Josh Rosner on How Dodd Frank Institutionalizes Too Big to Fail

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Josh Rosner of Graham Fisher testifies before a subcommittee of the House Financial Services committee today on why Dodd Frank has not ended too big to fail, but also has managed to entrench the megafirms’ advantaged position.

Rosner provided Congressional testimony on this same topic in 2011, and deemed Dodd Frank’s plans for winding down systemically important firms to be unworkable. Rosner has good company here; the BIS and the international bank lobbying group the IIF reached the same conclusion.

Rosner stresses that he’s not advocating the repeal of Dodd Frank but describing what is flawed so it can be remedied or replaced, and that he sees the sort of fixes embodied in the bills approved in the House to weaken derivatives regulations as a step in the wrong direction.

Rosner focuses on Articles I and II of Dodd Frank and describes how their plans to deal with resolving large firms has only made matters worse. It’s key to understand that these two sections are somewhat at odds with each other. Dodd Frank peculiarly provides for two ways to wind up systemically important firms. Title I says they should prepare for bankruptcy. They need to clean up how they are organized and make sure activities fit or can be mapped into legal entities and prepare living wills, which are plans for how they would wind themselves up. But confusingly, banks can also be “resolved” which is more like “rescued with a little pain inflicted on investors” under Title II. Title II provides for a second way to deal with stressed financial firms, which includes having the government provide what amounts to debtor-in-possession financing while the bank is restructured. This, sports fans, is what is otherwise known as a bailout.

In his previous testimony, Rosner criticized how having two ways to resolve a firm would create uncertainty in times of stress:

It is especially problematic that Dodd-Frank allows for ambiguity when defining institutional failure. The manner in which one is allowed to fail determines and defines its “going concern” value when alive. Every firm must be able to fail under the same regime—a different resolution regime for a select group of firms will create incentives for creditors of those firms to treat them differently in life than the “less important” firms. It was this ambiguity that created the incentives for Lehman to make itself less able to fail and thus less easily resolved.

Put it another way: you wouldn’t need Title II resolutions, described in the bill as the Orderly Liquidation Authority, if the authorities believed they could put them down using the bankruptcy code.

And, not surprisingly, the banks haven’t been fully cooperative in drawing up those living wills. And why should they? Follow the incentives. In a bankruptcy, top management is out and a trustee is in charge. By contrast, in a Title II resolution, the odds are good they’d survive. As Rosner writes:

While a true liquidation would result in the replacement of management, in the FDIC’s proposed regime, key management of failed operating subsidiaries would be able to continue to manage the newly recapitalized firm. Although the FDIC claims they would replace personnel there is no requirement to do so. Their decisions will be arbitrary and driven by both the perceptions of regulators and market realities. The risk remains that, even in instances in which it is clear that management should be replaced there may be a lack of a deep bench of available industry management. This was the reality during the past crisis. Artificial enrichment of personnel responsible for corporate failure is only one of the major problems with Title II.

So not surprisingly, the latest reports, filed a month ago, showed that the banks were going through the form of preparing living wills and far from having viable plans. From the Wall Street Journal:

U.S. regulators are demanding extensive new information from banks detailing how the government could dismantle their operations in the event of a crisis, saying information provided so far presents “obstacles” to an orderly resolution….

Banks are being asked to provide specific discussions of each of the five “obstacles” identified by regulators in the living wills, as well as a discussion of what steps they plan to take to mitigate the problems.

Now in fairness, the banks have a point. We’ve said the the OLA is unworkable, and so are bankruptcies, because resolution is a national process but these firms are international, with many trading books passed from time zone to time zone over a 24 hour day. Another major impediment are derivatives. Internationally recognized expert Satyajit Das has written about how “largely untested legal arrangements failed to work as intended” in the Lehman bankruptcy. He has also discussed at some length about “standardized” derivatives documentation isn’t as standard as you’d think, how many contain options as to how and when they are closed out (which will inevitably be exploited whenever possible) and how their valuation is often contested. This implies that reducing TBTF firm OTC derivative exposures and revisiting how they are wound down in bankruptcy and resolutions are essential to making a resolution a real possibility, but no one seems willing to cut that Gordian knot.

Rosner draws out the implications of the OLA:

The FDIC recognized that a “liquidation” authority would be deleterious to financial markets in a moment of crisis. Restructuring a firm, not liquidating a firm, is the proven way to preserve an institution’s value….Bankruptcy has and should continue to be the preferred means to restructure the assets of failed firms. Instead, OLA is effectively a cram down that requires a huge amount of debtor-in-possession (DIP) financing from the Treasury.

