Rules for Bailouts

The Dodd-Frank law long ago disappeared down the rabbit hole of the rule-making process — and there’s a lot of interesting stuff going on down there. 

As the lawyers at DavisPolk point out in their Dodd-Frank progress report for the month of May, Dodd-Frank required regulators to write 398 rules. So far, regulators have missed 148 of the 221 rule-writing deadlines — two-thirds — that have already passed.

You shouldn’t blame the regulators. Mr. Dodd and Mr. Frank sponsored a bad law. Appointees and civil servants face an impossible task. To see how regulators are stuck with a knot impervious to untangling, look to just one rule just now completed. 

Remember, Dodd-Frank was supposed to end bailouts. In signing the bill nearly two years ago, President Obama said that the law would ensure “[t]here will be no more tax-funded bailouts — period.” The president’s signature has now required the FDIC and the Treasury Department to formulate a rule governing . . . future bailouts.

Last week, the FDIC and Treasury announced their final rule to carry out their duties under Dodd-Frank’s “orderly-liquidation authority.” This orderly-liquidation authority, regulators explained, “is intended as a limited exception to bankruptcy.”

#more#Under this liquidation mechanism, the FDIC has “broad authority” to use money borrowed from the Treasury to take over and run an otherwise-failed financial institution, not necessarily a bank. As the FDIC and Treasury note, this job could include

continu[ing] key operations, services, and transactions that will maximize the value of the firm’s assets and avoid a disorderly collapse in the marketplace.

The FDIC and Treasury have now determined just how much of a burden — “maximum obligation limitation” — it can take on with borrowed taxpayer money.

Answer: in the long term, for each bailout, not more than “90 percent of the fair value of the total consolidated assets of each covered financial company.”

This rule-making confirms a Dodd-Frank problem: The government can still take over a financial firm and use vast amounts of taxpayer money to take on that firm’s obligations to bondholders, derivatives-trading counterparties, and other creditors — obligations that otherwise would pass through the bankruptcy process.

And “maximizing the value of the firm’s assets” will just be an excuse for the government to run the firm as long as possible. That’s what has happened in Britain, with the Cameron government afraid to sell off Royal Bank of Scotland and Lloyds and realize a loss for the taxpayers. It’s not the government’s job to maximize value for private creditors. Investors should consider the risk of value-loss stemming from bad financial management — including reliance on short-term debt — before investing in a firm. 

Dodd-Frank’s supporters (are there any now?) would say that orderly-liquidation authority does not constitute a blueprint for bailout, for two reasons.

One reason is that the purpose of orderly-liquidation authority is to “liquidate” the firm. The firm would not survive after eventual “liquidation.” No firm, no bailout. This excuse ignores that fact that creditors don’t care if a firm is liquidated if they’ve been paid off. Orderly-liquidation authority gives creditors, particularly senior creditors, no incentive to scrutinize a firm’s operations before it goes under. 

The second reason supporters would proffer is that the FDIC and the Treasury are supposed to get back any money they spend by levying an assessment on other financial firms, so orderly-liquidation authority doesn’t constitute a bailout..

But if I’m a shareholder of a large financial firm that doesn’t fail, why should I lose a bit of my profit bailing out a firm that should have failed? A bailout socialized by the government through the private sector is still a bailout.

— Nicole Gelinas (@nicolegelinas on Twitter) is contributing editor to the Manhattan Institute’s City Journal.

Most Popular

Elections

Romney Is a Misfit for America

Mitt’s back. The former governor of Massachusetts and occasional native son of Michigan has a new persona: Mr. Utah. He’s going to bring Utah conservatism to the whole Republican party and to the country at large. Wholesome, efficient, industrious, faithful. “Utah has a lot to teach the politicians in ... Read More
Law & the Courts

What the Second Amendment Means Today

The horrifying school massacre in Parkland, Fla., has prompted another national debate about guns. Unfortunately, it seems that these conversations are never terribly constructive — they are too often dominated by screeching extremists on both sides of the aisle and armchair pundits who offer sweeping opinions ... Read More
U.S.

Fire the FBI Chief

American government is supposed to look and sound like George Washington. What it actually looks and sounds like is Henry Hill from Goodfellas: bad suit, hand out, intoning the eternal mantra: “F*** you, pay me.” American government mostly works by interposition, standing between us, the free people at ... Read More
Film & TV

Black Panther’s Circle of Hype

The Marvel Cinematic Universe (MCU) first infantilizes its audience, then banalizes it, and, finally, controls it through marketing. This commercial strategy, geared toward adolescents of all ages, resembles the Democratic party’s political manipulation of black Americans, targeting that audience through its ... Read More