a comment on that?
Mr. Taylor. Most likely, absolutely. They will be able to
capture it partly by passing it on to their customers, whether
they are regulated or not, quite frankly. Economics says that
kind of--
Mr. Ross. So if I am a consumer who has a AAA rated, mutual
insurance company that is now being assessed, I am going to
have to pay for somebody who has been a bad actor. This reminds
me of a situation where we have created the ultimate hangover
cure in Title II, and every morning, these SIFIs, these
Systemically Important Financial Institutions that are
performing badly can take this hangover cure and go on and
continue to perform, and yet they do so at the risk and at the
cost of those who are not the drinkers in this situation.
Lastly, one of the three, and I am going to--give me a
second, here, Dr. Taylor. You talked about the competitive
advantages, including capital requirements. So if my State of
Florida has certain capital requirements for an insurance
company, those would be totally disregarded by the bridge
holding company under Title II, is that correct?
Mr. Taylor. No.
Mr. Krimminger. I would just say it would not because
certainly under Title II, the insurance company--frankly,
insurance companies are not really eligible for Title II until
it has already gone through a--
Mr. Ross. But the process is there, and I only have a
second. The process is there that if they have been deemed
Systemically Important Financial Institutions as an insurance
company, they can have lesser capital requirements in conflict
with State regulation.
Mr. Krimminger. No, that is not true, but we can talk
later, sir.
Mr. Taylor. The example of the insurance companies, there
are many other examples you could use for which the capital
requirements could be lower, as in Title II at this point.
Mr. Ross. And I will follow up. Thank you, Mr. Chairman. I
yield back.
Chairman McHenry. The gentlelady from Ohio, Mrs. Beatty, is
recognized for 5 minutes.
Mrs. Beatty. Thank you so much, Chairman McHenry, and
Ranking Member Green. And to our guests here testifying today,
as you know, this is one of three hearings that we have had,
and I am certainly looking forward to hearing your comment.
This has been an ongoing discussion that we have been having in
learning a lot of new terminology, hangover, from what I am
drinking, to SIFI and all of the other things we are talking
today. So I certainly welcome this healthy debate on the issue.
But first, I think it is clear that size and scope and
scale and interconnectedness of the largest financial
institutions prevent the elimination of all possible fallout
resulting from a failure. But in Dodd-Frank Title II, it
provides a new mechanism, I think, and I am interested later to
hear your comments on that for government to resolve the most
complex forms without creating new systemic failures associated
with bank loans or across default provisions or acute asset
value decline.
But as I look through your testimony, I guess one of the
questions I would like to ask that we haven't quite touched on
this morning is what is happening at an international level.
And I think I want to address this question to you, Mr.
Krimminger.
Can you tell us if what we are doing here today, if they
have had any better results, for example, in China, with using
Title II in their complex and in their monetary system?
Mr. Krimminger. Certainly. I think Title II, as I said
before, provides a statutory framework that I think has
facilitated a lot more cooperation. One of the steps that has
been undertaken over the last few years as a result of the
crisis was that many other countries recognize that the old, if
you will, liquidation process for banks as well as other types
of financial companies was not very effective. Part of the
problem, particularly in Europe, is that effectively they have
always bailed out all of their banks because their only option
was essentially a liquidation rather than the continuity that
you even get under the Federal Deposit Insurance Act with the
insured banks in the United States.
So one of the things that has gone on internationally is
there has been a great expansion of cooperation, a great
expansion of moving towards more similar types of legal
infrastructures, as I noted in my testimony, and the heads of
the state of the G-20, the Financial Stability Board and
others, the types of authority that Dodd-Frank gives has really
effectively become the international standard for the most
complex financial companies.
One of the things we have to make sure we push against is
the continuing desire in some countries to go to a bailout-type
process. The problem is if you have nothing but a bankruptcy,
or an old-fashioned bankruptcy liquidation process, or a
bailout, these countries have always opted for a bailout. So
the FDIC and other U.S. regulators are doing a lot to work more
cooperatively with other international regulators to make sure
that a plan is put in place, because planning and the ability
to plan in advance is, I think, a major advantage provided by
having this type of insolvency framework.
Mrs. Beatty. Okay, thank you. Others, please?
Mr. Rosner. Dodd-Frank provides no mechanism to deal with
the international resolution process, and the Fed has
recognized that and has made proposals on that basis for an
intermediate holding structure for foreign banks operating in
the United States. I think it is a little bit disturbing for us
to fail to accept the reality that different countries have
different legal regimes, and those cannot be handled through
cooperation among regulators, or bridged I should say, by
cooperation among regulators. That is something that is left
and intended to be left to law, and each jurisdiction has its
own.
We currently have memoranda of understanding between
various jurisdictions. Those are largely unworkable when push
comes to shove, especially because of the legal barriers
imposed upon regulators. So I think this is an issue that needs
to be addressed affirmatively by legislators, not outsourced to
policymakers. It needs to be done before, not during or after a
crisis.
Mr. Krimminger. If I might comment on that, it is somewhat
odd to assert as a defect of Title II that it doesn't deal with
all of the international law issues when other countries have
the ability to adopt their own laws. But what it does do, and
what has occurred is a great deal more pre-planning. You have
to have planning if you are going to have an effective
resolution. And yes, I agree that paper documents don't do it.
But you have to have planning if you are going to have any
progress in the future. And to ignore the planning is to
basically set yourself up for failure the next time.
Chairman McHenry. The gentlelady's time has expired. I am
going to yield myself 5 minutes. Professor Skeel, I just want
to follow up on a comment, a suggestion I made in my opening
statement, which is since the FDIC can loan up to 90 percent of
total consolidated assets to a bridge holding company,
presumably it could loan 0 percent. Is that correct?
Mr. Skeel. It can loan as little or as much as it wants up
to that 90 percent, which is as much as $1.8 trillion.
Chairman McHenry. What are the ramifications or problems
with that scenario?
Mr. Skeel. It reinforces the things that we have been
talking about. It creates an enormous amount of uncertainty. It
gives the FDIC complete discretion as to what it does with
Title II, and there really is no check on that.
Chairman McHenry. Dr. Taylor, given this wide latitude in
funding authority, could the FDIC use it to change the degree
to which they require creditors to suffer losses due to write-
downs of their debts?
Mr. Taylor. Absolutely. It has the power to do what it
needs to do, or what it wants to do to favor certain creditors
maybe because there are concerns about systemic issues with
those creditors, or there may be other reasons we don't know,
but it has the power to do it. And it could do that even
without this by hurting, if you like, other creditors who are
not so favored compared to the bankrupt rules. So it definitely
has that power. It is one of the uncertain things here you
can't plan for. It is really not a rule of law as would exist
under the Bankruptcy Code where you have priorities or specific
ways you handle various kinds of creditors.
Chairman McHenry. Mr. Rosner?
Mr. Rosner. Yes. I think that problem is probably the
biggest issue to contend with, the ability to hand the FDIC the
authority to treat similarly situated creditors differently at
their whim under the guise of protecting the ability of
potential counterparties to continue to serve in supporting
essential functions of the institution. And so, they do have
far too much discretion. It is absolute discretion, and by the
way, the ability to fund can conceivably take what is a failed
firm into being the most profitable firm overnight if we pump
in enough taxpayer dollars.
Chairman McHenry. Mr. Rosner, if a bridge holding company
borrowed at lower interest rates than its competitors while
also avoiding all taxes, how significant would those combined
advantages be?
Mr. Rosner. Starve competition, increase the scope and
scale and size of that utility, provide opportunities for that
utility to justify to neighboring jurisdictions its ability and
capability to operate in those markets. And it would ultimately
just reinforce the oligopolistic market power of that
institution and the small group of institutions that are
similar.