This financing is a taxpayer-funded and anti-competitive subsidy. It supports the continuation of a banking system in which “All animals are equal but some animals are more equal than others”. This is perhaps the easiest way to understand that these companies are far too large; the system simply can’t fund them in bankruptcy..

Simply stated, Title II creates further subsidies for a handful of firms that will be costly to taxpayers and bestow further advantages to systemically important financial institutions (SIFIs) relative to non-SIFI firms…. The OLF will be cheap and will provide great benefit – only the non-systemically holding company creditors will take losses, and the company will emerge from OLA much as it entered, to do it all again. We can’t allow this to happen – OLA rewards companies for becoming “systemically important” and overly influential, it hurts smaller companies, and stifles innovation. The government created it and the government can and should take it away

I urge you to read Rosner’s testimony in full. It’s short, well written, and makes some important technical issues accessible to laypeople. And it makes the key point deadly clear: Dodd Frank didn’t address too big to fail adequately, but measures that water it down only make a bad situation worse.

Rosner Testimony on Title II – 05/14/2013

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  1. Murky

    From the Rosner testimony:

    “Because various cross-border legal regimes exist, the management of these problems should not wait to be dealt with in the next crisis…”

    According to Simon Johnson, that cross-border legal stuff just isn’t in place now or any time soon, not with most European countries, and certainly not in various tax havens which dodge any kind of cross-border accountability.

    Given a failing financial institution spread across the globe, gaining resolution authority over the transnational portions of that company will be next to impossible. TBTF banks have gamed the system so thoroughly, that no one nation can take them down.

    So, anybody have other ideas about how to kill a TBTF bank? Without breaking too many laws?

  2. Forest Tress

    Isn’t this well known? Black said DF could have been three pages, and lobbyists were set loose from day one. I’ll get edited – but Rosner has a credibility problem, particularly with victims of not only the housing crisis but readers of his and Gretchen’s book. Why is he so listened to and in DC in front of subcomitees so much? Just askin’

    1. Murky

      Forest Tress wrote:

      “but Rosner has a credibility problem, particularly with victims of not only the housing crisis but readers of his and Gretchen’s book”

      This comment puzzled me, so I googled Joshua Rosner. All I can find are raves about Rosner. He is an independent analyst, and his criticisms of the financial services industry appear to be of very good quality.

      Maybe I’m missing something? And I read that book, Reckless Endangerment, by Rosner and Morgenson. I can’t fault either of these authors. So how does Rosner allegedly lack credibility with victims of the housing crisis?

      Wow, it’s really weird when some of the best and most responsible journalists, like Morgenson and Rosner, get slimed here at Naked Capitalism.

      1. Pedro Hisquale

        In their tome to the financial crisis, Gretch and Roz in part claimed Johnson blew up the universe. It’s crap, they acknowledge too big to fail, deregulation, but it’s a political soap opera for educated fans who need distraction.
        The dynamic duo cannot write to offend the corporation, it’s forbidden. Anywho, the pulp wasn’t completely sophistic, but since it’s 2013, more irrelevant with each passing day, and lots of work has been done since by a busy body. To clarify the problems with what passes for news these days – We have a large group of financial writers, completely encumbered with conflicts of interest right out of the gate – who claim data, scientific analysis, tacit white color fundamentalism as they load more paper product into the breach to be fired off as criticism, which following the money, serves their own interests.
        Meanwhile lives are destroyed in a nearby communities, and the empire burns and bombs in some distant land. Does anyone need a prancing cartoon who hustles for the rich to hand out the indifference? Depends on what you do for living. Come to think of it, Josh belongs in a subcommittee, wailing away at stooges, with decorum and irrelevancy.

      2. Murky

        Mr. Pedro Hisquale,

        You have never posted at NakedCapitalism before. And yet you attack two very reputable journalists. And so I read your post with extreme skepticism.

        You write that Morgenson and Rosner wrote a, “tome to the financial crisis”. This was not what their book was about. Reckless Endangerment had a much narrower focus, specifically the subversion of Fannie May from it’s mission by its executives, the most reckless of whom was Jim Johnson.

        You claim that Morgenson and Rosner, “cannot write to offend the corporation”. Did you bother to read the Rosner’s article linked above? He is extraordinarily critical of TBTF corporate behavior. It’s highly unlikely that you have read Reckless Endangerment, either, as the criticism of corporate cronyism in that tome is exceptionally thoroughgoing.

        You declare their book to be ‘crap’, and use the adjective ‘pulp’ to describe their writing. You speak of sophistry and claim their work is irrelevant. You claim these writers only hustle for the rich, and that they have some direct complicity in the destruction of the American housing sector by big banks.

