As readers may know, we’ve been engaged in a long-running argument with a persistent Administration defender on the subject of Dodd Frank resolution, which is the one of the big arguments used for not doing much to make the TBTF banks less TBTF (see here for the latest in the series). The argument goes that since they will be allowed to fail, and they can be resolved non-catastrophically, the problem is solved. We’ve gone through the FDIC’s example of how they say they could have used the new powers under Article II of Dodd Frank and pointed out numerous (ahem) unrealistic assumptions, as as well as made more general arguments against its viability with anything other than a purely domestic institution. It’s also worth noting that a number of domestic banking and bankruptcy experts, as well as the BIS Cross-border Bank Resolution Group and the Institute for International Finance have also expressed serious doubts about the viability of Article II resolutions.
The latest critique comes from former Treasury official Jim Millstein who was the chief restructuring officer and headed the AIG rescue. His comment in the Financial Times echoes a concern voiced by some critics, including yours truly, that the Article II procedures not only make unduly optimistic assumptions about the ease and timetable for finding buyers of capital market businesses, but are also likely to accelerate a run. The key section:
Most important there must be agreement on the plan among all global regulators, so that, at the moment of truth, suitable buyers are lined up to purchase financial assets at values that will not lead to new market shock. Strategic buyers must also be found who have the financial wherewithal and regulatory backing to buy the large regulated businesses that exist within a global financial superstore such as AIG, in each case, so that franchise values inherent in its multinational operations can be realised for the benefit of its creditors. Finally, a plan for the disposition of its derivatives books must be in hand to avoid market instability from a disorderly mass contract termination.
If these conditions are missing, the orderly proceeding Dodd Frank imagines will be anything but. And if the disposition of the global superstores’ operating units cannot be done swiftly, customers, depositors, universal life and annuity holders will rapidly flee an entity operated by the Federal Deposit Insurance Corporation in a mandatory liquidation proceeding: no sensible person will buy life assurance from a company whose parent company is in liquidation.
We are left with a dilemma. The financial stabilisation policies used over the past three years have worked, but Dodd Frank has stripped away the powers that made them a success. The orderly liquidation process is, paradoxically, now the only forum in which the government can provide company funding to mitigate contagion. At the same time, as a result of the marriages of nearly failed institutions (like Bear Stearns) with the then-less fragile (like JPMorgan) the industry is more concentrated, with fewer of the same highly interconnected organisations.
Millstein concludes with the argument made by the loyal opposition: that pretending this dubious construct is likely to work is sticking one’s head in the sand and increases the odds of catastrophic outcomes the next time a big US financial firm gets in serious trouble. It’s time to own up that Dodd Frank got this one wrong and work on better remedies.