Chairman McHenry. Professor Skeel?
Mr. Skeel. I just want to follow on to that. I agree
completely, and I would like to make a comment about the
comparisons that have been made to the way financial
institutions are regulated in Europe. I think it is important
to keep in mind that the approach to financial institutions in
Europe is completely different than the U.S. approach. Too-big-
to-fail is a long-standing tradition in European regulation,
and so the idea that we would be replicating what they are
doing is not an idea that I think we should be sympathetic to.
We have a very different perspective on the importance of
competition in this country.
Chairman McHenry. I yield back the balance of my time.
I recognize the gentleman from California, Mr. Sherman, for
5 minutes.
Mr. Sherman. Let me start by asking Mr. Krimminger to also
respond to the latest, the last question.
Mr. Krimminger. I don't think anyone is suggesting we
should adopt the European model for our financial regulation.
This point was simply being made, was that the authorities to
dissolve companies in Title II are being adopted in Europe, not
the other way around. So I think that everyone has recognized
that you simply can't have only a liquidation under bankruptcy
as the only alternative under the existing Bankruptcy Code. We
agree that we need to make improvements to it, but we need to
look at the alternatives to make sure that you can deal with
the potential systemic unwinding of the financial institution.
That is why, frankly, under Title II there is some discretion,
just as there has been for many, many years under the Federal
Deposit Insurance Act, to provide for some additional payments
to creditors that are essential to keep the company operating.
Bankruptcy also has first-day orders. In fact, one of the
recommendations by many with regard to bankruptcy improvement
has been to expand the ability to make sure that you can keep
the essential functions operating beyond the traditional way of
looking at first-day orders. So this is not a huge departure in
terms of the tools that are available from the Bankruptcy Code.
I think the departure that people are concerned about
apparently is that there is the ability to act quickly with ex
post judicial review instead of an ex ante judicial oversight.
Mr. Sherman. Thank you. We sometimes speak a different
language than those who favor bailouts, should deal with
translation. They believe that you have checks and balances if
several different executive department officers have to sign
off on the same thing, that you don't need Congress to have
checks and balances on enormous power. And they also believe
that it is not a bailout if the shareholders lose their money,
even if the creditors are fully bailed out. And I disagree with
that simply because the key in financial services is your cost
of capital. And if you can assure creditors that they will be
bailed out, you will have a lower cost of capital.
Mr. Taylor, for the record, if you could expand on in a
written response how Title II provides for an almost crony
capitalism as to which creditors get paid and which don't,
because I am familiar with regular bankruptcy; you are either a
secured creditor or you are an unsecured creditor. All of the
unsecured creditors are equal. Apparently in this world, some
animals are more equal than others. So if you could provide us
with a written response there, certainly what worries me is
that the key to being a successful business ought to be a
successful business, not covering yourself by being well-
connected and well-respected in Washington, D.C.
We have been focusing on what happens if there is a great
catastrophe, a great storm, but the effect of this too-big-to-
fail affects us even now on a relatively calm day, because the
giant banks are getting bigger, and my concern is not so much
for the banks. It is for the borrowers. We had Jamie Dimon
sitting there saying he couldn't find small businesses in
America to loan to, so he sent his money to London, where it
got eaten by the whale. And the really big banks would rather
make a billion dollar bet than a million dollar loan.
One controversy that has swirled is how much do the big
banks benefit from this belief that when you lend the money,
you are not just relying on their balance sheet; you have Uncle
Sam's safety net? I have heard estimates of 80 basis points, 60
basis points. I would like to go down the list. Take the second
or third largest banking institution in America, how many basis
points do they save on their borrowed capital?
Mr. Skeel. As John Taylor has noted, there is a lot of
controversy about this, but I have heard anywhere from 70 or 80
basis points to higher. I have heard up to 2 percent in some of
the estimates. There are a lot of numbers that are swirling
around, but it is clear that the benefit is very, very large.
Mr. Sherman. Mr. Taylor, do you have an opinion?
Mr. Taylor. I think there are 80 basis points, that is what
translates into $83 billion, is based on a study which I have
looked at. I think it makes sense. They are looking at how
different types of government policies affect credit ratings,
which in turn, affect interest rates. I think that is a good
number.
Mr. Sherman. Mr. Rosner?
Mr. Rosner. Yes, I would agree. The NY study is actually
fairly robust. I would also point out that any subsidy that
advantages these institutions relative to the seven other firms
in our country is anticompetitive and too much, and I would
request or suggest that you turn to page 8 of my testimony, in
which I refute many of the claims made about scale and benefit
that we receive as a result of large global financial
institutions.
Mr. Sherman. Mr. Krimminger?
Mr. Krimminger. I am not sure that I have a number I would
give. I think the key thing is to make sure that these large
institutions are all subject to insolvency processes that will
have the market discipline act and operate.
Mr. Sherman. My time has expired. I yield back.
Chairman McHenry. The gentlelady from Missouri, Mrs.
Wagner, is recognized for 5 minutes.
Mrs. Wagner. Thank you, Mr. Chairman. Professor Skeel, in
your opinion, does Title II of Dodd-Frank do anything to limit
the maturities of loans that the FDIC provides to the bridge
company? In other words, could the FDIC just continuously
provide short-term loans at favorable rates to the bridge
company?
Mr. Skeel. Sure. The FDIC can essentially cherry pick the
rate it wants by picking obligations of the maturity that has
an attractive interest rate. So, there is very, very little
limitation on them.
Mrs. Wagner. So while a private corporation would have to
worry about renegotiating its credit line every 6 months or so,
a company under OLA would have guaranteed access to favorable
loans backed by the taxpayer?
Mr. Skeel. Absolutely.
Mrs. Wagner. I direct this both to Professor Skeel and Dr.
Taylor. Would you say that one of the biggest risks financial
institutions face, which is liquidity risk, would be largely
eliminated for a financial institution that enters OLA?
Mr. Taylor. Once it is in the bridge form, yes, basically
it can provide as much credit as it needs. That was put in the
Act on purpose, I am sure, but it creates, if you take care of
the liquidity problem, then you can do a lot of other things at
the same time. So, it is a huge advantage.
Mrs. Wagner. Professor Skeel?
Mr. Skeel. Yes, all of those numbers we have been talking
about are available to eliminate any hint of a liquidity
problem.
Mrs. Wagner. Dr. Taylor, what kind of advantages would this
confer upon the company under OLA versus private financial
institutions that don't have access to cheap, taxpayer-backed
loans?
Mr. Taylor. One thing it could do which is actually kind of
perverse is since it doesn't have to worry about liquidity, it
doesn't have to worry about accessing the private market
liquidity, you can take actions actually which are more risky
than otherwise and be covered by that, and therefore that gives
us a direct advantage. That would be one example.
Mrs. Wagner. Professor Skeel, a little over a year ago,
Martin Gruenberg as the Acting Chairman of the FDIC, gave a
speech regarding OLA and talked about the need to, as you put
it, craft a resolution, undergo a market test of viability, and
appoint a temporary new board of directors, and a CEO from the
private sector. When you were talking about an institution with
potentially trillions of dollars in assets, wouldn't these
steps to running a bridge holding company potentially take
years?
Mr. Skeel. Potentially, they could. And I worry more about
this, about how we are going to decide who is going to be
managing these giant bridge institutions the further we get
away from 2008. If it happened right now, everybody has been
focusing on it for 2 years. It is possible you could come up
with some folks to run these companies. The further away we
get, the more worried I am, and it is a huge question mark even
now.
Mrs. Wagner. The FDIC really has no experience winding down
a large, internationally connected complex institution?