        But you do not substantiate any of your claims. There is no coherent argument whatsoever in your post. You’ve only piled up rather grotesque mischaracterizations and name-calling.

        Slime attacks may be your preferred style of communication, but they don’t work well on this blog. Lose the slime. Try persuading people here with some quality of argument.

        1. Smith and Jones

          At least Josh hasn’t claimed he’s doing “God’s work”. Insitutional investors, hedgies, lil’ Eichmans all have an axe to grind with them Banks, but perhaps if these wealthy alleged experts are threatened with eviction or worse, they’ll up their game a tad and be more socially responsible.

    2. Yves Smith Post author

      Rosner was a GSE analyst when there were GSEs to analyze, and was the first to call out the dangers of overly generous mortgages (a 2000 paper, “A Home with No Equity is a Rental With Debt”).

      Reckelss Endangerment made Democrats mad because it described how Jim Johnson at Fannie Mae used his position and the high profits of Fannie to create a powerful pro-housing-subsidies coalition. This is widely mischaracterized by trying to claim that the GSEs caused the crisis. It is probably more accurate to say that the book says we might not have had a crisis were it not for the coalition Johnson created. In other words, it’s often depicted as if it was an economic story of the housing crisis, when it tells a political story, and one that has the Dems looking not very good.

      The book also didn’t have enough of an architecture put on it, in terms of being clear what its main message was. And it has some factual errors, like saying the first subprime securitization was in 1993. They’d been around for 4-5 years by then. The deal the book cites as being the first subprime to get an AAA on its top tranches.

      1. Smith and Jones

        Nobody buys political parties, they were all in on it. There are no teams either, just different swells of powerful groups who are aligned in far less pedestrian ways than party affiliation. Wall Street bankers, mortgage originators and loan processors will never see justice, but lets blame the imaginary other team, the Gov’mint. Not to quibble with semantics, what is generous about the violence of predatory lending? Call terrorism by it’s proper name.

        1. Yves Smith Post author

          The “affordable housing” coalition was a Democratic party creation, and Johnson is most assuredly a Dem and ran Fannie as a Dem pork machine. That’s one reason the Rs are so hell bent for leather to put it out of business.

          1. Smith and Jones

            Talk in circles much? You’ve said nothing and that’s not an ad hominem. I say this because I don’t know many people who give a crap about political parties anymore unless they’re in the business or otherwise selling something. Incidentally, what exactly was happening at Fannie Mae? Gretch don’t know. The whole schmear was a public-private screw job, it’s a shame we can’t quickly confirm accuracy when abuse and cruelty are endorsed by fine outfits like AEI. Perhaps that’s just it, when a well coiffed speaker glazes over tragedy like it ain’t no big thang, I’d say that’s a fail.

  3. TomDor

    What amazes me is how the TBTF and their surrounding brown-noses have so completely gamed any legislation via the simple ploy of creating fear and pacifying our elected officials with bribes. It’s as if they are yelling ‘fire’ in a theater when no fire exists.
    Although this comment is just a rant — What total cowards we have elected – they are shameless miscreants. – Not all mind you but, most.

    “To sin by silence when they should protest makes cowards of men.” – Abraham Lincoln

    That last quote by Lincoln – How long can congress remain silent — oh yes, I forgot….they are past the line… cowards most all of them!!!

    Isn’t there some way of transferring bone from a politician’s head to his back??

  4. Jackrabbit


    TBTF Banks are very unlikely to ever be resolved because DF has established a get-out-of-jail-fee card in the form of FSOC (the Financial Stability Oversight Council).

    Among other things, FSOC can nullify consumer protections. Essentially, this sets the stage for ‘bail-in’s of various kinds.

    Problem solved!/sarc
    Politicians that take $$ from Banks (most do) never face the uncomfortable position of bailing them out and Bank execs can sleep easy.


    What are the chances that FSOC’s ‘bail-in’ authority will be discussed at the hearing?

    1. Jackrabbit

      Forgot to mentino the Fed!
      The Fed will also help TBTF by providing low-cost loans when they get into trouble. (They have a seat on the FSOC Board.)


      When will accounting rules be restored? We’re approaching the fifth anniversary of the GFC!

      They are supposed to be f*king BANKERS. They should not have been allowed – nay, they should’ve been ashamed to accept – any bonuses until:
      1) TARP was repaid;
      2) they could prove soundness via MtM accounting; and
      3) they each issued a public apology signed by every VP or above.

