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From Banking and Finance Law Daily, July 21, 2014

Committee report finds Dodd-Frank Act did not end TBTF

By John M. Pachkowski, J.D.

House Financial Services Committee Chairman Jeb Hensarling (R-Texas) and Oversight and Investigations Subcommittee Chairman Patrick McHenry (R-NC) released a committee staff report that concludes the Dodd-Frank Act did not end “Too Big To Fail” as the law’s supporters claim, but actually had the opposite effect of further entrenching “too big to fail” as official government policy.

Rationale for the report. In issuing the report entitled Failing to End “Too Big To Fail”: An Assessment of The Dodd-Frank Act Four Years Later, the Financial Services Committee cited a number of reasons in doing so. The Committee noted that the Rules of the House of Representatives directed the Committee to examine “on a continuing basis” the application, administration, and effectiveness of the statutes within its jurisdiction, including the Dodd-Frank Act. The Committee also cited that there is a “significant and growing number of financial experts, regulators, and market participants [that] are beginning to think that the Dodd-Frank Act has failed to accomplish its objectives, and that rather than ending the practices that led to the financial crisis, the Dodd-Frank Act instead made them a permanent part of the regulatory toolkit.” Finally, the Committee stated, “Congressional oversight is particularly appropriate in this instance because the Dodd-Frank Act was conceived in the midst of the financial crisis and enacted shortly after the most acute phase of the crisis ended” and that since “the exigencies of the financial crisis have receded, the Committee has not only the opportunity but also the responsibility to assess whether the Dodd-Frank Act addressed the risks that precipitated the crisis, grounding its assessment on reason and experience rather than fear and emotion.”

Report findings. The report found the Financial Stability Oversight Council (FSOC) to be “an unwieldy conglomeration of regulatory officials charged with identifying risks and taking steps to mitigate them” and that “FSOC has failed to live up to its statutory mission to identify and mitigate systemic risk.”

Regarding designation of nonbank financial companies as systemically important financial institutions (SIFIs), the report noted that these designations undermine market discipline by signaling that some firms are “too big to fail.” The report also found that the designation process highlights flaws in FSOC’s governance structure and statutory mandate in that the process displaces regulatory expertise and makes FSOC itself a source of systemic risk.

The report also faulted FSOC’s record-keeping practices noting that these practices undermine public and congressional oversight; reduces FSOC’s accountability and increases the likelihood that FSOC will not remedy deficiencies in its operation.

Turning its attention to the Office of Financial Research (OFR), the report noted that the OFR has taken some steps to carry out its mission of collecting financial data to identify systemic risks, but its progress has been unsatisfactory and its data collection efforts risk imposing substantial costs in return for speculative benefits. The report stated that the OFR “failed its first high-profile test in identifying sources of ‘systemic risk’” when it issued an analysis of the asset management industry. The report noted that a non-profit group, which usually advocates for increased government intervention, found the asset management report to be “vague and amorphous,” “of little value,” and “misleading.”

The report also examined the “Orderly Liquidation Authority” found in Title II of the Dodd-Frank Act and concluded that the proponents of Dodd-Frank never offered an adequate explanation of how the “Orderly Liquidation Authority” would end bailouts. The report added that the effectiveness of the “Orderly Liquidation Authority” as a tool for addressing the failure of large, complex financial institutions remains seriously in doubt. The report also observed that the Federal Deposit Insurance Corporation’s strategy for implementing Title II—the Single Point of Entry—is a “recipe for future AIG-style bailouts.”

Finally, the report cites to other problems that the Dodd-Frank Act either missed or created. Namely, the report found that:

  • the Government-Sponsored Enterprises (GSEs) are still “too big to fail;”

  • firms designated as Financial Market Utilities under Dodd-Frank are the next generation of GSEs;

  • section 13(3) of the Federal Reserve Act, as amended by the Dodd-Frank Act, remains a powerful bailout tool;

  • the Dodd-Frank Act did not rein in other bailout authorities possessed by regulators; and

  • regulatory requirements imposed under the Dodd-Frank Act created compliance burdens that distort the free market by making it harder for small-to-medium sized financial institutions to compete with larger firms, further entrenching “too big to fail.”

Commenting on the report, Committee Chairman Hensarling noted, “In no way, shape or form does the Dodd-Frank Act end ‘too big to fail,’ but “enshrines” the concept into law. Subcommittee Chairman. McHenry added, “Rather than institute market discipline and a clear rules-based regime, four years later, Dodd-Frank's failed policies have only worsened the risks within the financial system and recklessly handed financial regulators a blank check for taxpayer-funded bailouts.”

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