Mr. Skeel. No. That is a very important point, and if I
may, let me throw in an additional cause for concern. We have
been talking about what the FDIC does with its bank
resolutions, what it has done for a long time. It is very
important to keep in mind the normal FDIC bank resolution looks
nothing like the institutions we are talking about.
Mrs. Wagner. Right.
Mr. Skeel. The small mom-and-pop institution, all of its
liabilities are deposits. This is a completely different
creature and this is uncharted territory.
Mrs. Wagner. Absolutely. Mr. Rosner, if OLA were
implemented prior to 2008, is it reasonable to assume that
multiple firms would have undergone the OLA process as a result
of the financial crisis?
Mr. Rosner. It is reasonable to expect that they would try
because of congressional legislative mandate. Is it reasonable
that it would succeed? No.
Mrs. Wagner. So, if multiple institutions are undergoing
the OLA process at the same time, is it reasonable to assume
that the FDIC would find itself, as we have just discussed with
Professor Skeel, quickly overwhelmed?
Mr. Rosner. I think the answer is, absolutely. And in fact,
during the crisis we had managements that needed to be replaced
and there was not an available pool of talent within the
industry to bring enough management in, so we often found
management left in place under greater supervision, which is
neither an equitable outcome, nor is that the proper resolution
to have the people who created failure continue to run an
institution in failure.
Mrs. Wagner. My time is short here, but if the FDIC proves
itself--as we just discussed--incapable of running a bridge
holding company into the ground after exercising discretion
over its assets, could this potentially, I assume, cause
irreversible harm to the broader economy?
Mr. Rosner. I don't think there is any question, and I
think you raise an important point, which is if in failure, or
if we find OLA results in failure, what are the remedies at
that point?
Mrs. Wagner. Right. Thank you, I appreciate it. I believe I
have run out of time.
Chairman McHenry. We will now recognize the gentleman from
Maryland, Mr. Delaney.
Mr. Delaney. Before I ask my questions, I want to say that
I actually think the FDIC did a very nice job through the
financial crisis. We had a situation where 19 of the 20 largest
financial institutions in the United States, 19 of 20, either
failed or required massive investment by the U.S. Government.
The only one that didn't was Berkshire Hathaway, and we, within
a relatively short period of time, completely recapitalized the
banking system and the financial system continued to function.
So it is not clear to me why there is a sense that the FDIC
would not manage this process well. Does anyone have data that
suggests that the FDIC did a bad job managing this process?
Mr. Rosner. I don't think the question is, did the FDIC do
a bad job. As you said, 19 of 20 either failed or required
capital investments.
Mr. Delaney. Yes.
Mr. Rosner. And that in itself, is inequitable, that we
ended up backstopping, supporting, saving, keeping in place
management of companies that otherwise would neither have been
able to fund or exist to the disadvantage of the other banks
within our banking system.
Mr. Krimminger. If I may just respond, of course, one of
the reasons we now have have Title II is to have an alternative
to a bailout that occurred in TARP, and I think that we also--
again, I have a theme here, what are our alternatives to having
a process where the FDIC can help take over these institutions
and make the shareholders and creditors bear the losses. In
bankruptcy, in Chapter 11 we often ignore the fact that the
debtor in possession, which is typically the old management, is
operating the company in reorganization. So there is always
going to be a challenge with getting the right-skilled people
to take over these companies.
Mr. Delaney. Exactly, and that is why I wanted to just put
this in context because I think it is a great discussion, and
an appropriate discussion of that inequality that occurred as
it relates to the response to the financial crisis, because I
certainly believe there was significant inequality. But perfect
is the enemy of the good, and we had to save the financial
system because the consequences, in my judgment, would have
been worse.
And my point was, as it relates to the FDIC, I don't see
anything in their behavior that would indicate that they are
not in a position to manage this process well, because in fact,
when tested, their deposit insurance fund did not in fact, need
a significant--I am going to move on to my next question--
bailout, and I think again, in the context of things, they
operated prudently. And this is a roadmap for handling it, one
which did not exist before. So if you look at their past
behavior, when they didn't actually have a roadmap, and assume
that with a roadmap I would actually judge that they would do
better, but what I do worry about, which is what my question
is, that the ability to provide funding to these financial
institutions fails for one of three reasons: fraud; credit
risks; or liquidity risk. And these large institutions have an
advantage as it relates to liquidity, because they have
liquidity built in to the extent they were to fail. And while
it is very clear that equity and management and those kind of
things get wiped out, stabilizing the institutions does help
its creditors, and the equity of these institutions is 10
percent of the balance sheet; 90 percent of the balance sheet
is creditors, so having in place a mechanism to stabilize the
institution with liquidity, while the liquidation occurs, one
would argue is good for its creditors because it allows an
institution to actually liquidate its assets in an orderly way
where you typically get better prices than if you have to
liquidate assets in a non-orderly way where you get worse
prices. So the question is, do you think this mechanism will in
fact over time--and I apologize if you testified on this
before--provide an advantage to how these institutions borrow
in the unsecured debt markets?
I will open that up to Mr. Skeel and Dr. Taylor.
Mr. Skeel. I certainly do think it will provide an
advantage, particularly with short-term debt. The proposal that
the FDIC is putting forward, the single point of entry
proposal, would, if it were ever used, write down bond debt, so
I think there may be some negative effect on the price with
respect to bond debt. But with short-term unsecured debt in
particular, I think there is going to be a significant increase
in the attractiveness of this debt. The cost is going to go
down a lot, and there is still a general too-big-to-fail
subsidy that is going to reduce credit costs as well.
Mr. Taylor. I think a lot of the things you would like to
have orderly, et cetera, could be achieved with the Bankruptcy
Code in the right format. And don't forget that the Bankruptcy
Code avoids all of this rule of law violation, all of these
special things we are doing for favored creditors here. It has
a procedure to handle that and it can be modified so that you
do have the orderly kind of process if you want to.
Mr. Delaney. Thank you. Mr. Krimminger?
Mr. Krimminger. I will just note that I think the idea
that, yes, there could maybe be a subsidy to creditors in some
ways if they are carried over to the bridge bank, we have to
put that, again, in consideration of the alternatives.
Mr. Delaney. Right.
Mr. Krimminger. Right now, everybody has been saying that
the banks have uplift based upon the expectation of too-big-to-
fail. If you remove an alternative way of resolving these
institutions, whether in the extraordinary case where the
Bankruptcy Code won't work, and again, I think we need to make
it where the Bankruptcy Code can be more successful, removing
that alternative way is simply going to emphasize that too-big-
to-fail may still be the case in a crisis.
Mr. Delaney. I agree with you; it is better than the
alternative. I just think we should be observing how much these
spread differentials in fact occur.
Mr. Rosner. Can I just make one point?
Mr. Delaney. Please.
Mr. Rosner. We are also forgetting a key issue here, which
is we are creating incentive through this structure for the
institution to issue debt at the OPCO level, rather than at the
HOLDCO level, and creditors who prefer to invest in the
operating company level, rather than the holding company level
because of the difference in treatment.
Mr. Delaney. I am not sure that is a problem. I am going to
take back my time, because the problem was HOLDCO debt, not
OPCO debt, generally speaking.
Chairman McHenry. The gentleman's time has expired. I would
love to engage more deeply on this question, because where
those unsecured creditors are going into a crisis may be
significantly different under the Orderly Liquidation Authority
and their rights are very unclear, and that is--I have a
question about that when we get to the second round, which I am
hopeful we can, and I would love to engage with you about that.
With that, I will recognize Mr. Hultgren for 5 minutes.