  5. William Falberg

    The only way to control invincible monsters is to not create them in the first place:

    28th Amendment (The Constitutional Emergency Amendment)
    Corporations are not persons and shall be granted only those rights and privileges that Congress deems necessary for the well-being of the People. Congress shall provide legislation defining the terms and conditions of corporate charters according to their purpose; which shall include, but are not limited to:
    1, prohibitions against any corporation;
    a, owning another corporation,
    b, becoming economically indispensable or monopolistic, or
    c, otherwise distorting the general economy;
    2, prohibitions against any form of intervention in the affairs of government by means of;
    a, congressional lobbying
    b, electoral sponsorship or advocacy
    c, educational sponsorship or publication
    d, media news reporting
    3, provisions for;
    a, the auditing of standardized, current, and transparent account books
    b, closing the FRB and the establishment of state-owned banks
    c, civil and criminal penalties to be suffered by corporate executives et al for violation of the terms of a corporate charter.

    Optional: (or possible 29th amendment)
    The 16th Amendment to the United States Constitution is hereby repealed and Congress shall re-write the U.S. Code to reflect the changes embodied herein.

  6. clarence swinney

    The House Farm Bill proposes reducing Food Stamps $39.7 B over next ten years.
    Much of this cut comes from food stamps and other nutritional programs.
    No expiring tax cuts for top 2% with incomes As high as $1000 Million.
    Wall Street is staffing with former government employees who have influence in Congress.
    The Big Banks in particular. Ben White at Politico gave a list showing hires by Goldman Sachs, Morgan Stanley, IBM, GE,, Citigroup, Credit Suisse and JP Morgan.
    Buying influence.
    The Republicans in the House plan to held another Debt Ceiling Hostage to demanded unspecified tax reform at a future date. The leaders are too chicken to tell their backers that we have to increase the debt ceiling to pay off bills Congress has already voted on and spent.
    We have a $14,000 Total National Income and in 2013 fiscal year we get $2700B Revenue And spend $3600B. We borrow $900B. Shameful that the richest nation refuses to tax wealth to balance the budget. $2700B of $14,000B is a 19% Tax Rate. If we were to tax to pay our budget of $3600B
    it would be a 26% National Tax Rate.
    We rank third in OECD nations As least taxed.
    It is time to tax wealthy estates and top incomes at a much higher Effective rate.

  7. kevinearick


    Wartime Housing

    An empire seeks to prove that all individuals are selfish in nature, incapable of working effectively without it, as its self-fulfilling prophesy. Giving it the data it wants to see, in any equation you like, is not difficult. Building the necessary gravitational cantilever is the easy part. Simply concur with its operation, explicitly.

    Because the empire borrows income from future generations to ensure confidence in its continued operation, you are at war upon birth. Each time you accept a false assumption by replicating the associated behavior, you fall deeper under its spell. Before long, your time has no value, and the empire’s currency, compliance, is all that matters. Within the empire, you are either the wh- or the n-r, the master or the slave, depending upon artificial circumstance.

    The line of lines is designed to destroy your spirit with time, to ensure compliance. Do not wait in line, unless you want others to see you waiting in line. School is designed to destroy your intellect with wasted effort, to ensure compliance. Capital’s labor is designed to break your body with stupid work, to ensure compliance. Work intelligently and with spirit, on your own time. Give the empire no more and no less than 10%.

    Economic war is designed to place you within artificial boundaries, a prison within prisons, for the ultimate implementation of physical war, to reboot the demographic ponzi when the replication virus consumes all easily exploitable resources. Capital clear cuts, lets nature replenish itself, and blames the resulting pestilence, disease, and starvation on Act of God.

    The nuclear bomb ending the last major war was a crude weapon resulting in crude technology, which is why financial instrumentation returned so quickly. Completing the reaction to get rid of all that waste is a good mental exercise, but it will not get you anywhere you want to go.

    What is your time worth?

    Why are there so many middle men/women between your labor and the home required to raise your children? Why is the actual utility of housing so low and its price so high? Do you really think that the top 2% of the population is the only group ‘profiting’ from the empire’s banking function, top-down family civil law? What does that tell you about military law and how you might want to raise your children?

    What is your price? From a practical utility perspective, is there any other sector with more excess capacity than housing? What is the critical path to human development? Why do you suppose they built MAD derivatives? What is integral and what is derivative? What are your priorities?

    Children don’t come with a book on parenting for a reason; each is meant to be unique. You will learn far more from them than they will from you. All empire beauty is a lie, hiding an ugly truth not too far from its surface. Sacrificing for the sake of your children is not something you learn in an empire. Write your own book.

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