Mr. Hultgren. Thank you, Mr. Chairman. And thank you all
for being here. I want to follow up briefly on Representative
Sherman, who was questioning a couple of minutes ago. I think
he had to step out maybe to another meeting, but to follow up a
little bit on some of his points that he had started
discussing, I was looking at a speech that Richard Foster,
President and CEO of the Federal Reserve Bank of Dallas, had
made back in January where he referenced some numbers given by
Andrew Haldane and gave estimates of the current implicit too-
big-to-fail global subsidy to roughly $300 billion per year for
the 29 global institutions identified by the Financial
Stability Board as systemically important. To put that $300
billion estimate annual subsidy in perspective, all of the U.S.
BCs summed together reported 2011 earnings of $108 billion.
I wondered if I could ask Professor Skeel, and also
Professor Taylor, to the extent Dodd-Frank and Title II truly
eliminate bailouts, shouldn't this be reflected in increased
borrowing costs to the institutions covered by the title?
Mr. Skeel. It should, and the Haldane speech--which I would
commend anybody to read; it is a terrific paper--very, very
strongly suggests to the contrary that we are going in the
opposite direction, that the too-big-to-fail subsidy has gotten
bigger since the crisis, not smaller.
Mr. Taylor. And the IMF study we discussed a few minutes
ago finds that the basis points have increased since the
crisis.
Mr. Hultgren. I wonder if you could just elaborate a little
bit more. To the extent the borrowing cost advantage persists,
does this imply that the expectation for bailouts persist as
well?
Mr. Skeel. Absolutely, and the trend line is not good. To
refer to something else that is in that Haldane talk, the top
three U.S. banks in 1990 had 10 percent of industry assets.
They now have 40 percent of industry assets. So we are very
much going in the wrong direction.
Mr. Rosner. I think it is also demonstrable. If you look at
the rating agencies' response to the Brown-Vitter bill as
introduced, it was that if it were enacted, it would eliminate
the upsweep support of the government that they include in
their ratings of these companies.
Mr. Hultgren. Following a little bit further on that with
Professor Skeel and Professor Taylor, what other factors do you
see that contribute to the borrowing cost advantage enjoyed by
bigger institutions, and any other factors besides an implicit
guarantee that affect the creditworthiness and borrowing costs
of banking institutions?
Mr. Skeel. We have talked about a lot of the factors, the
likelihood that creditors will be bailed out, the likelihood
that the institution wouldn't be allowed to fail. Also in that
is an assumption that the capital requirements that everybody
is talking about as the solution to too-big-to-fail won't work.
Historically, capital requirements have not worked. They
haven't predicted crises. They haven't avoided crises, and I
think the market is pretty confident they are not going to work
this time either.
Mr. Taylor. I think it is hard to control for all of the
different factors that affect the spreads, and these studies
tried to do that. But there could be other differences with
large banks. Mr. Rosner says he doesn't find particular
advantages of larger banks, but there may be some advantages
besides the Federal support which provides a different rate. So
it is important to take that into account and if you are going
to have a good debate about these issues, consider the other
sides. But when you look carefully, it seems to me that the
expected Federal Government support, if you like, the
expectations of bailouts, is a big factor in this favorable
rate.
Mr. Hultgren. But any specifics? Besides the backstop, what
other implicit benefits?
Mr. Rosner. I should make sure it is understood that I
wasn't saying there were no benefits. I was suggesting that the
social benefits, the systemic benefits of these global
institutions are overstated and not substantial.
Mr. Skeel. Just to throw one more benefit in, the big
institutions were given enormous tax breaks during the period
of the crisis, as well. And these were ad hoc tax breaks, where
the IRS changed its rule on things like net operating losses
for the benefit of the institutions. So there is an assumption
that the government is going to be behind them helping them out
in the event of a crisis.
Mr. Hultgren. My time is winding down, so I am not going to
really have a chance to ask another question, but I would love
to follow up. There has been some allusion to needed changes in
the Bankruptcy Code, dealing specifically with this, so I would
love to hear any suggestions you might have on that, of what we
should be looking at or working on with other committees,
Judiciary and other committees, to be able to address that, and
to also make sure that this never happens again.
Thank you so much. I yield back.
Chairman McHenry. Mr. Heck is recognized for 5 minutes.
Mr. Heck. Thank you, Mr. Chairman. For those of you who
said that having access to the Orderly Liquidation Fund yields
some kind of funding or competitive advantage, that is clearly
implying that there is an incentive to do so. So my question
is, is there evidence to suggest that banks have engaged in
merger talk to reach that magic $50 billion threshold to take
advantage of this? Is there evidence that banks are lobbying
any of us to lower the $50 billion threshold so that they could
achieve this status? Is there any evidence that non-banks are
lobbying FSOC to be designated as SIFIs so they could take
advantage of what you are suggesting is competitive and funding
advantage?
Mr. Rosner. Can I turn the question around a little bit?
Mr. Heck. No.
Mr. Krimminger. I would be happy to answer it, briefly. I
think it is very clear--
Mr. Heck. I was teasing him. He is welcome to turn it
around.
Mr. Krimminger. I would be happy to say that I think by and
large, companies have not been willing to be over that $50
billion threshold. Certainly, Title II of Dodd-Frank does not
apply to any company over the $50 billion threshold. Of course,
it applies to the very largest where bankruptcy would
potentially create systemic risk, and it is trying to address
that systemic risk. So companies certainly would not want it to
be over $50 billion because they would not want to undergo the
additional supervisory oversight by the Federal Reserve and
other preparation of living wills and things like that.
Mr. Heck. So are the funding advantages and the competitive
advantages neutralized or negated by this additional
requirement?
Mr. Krimminger. I certainly don't think that the
institutions perceived there being a funding advantage,
particularly at that $50 billion threshold cutoff.
Mr. Skeel. It seems to me that the issue isn't the $50
billion threshold. It is the $800 billion, $1 trillion
threshold. So in my view, the reason why people don't want to
be over the $50 billion is because they are not the
beneficiaries. The beneficiaries are JPMorgan and Citigroup and
Goldman and Morgan Stanley, and those banks, and so if you get
just over the $50 billion threshold, you get the disadvantages
of being singled out without the advantages of being singled
out.
Mr. Heck. So at what dollar level does the advantage kick
in?
Mr. Skeel. I couldn't put a precise dollar level, but when
you get into the top 10 banks or so in the country--
Mr. Heck. It is not clear to me how that changes the spirit
of my question, though. Then why aren't multiple regional banks
talking with one another to achieve this holy grail of the
funding advantage and competitive advantage of--
Mr. Rosner. I do think that we have institutions that have
sought to be what I call aspirational too-big-to-fail
institutions that have grown in precisely that manner with--
Mr. Heck. Can you name names?
Mr. Rosner. I think that is one of the drivers we have seen
with PNC over the years, and previously with SunTrust and with
regions at times. So I think there is this class of
aspirational too-big-to-fails, but where I was going before was
if we do not see the Orderly Liquidation Authority as a
benefit, or the DIF funding as a subsidy, then why don't we
just open that DIF funding to every single institution in this
country in case of trouble? Allow everyone to access low-cost
Treasury capital when they are in trouble. It is absurd. It is
an absurd suggestion, and the fact that we all recognize it is
an absurd suggestion demonstrates or points to the inequity of
that financing in the first place.
Mr. Heck. I am glad you made a reference to DIF. I would
like to move on if I may, sir. As you define bailouts, would
the traditional FDIC resolution process to wind down a
depository institution qualify as a bailout?
Mr. Rosner. No, because it is actually a liquidation rather
than a restructuring. And in fact, it seems that the
institutions have sought to make themselves intentionally more
complex even within the banks by moving their derivative books
which had historically in many cases been outside the banks
into the banks to increase the complexity and the difficulty of
resolving a bank.
Mr. Krimminger. Having a little bit of experience with the
FDIC, I think it is--you can't make that distinction, frankly,
between the FDIC process and banks being a liquidation and this
being a reorganization. What happens in a bank is that you sell
it to another bank. You put it into a bridge and then sell it
to another bank. Here, you don't want to put it into a bridge
and sell it to another large institution because then you just
treble the size of the large institution, potentially. So you
really can't draw that distinction. I think the FDIC certainly
has a lot of experience in dealing with those bank resolutions,
but certainly I think under the Dodd-Frank Title II provision,
we want to make sure that the Bankruptcy Code can be effective
up to the largest possible size. I don't think, frankly, banks
have been moving their derivatives portfolios into the bank to
increase their magic complexity, but there is funding because
you have a deposit base that is insured. That is why people
like to have that solidity of the deposit base. You can debate
whether that is the appropriate step or not, but that is the
reason, not--
Mr. Rosner. I think there are multiple reasons. I don't
think they are mutually exclusive.
Chairman McHenry. The gentleman's time has expired. I will
now recognize Mr. Barr of Kentucky for 5 minutes.
Mr. Barr. Thank you, Mr. Chairman, and thanks to the
witnesses for your testimony this morning. Professor Skeel, I
was particularly impressed with the arguments that you made
that OLA does, in fact, afford a competitive advantage to
failed financial firms that access the Title II provisions. I
would like all of the witnesses to maybe comment and amplify on
those thoughts, and in particular, how the tax exemption, the
funding advantage, the capital advantage, for a bridge company,
how would that contribute to the perception or reality of an
implicit government guarantee contribute to moral hazard, and
in your comments in answering that question, I would like for
you to address the arguments made by those who defend Title II,
that Title II doesn't somehow enshrine too-big-to-fail because
it imposes losses on shareholders, because it imposes losses to
creditors, because management has changed; in other words, that
Title II does impose consequences on failed institutions.
Mr. Skeel. Okay, a couple of quick comments on that. I do
think that the bridge institution would be a specially
protected non-market driven institution. It has all of these
benefits we have been talking about, the tax benefits. It is
also the case that the FDIC would not let it back out into the
world until it was healthy and there was no way it was going to
fail. So I think there is this limbo state in which it would
have enormous advantages.
With respect to the claim that taxpayers will never pay
anything, I don't think that is accurate for two reasons. One
is, we have talked about a number of ways in which taxpayers
will pay, even though in theory they are not paying. Taxpayers
are paying if the interest rate on loans that the bridge
institution has is a below-market interest rate. Taxpayers are
paying because of the tax exemption that the bridge institution
has. So there is that set of issues. The other set of issues is
that even if some of the costs of resolution were ultimately
recovered from the industry down the road after 5 years or
whatever, that is a tax of sorts, as John Taylor has said.
Effectively what we are doing is taxing a particular industry
to support the resolution of the failed institution.
Mr. Taylor. I would just agree with that, but it is a
different--under a bankruptcy, the shareholders get wiped out,
so there is not an issue there. The issue is about other
creditors. And in Title II, it is hard to see how it wouldn't
happen. You would be giving special favors to certain creditors
and charging the assessment fund for that, if not the Treasury
directly, or also just charging other creditors for that, and
that has all of the elements of a bailout, all of the dangers
that we are worried about of a bailout, too much risk-taking,
the moral hazard, the uncertainty, the lack of rule of law, and
those are the concerns. That is why we keep coming back to some
notion of a Bankruptcy Code trying to do this, but also, it is
fair. It deals with Wal-Mart, and other firms as well.
Mr. Barr. I am mindful of my time, so if I could just move
on to a second question. Many of you testified that an enhanced
bankruptcy procedure perhaps amending Chapter 14 is preferable
to a Title II OLA. What about the criticism of those who say
that a bankruptcy process is too slow, particularly in a 2008
financial meltdown scenario? What is the response to those
criticisms, and also speak to access to debtor and possession
financing in a liquidity crisis?
Mr. Skeel. Just a couple of things very quickly on that.
Bankruptcy can be used very, very quickly. One of the
interesting things that a group of us are working on now is the
idea of using bankruptcy to do a resolution somewhat similar to
the one that the FDIC has in mind, where you sell the assets of
the holding company immediately, and then you have a new
institution that is subject to market forces out there. So it
seems to me the idea that bankruptcy can't be used quickly is a
misperception, and that you can do all of the things we have
been talking about with Title II with a couple of tweaks to the
Bankruptcy Code in bankruptcy, and if you did it in bankruptcy,
you would have a new institution that would be fully subject to
market pressures.
Chairman McHenry. I thank the gentleman.
Professor Skeel, as previously announced, your departure
time has arrived, and we thank you for your testimony, and you
are dismissed. We will continue with the remainder of the
panel.
We will now recognize the ranking member, Mr. Green, for 5
minutes.
Mr. Green. Thank you, Mr. Chairman. We have now concluded
that Dodd-Frank is not perfect. The current Bankruptcy Code is
not perfect. But we can, it seems, make the Bankruptcy Code
perfect, whereas we cannot make Dodd-Frank perfect.
So let me start by asking who among you would eliminate
Dodd-Frank completely? If you would do so, would you kindly
raise your hand? This way, I will be able to move quickly. Who
would eliminate Dodd-Frank completely? Mr. Taylor, would you
eliminate it completely?
Mr. Taylor, I hate to do this because time of the essence.
Mr. Taylor. There are some things in there I would not
eliminate.
Mr. Green. Okay, so you would keep some portions of Dodd-
Frank.
Mr. Rosner?
Mr. Rosner. I would keep some portions of Dodd-Frank.
Mr. Krimminger. I would keep some portions of it. We
clearly need an alternative. Just very quickly, I know you have
very little time, is that mainly the tweaks we need to do with
the Bankruptcy Code, they are in all of the recommendations,
actually make it more like Dodd-Frank in many ways to
accomplish some of the goals. Bankruptcy needs cash because in
a huge crisis, debtor-in-possession financing is not always
available.
Mr. Green. You are going to segue into my next question, so
let me just toss it to you. Dodd-Frank mimics the Bankruptcy
Code as much as possible, but it has some additional things
that the Bankruptcy Code doesn't have. Can you take just a
quick moment and give us some thoughts on those different
things, please?
Mr. Krimminger. A couple of things. First of all, it does
have liquidation funds we have talked about a lot. The
Bankruptcy Code would need cash in order to be able to do a
resolution. If you are trying to deal with systemic risk, you
need to have some ability to deal with systemic risk and to say
you want to eliminate any ability to make sure you can maintain
operations which does involve preferencing some creditors, I
think is not consistent with trying to deal with systemic risk.
The Bankruptcy Code, itself, has some mechanisms to continue
those things. They might need to be expanded. The ex ante, or
the before decisions are made, a decision by a judge on each of
the questions, is something that Dodd-Frank puts after the fact
for lawsuits to challenge what the receiver has done, and the
receiver would need to be able to act quickly. That is one of
the things that Title II does, and it also provides for
borrowing authority to transfer things to that bridge financial
company.
Mr. Green. Thank you. I asked the question about Dodd-
Frank, and mending it, because there are some people who want
to end it. And there are some people who want to use your
testimony to end Dodd-Frank and bring in a regime under
bankruptcy.
Let's point to something else. There was talk about the
industry being taxed after the fact once the liquidation has
taken place. That taxing, as you have called it, isn't that
similar to the premium paid by banks with the FDIC? Mr.
Krimminger?
Mr. Krimminger. It is. The difference, of course, is that
the Deposit Insurance Fund is funded up front by risk-based
premiums.
Mr. Green. Right.
Mr. Krimminger. The Orderly Liquidation Fund is repaid. If
all the cash that is paid, that is received through the bridge
company could not be paid to Treasury, which I think is very
unlikely, you would have to almost have the value of that
company being zeroed out because Treasury takes off the top.
The cash is risk-based, and it is paid ex ante, very much like
the Deposit Insurance Fund.
Mr. Green. So it is similar, just that one is paid up
front, and the other is paid after the fact, correct?
Mr. Krimminger. That is correct, and the important
difference, to respond to one of the questions earlier, this is
only paid by those institutions that are over that $50 billion
threshold or have been designated as 50 that is not paid by the
thrift and savings and loans that are smaller.
Mr. Green. Mr. Krimminger, in your paper--by the way, I
thought it was excellent, and I plan to post it on my Web
site--you indicate that there is an additional thing that Dodd-
Frank does that bankruptcy doesn't do. Bankruptcy deals with
creditor claims, whereas Dodd-Frank also deals with protection
of the public, and it looks at the impact on the economy. Can
you please give me your thoughts on this, because it is
important for us to note that in 2008, the crisis was so large
that banks were not lending to each other, that a prepackaged
bankruptcy was not possible because you didn't have the
liquidity to take into that process. So with that in mind,
would you kindly explain how this notion in Dodd-Frank of
protecting the public becomes exceedingly important?
Mr. Krimminger. The reason that Title II was created in the
first place was because of making sure that in that rare
extraordinary circumstance where you had a systemic crisis, you
had an additional option that could impose losses upon the
shareholders and the creditors as much as possible while making
sure you could continue this operation of the institution that
would deal with systemic risk. That is why you needed funding
and that is why inevitably, just as you do in bank failures
because of maximizing value, you do have some creditors who get
more than others. To say that all creditors should get only the
amount provided for under the priority system, in some ways is
not even true under bankruptcy at times because you need to
continue operations.
Mr. Green. One final quick question. How many of you would
make the big banks smaller? There has been talk about doing it.
Let's see now if you would do it. Would you raise, would you
make the big banks, would you downsize them, break them up? If
so, kindly raise your hand. Okay, we have one person, Mr.
Rosner would. Mr. Taylor?
Mr. Taylor. You asked, would I like to get rid of this too-
big-to-fail? I would like to deal with it that way.
Mr. Green. I understand, but the question I am asking is,
would you break up the big banks?
Mr. Taylor. It would have those effects. That would have
those incentives. When you ask the question that way, you
missed, I think, the point that we have a problem that is--
Mr. Green. I understand the point, but when you make
statements about breaking up the banks, I would like to know if
this is what you would do.
Mr. Rosner. When I say break up the banks--
Mr. Green. My time has expired, and I have gone over. So I
have to yield back, Mr. Chairman.
Mr. Rosner. Can I just respond?
Chairman McHenry. The gentleman is trying to answer the
question.
Mr. Rosner. So to clarify, if the Fed took seriously its
obligations under Title I, which would be to use the living
will process to figure out how institutions can fit through the
Bankruptcy Code, Title II becomes unnecessary. Would I use that
process to achieve those ends? Yes. Is that forcibly breaking
them up? No. It is creating incentives to make sure that they
are manageable through the bankruptcy process.
Mr. Green. And in effect, what you are doing, what you are
acknowledging, is that Dodd-Frank provides a means by which
this may be done.
Mr. Rosner. No, what I am acknowledging is that there is a
tool that creates a living will, which is a blueprint for how
things could work, not how they will work.
Mr. Green. I didn't say how they will, but I do contend and
I believe you agree that Dodd-Frank provides the means by which
it may be done.
Chairman McHenry. I appreciate the dialogue and debate. We
will now recognize Mr. Duffy for 5 minutes.
Mr. Duffy. Thank you, Mr. Chairman. Mr. Taylor, I don't
know if you wanted to further answer that question that was
asked about your thoughts on breaking up big banks.
Mr. Taylor. I think I would like to. A lot of the concerns
about too-big-to-fail and the anticipation of bailouts is that
it does give advantages to certain institutions. And so that
could make that larger. There is also the question about what
capital should be. There is a real concern about capital, in my
view, and so that would also have an impact on the size of the
institutions. I think that is what you want to do. You want to
level the playing field.
And also with respect to repealing or eliminating Dodd-
Frank, the question really--there is the Office of Thrift
Supervision which is eliminated, you have the central
clearinghouses. So those are good reforms, but Title II itself,
it seems to me, has real problems. And if you could replace it
with modification of the Bankruptcy Code, I think that would be
far preferable. If for political reasons, you have to keep it,
and put in the Bankruptcy Code reforms, then I would be all for
that. But Title II itself is problematic.
Mr. Duffy. I think we have engaged in a really nice
conversation today to try to find some solutions on how we can
move forward to truly end too-big-to-fail, and I think you see
a bipartisan approach to that effort. And I think we can all
work together to improve the current legislation, and I think
there is a willingness today, more so than there has been in
the past, to try to find a system that is workable, and
breathes certainty into the marketplace. But one of my concerns
in regard to too-big-to-fail and SIFI is looking at Title I,
and Title II, is the implicit Federal backstop for the
operating subsidiaries. And my concern is that if you have this
Federal backstop and you are designated an SIFI, what does that
do to the borrowing costs of those various institutions? Does
it create an actual benefit before they are thrown into Title
II? If they are just operating as an SIFI, doesn't that
automatically give them a borrowing advantage?
Mr. Taylor. Data certainly suggest that large institutions
get this advantage and that it has increased since the
financial crisis. So that is what the data show, and then when
you go through and look at the details, you could see why that
might be the case.
Mr. Krimminger. If I could just say, I think that, clearly,
it has been a long-term issue about too-big-to-fail and the
uplift, if you would, provided for the largest institutions. I
think in some ways it would be difficult to, but we need to
separate out the uplift that might have increased the Federal
filing requirements because we took what was an expectation of
too-big-to-fail and made it reality. So the markets
incorporated that concept as well.
As far as the operating subsidiaries, certainly it is
important to make sure that Title II, whether it is used at the
single point of entry at the holding company, or at different
levels, is kept in mind. I try to remind people--and I reminded
people when I was at the FDIC as well--that single point of
entry could not be the way it would work out because you might
have multiple entities within that holding company that simply
can't go on. Multiple point of entry so that you close the
subsidiaries has to be looked at as being a viable option as
well so that you reduce that filling of the subsidy for the
subsidiaries.
Mr. Duffy. But wasn't it in your testimony that you
admitted that there is a subsidy there to the operating
subsidiaries?
Mr. Krimminger. In the case of a subsidiary that doesn't
fail, you don't close a company just because they happen to be
a subsidiary of a failed company. If the subsidiary is
operating in the best value for that subsidiary, and it is
making money, to continue for it to make money, then that would
be the rational thing to do in any type of insolvency process.
Mr. Duffy. But if you are a creditor to that subsidiary,
you are not going to be allowed to have that debt not met,
right? The holding company is going to go to Treasury. They are
going to access dollars from Treasury, and they are going to be
able to meet--go find the creditor, and I am going to lend to a
subsidiary. I have a Federal backstop. So I am going to be able
to, if I am one of those subsidiaries, I don't have a benefit
in borrowing.
Mr. Krimminger. If that subsidiary is insolvent, it should
be closed. That is why I am talking about the multiple--
Mr. Duffy. What happens to the creditor if it is insolvent?
Mr. Krimminger. If it is closed, then it goes through an
insolvency process, and it would either go in through an
insolvency process in bankruptcy, or it would go through an
insolvency process under Title II, and the creditors--
Mr. Duffy. I am saying if we are in Title II.
Mr. Krimminger. Okay, but the holding company could be in a
Title II resolution, a single point of entry, but there also
could be a failure of a subsidiary. So that subsidiary under
the statute could go right into bankruptcy or under Title II if
it were systemic itself, and if it is systemic and it goes
under Title II, the creditor is still going to take losses
because you don't have the kind of single point of entry
approach at that level of the entity.
Mr. Duffy. Do you agree with that, Dr. Taylor?
Mr. Taylor. This is the question about whether there is the
Federal backstop and how that is affecting rates?
Mr. Duffy. Right. Yes.
Mr. Taylor. I will stand with what I said before. It is
there and it is affecting rates and it has increased since
Dodd-Frank was passed.
Mr. Duffy. Mr. Rosner?
Mr. Rosner. I agree. And again, it creates an incentive for
creditors to choose to invest in the OPCO rather than the
HOLDCO, further distorting the ability of the HOLDCO to be a
source of strength to its operating subsidiaries.
Mr. Duffy. I yield back.
Chairman McHenry. All right. The first round of questioning
is now done.
I expressed at the beginning of the hearing that our
intention was to adjourn by noon, but we have additional
Members with a few extra questions, so I ask unanimous consent
that we have 7 additional minutes per side, with 5 minutes
going to Mr. Barr, and 2 minutes to me on our side. I will now
recognize the ranking member for 7 minutes.
Mr. Green. Thank you, Mr. Chairman. And if there are other
Members who would like to speak, if you will kindly let someone
know, I will adjust my time.
Let's come back to Dodd-Frank versus bankruptcy, because
this is what this has become about today. Let's ask this
question. What is it that you find that you can do with
bankruptcy that you cannot do with Dodd-Frank?
Mr. Taylor. The advantage of bankruptcy is it is part of
our system for creditors. It has been around as part of the
rule of law. It can work for all kinds of--
Mr. Green. I understand.
Mr. Taylor. And that is what you want to--
Mr. Green. Time is of the essence, and we have to move on.
Mr. Taylor. --make it available--
Mr. Green. Can you give me something that you can do under
bankruptcy that you can't do under Dodd-Frank?
Mr. Taylor. Yes. That is the main thing. You have the rule
of law applies and Dodd-Frank you don't.
Mr. Green. Dodd-Frank is not the rule of law?
Mr. Taylor. Dodd-Frank has tremendous discretion authority
given to--
Mr. Green. I understand.
Mr. Taylor. --to the FDIC.
Mr. Green. But that is under the rule of law.
Mr. Taylor. And how they treat creditors--
Mr. Green. Let me go on to Mr. Krimminger.
Mr. Krimminger, can you tell me something about Dodd-Frank
that allows it to do what we generally speak and want to do
with bankruptcy, please?
Mr. Krimminger. Essentially what Dodd-Frank does, as I
said, it is really supposed to be an alternative, and I worked
a long time, I worked with a number of people when I was at the
FDIC, to try to make sure that Title II would not be viewed as
being substantially or substantively different in the way it
would treat creditors. Yes, there was more discretion, but the
discretion is inherent to the ability to address a systemic
risk.
I think if we go and say we have to eliminate the
discretion, you are eliminating the ability to deal with a
systemic risk in a crisis. So, clearly, Title II will allow you
to do that. It is also simply not true to say that Title II
does not or ignores the rule of law. Title II just has the rule
of law after the decision is made initially and you can file
suit for damages.
Under U.S. law, it has always been viewed as being an
appropriate remedy to be able to file a suit for damages rather
than having a judge make every decision in advance. That is the
bankruptcy way, and bankruptcy should apply wherever possible.
Mr. Green. Let's talk for just a moment about bridge
institutions. There seems to be this notion that a bridge
institution is somehow going to come into existence, reap a lot
of benefits, and a lot of money is going to be made. What is
the purpose of the bridge institution, and talk about its
longevity, please, Mr. Krimminger?
Mr. Krimminger. The bridge institution is designed to be a
very short-term entity. I think that much of the discussion
today about the length of a bridge company being up to 5 years,
that is also true under the Federal Deposit Insurance (FDI)
Act, and the average length of time for a bridge institution
under the FDI Act has been less than 6 months.
Now, it might be longer under a Title II situation, but
remember, under the single point of entry approach the FDIC is
talking about, you would be taking over the holding company,
which is a very simple organization. There, the way they plan
to do that would be to do a--that debt for equity swap, if you
will, a creditor claim for equity swap for the debt within 6 to
9 months, because I will assure you, the FDIC does not want to
run a mega institution for any extended period of time.
Mr. Green. Mr. Krimminger, in your paper you also talk
about time being the enemy in a time of crisis. In 2008, it was
a time of crisis and time was the enemy. Would you please
elaborate on time being the enemy and juxtapose this to
bankruptcy as an option?
Mr. Krimminger. I think time is an enemy because you need
to act very quickly. In 2008, on the weekends when things
needed to be done, and it seemed to happen on far too frequent
a basis, you had to make the decisions and come to a conclusion
about how to deal with an institution by the Sunday night
before the business opened in Asia, because once the market was
open, it would be too late, and the illiquid institution would
fall.
If you look at the Lehman bankruptcy, and again, I would
like to see bankruptcy improve where it could deal with the
situation much better, but if you look at the Lehman bankruptcy
itself, it effectively allowed for a transfer of the broker-
dealer, in that case by keeping the broker-dealer open with
large funding from the Federal Reserve Bank of New York. We
want to get to a situation where an institution can be closed,
it can be resolved while losses are imposed rather than having
funding for an extended period of time so that some creditors
get out and complete their transactions.
I think the Lehman bankruptcy illustrated some of the
issues of bankruptcy and illustrated some of the ways forward
in how we can make improvements.
Mr. Green. We understand that banks don't go through
bankruptcy, generally speaking. They go through a process with
the FDIC. Is what we are attempting to do with Dodd-Frank,
which by the way is in its infancy, it is still being
developed, rules are still being promulgated. Is what we are
trying to do with Dodd-Frank similar to what is being done with
the FDIC and banks, generally speaking?
Mr. Krimminger. It is based upon essentially the similar
powers of the FDIC. I think, as I was saying here in my
testimony earlier, that it has been internationally recognized
that you need to have certain powers in extremis, if you will,
to be able to take those actions, so it is really based upon
the same models of authority to take action and then have a
determination.
Mr. Green. Now, there were some points that you wanted to
make earlier, and I remember you didn't get an opportunity to.
If you made note of them, I would like for you to use some of
this time to make those points.
Mr. Krimminger. I would just note, as I was trying to make
a lot--I just note in response to some of the questions earlier
that clearly some of the improvements we are trying to make in
the Bankruptcy Code, in order for the ability to act more
quickly, the first day order issue, the ability to find an
identifiable area of cash or debtor possession financing and
others, the ability to deal with systemic risk; in fact, the
creation through potentially a Section 343 sale under the
Bankruptcy Code of a sale to an entity that would be similar to
a bridge company is very much modeled upon what we are talking
about in Title II.
So I think we just have to keep in mind that the changes we
want to make should be appropriate for the types of entities we
are talking about, and I don't think we want to have all those
changes in the normal bankruptcy process anyway, so we need to
make sure that the changes in the Bankruptcy Code make it more
effective, but do not dramatically change the normal bankruptcy
process.
Mr. Green. Is it possible for bankruptcy itself to have an
adverse impact upon the economy in a time of crisis? For
example, if AIG had gone through bankruptcy in a time of
crisis, how would that have impacted the economy?
Mr. Krimminger. I don't want to really speak to AIG
particularly, being as it is an open company at this point, but
certainly I think that if you had the rapid deleveraging of a
company that is involved very much in the derivatives markets,
that could be very destabilizing in the marketplace. And one of
the great things about the ability to terminate net contracts
in bankruptcy or under the FDI Act after a one-day stay is that
it allows people to have liquidity in their market contracts.
One of the bad things is that if you have that ability to
immediately terminate those contracts and dump them on an
already illiquid market, you run the risk of having much more
illiquidity in the market and it freezes up the markets.
Mr. Green. Thank you. My time has expired.
Thank you, Mr. Chairman.
Chairman McHenry. With that, we will now recognize Mr. Barr
for 7 minutes, with my colleague understanding that I would
certainly appreciate a few minutes at the end. Two minutes at
the end would be great.
Mr. Barr. Absolutely, Mr. Chairman. Thank you.
Chairman McHenry. Thank you.
Mr. Barr. I would be interested in Dr. Taylor's and Mr.
Rosner's responses to the comments, the testimony that Mr.
Krimminger just made with respect to the perceived or real
deficiencies of bankruptcy, and please speak to the liquidity
issue and the timing questions?
Mr. Taylor. I will just make a couple of points. There is
no reason, and I document it in my written testimony, that you
couldn't be just as quick with a bankruptcy as what is being
contemplated with the FDIC's new single point of entry. In
fact, I describe how that could work with an example. It could
be done over the weekend, if you like. The process could be
very quickly.
We also have ways that we can have experts more involved
with the bankruptcy judges than they are now. There is a wide
range of things in terms of the reform side that could make
this very smooth.
And I would say even now when we think about what the FDIC
might do, we don't know. They are talking about issuing a
paper. They are talking about issuing some procedures. That is
very important to do, but that will still just be their
procedures. That is not part of the rule of law. That could be
changed on a dime. So it is quite different. All that
discretion is still there.
So I think those two things are the most important, I would
say, in response to what Dr. Krimminger said.
Mr. Barr. Mr. Rosner?
Mr. Rosner. I would agree. I would add, which is also in
response to Mr. Green's question, the same thing. The question
is almost more importantly asked, what does the Bankruptcy Code
offer that Dodd-Frank doesn't, and to that end, the answer is
clarity, certainty, due process. Those are the key features
that you want codified in law and in judicial process and
review rather than leaving it in the arbitrary hands of even
the most well-intentioned and well-meaning regulators.
Mr. Barr. A question for all of the witnesses generally on
the issue of too-big-to-fail systemic risk, I have heard the
argument made that size or largeness is not in and of itself
systemic risk, that the real question, the real problem is
overleverage, the real problem is liquidity risk, that is the
more fundamental problem in a crisis situation. And in fact, I
have also heard the argument--and I think there is a persuasive
element to it--that large institutions that are highly
diversified have the capacity, unlike non-diversified smaller
institutions, to absorb losses. As we kind of grapple with
policymakers with the issue of too-big-to-fail, could you all
kind of comment on that, and as we approach the problem, how
should we take that into account when we hear proposals to
break up banks?
Mr. Rosner. Look, I am sympathetic to the view that if we
are sitting here having discussions over a Title II authority
as treating institutions differently because they pose systemic
risk, we do have to stop, step back, and ask why we have all
chosen to live with a gun at our head rather than figure out
how to manage that so it doesn't pose a threat, and I think
that is really the starting point. And I think leverage is a
key issue there. I think capital is a key issue there. I think
clarity of structure, the ability to put through bankruptcy and
an international structure that would allow for management of
those operating subs in insolvency or some sort of a ring
fencing of those makes sense. I would start there rather than
by codifying too-big-to-fail through Title II.
Mr. Barr. I want to yield time back to my chairman, but if
Mr. Krimminger would like to follow up on that, and then I will
yield back to the chairman.
Mr. Krimminger. Just briefly, I think that the
diversification of assets and operations can certainly do a
lot. I think fundamentally, if you are looking to make sure an
institution of whatever size doesn't fail, it is a question of
risk management. I think the largest institutions as well as
the smaller institutions today have made a lot of strides in
the last few years in actually looking at ways to better manage
their risk, and I think the living will process has actually
paid some dividends because there has been some significant
changes in the way the operation has been done in reaction to
those efforts.
Mr. Rosner. Non-public, non-transparent, and frankly not
visible to the market outcome supposedly of Title I.
Chairman McHenry. Will my colleague yield?
Mr. Barr. I will. Thank you, Mr. Chairman.
Chairman McHenry. Thank you, Mr. Barr.
My question, Mr. Krimminger is, within the Act, within the
Dodd-Frank Act, Title II authority, liquidation authority as we
are discussing today, does the FDIC have discretion about the
order of creditors?
Mr. Krimminger. The FDIC has authority under the Act
subject to its own regulations to provide additional funding or
additional payments to some creditors if they are essential to
the operation of the receivership of the bridge.
Chairman McHenry. Okay. But there is discretion for the
FDIC in that process?
Mr. Krimminger. There is a statutory requirement, and the
FDIC put in place a regulation that said that their board of
directors had to approve any particular payments to a
particular creditor, but again, that is to deal with systemic
risk.
Chairman McHenry. How many members are on the FDIC board?
Mr. Krimminger. Five.
Chairman McHenry. And how many votes does it take in order
to make that determination?
Mr. Krimminger. It requires, under that regulation, a
supermajority, so I think it would end up being four.
Chairman McHenry. Four. So four individuals are given
discretion, just like in the crisis, they took the discretion
to reach out and insure a set of assets that they had never
previously, in the FDIC's history, insured.
Mr. Rosner, to this point, this question of discretion,
does that increase uncertainty or decrease uncertainty?
Mr. Rosner. In absolute terms and relative terms, it
increases uncertainty. It will have impact not only as an
institution approaches failure, but definitionally has impact
as we see in the cost of funds advantage long before we get
there.
Chairman McHenry. Dr. Taylor, you talk about discretion
with monetary policy and the challenges there. So, if you are
an unsecured creditor, unsecured debt within an institution,
does this process give you greater certainty than where you
would be in a bankruptcy process?
Mr. Taylor. The bankruptcy will be much clearer. Here, the
discretion creates uncertainty. There is no question about it.
Again, we don't know, even now, what the FDIC's policy is.
A paper may help, but it will still have the discretion to
change it when they want to.
Chairman McHenry. Okay.
Mr. Taylor. I think it is tremendous uncertainty, which is
one of my biggest concerns about that whole too-big-to-fail
process.
Chairman McHenry. Thank you, and thank you for your
testimony. I appreciate your answers to the variety of
questions posed today. We have a few takeaways accordingly:
that the Orderly Liquidation Authority leads to greater
uncertainty; that greater uncertainty is not helpful to the
marketplace, not helpful to our nature of the rule of law and a
regulatory policy that is clear to the marketplace.
Likewise, the functioning of this would--if an institution
went into an orderly liquidation, it could result in an
enormous bank tax, which would be put on other institutions,
surviving institutions, and thereby their consumers. And
finally, the overall question about taxpayers being on the
hook. I think that is pretty well resolved now that we better
understand what the Orderly Liquidation Authority actually
means.
Thank you so much for your testimony, and thank you for
being so forthcoming.
The Chair notes that some Members may have additional
questions for this panel, which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 5 legislative days for Members to submit written questions
to these witnesses and to place their responses in the record.
Also, without objection, Members will have 5 legislative days
to submit extraneous materials to the Chair for inclusion in
the record.
This hearing is now adjourned.
[Whereupon, at 12:15 p.m., the hearing was adjourned.]
A P P E N D I X
May 15, 2013
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