TCS Daily

Is Dodd Ending Too Big to Fail?

By Larry Kudlow - March 16, 2010 12:00 AM

Surprise, surprise. Sen. Chris Dodd's financial-regulation proposal raises the possibility of substantial progress on the road to ending "too big to fail" (TBTF) and bailout nation for banks and other financial institutions.

How the Dodd bill will play out in the final details remains to be seen. But when you read the Dodd fact sheet, there are a few key items to like.

First, under the Dodd scheme, large complex companies will have to submit plans for rapid and orderly shutdowns should they go under. These are called "funeral plans." Then, in terms of these orderly shutdowns, the bill would create an "orderly liquidation mechanism for the FDIC to unwind failing systemically significant financial companies. Shareholders and unsecured creditors will bear losses and management will be removed." Good.

Then comes the "liquidation procedure." This spells out that the Treasury, FDIC, and Federal Reserve must all agree to put companies into the orderly liquidation process. "A panel of three bankruptcy judges must convene and agree -- within 24 hours -- that a company is insolvent," the bill goes on to say. It also states that the largest financial firms will be assessed $50 billion for an upfront fund that will be used if needed for any liquidation. This is a kind of debtor-in-possession safety net for the bankruptcy-liquidation process. Also good.

Finally, under the heading of bankruptcy, the bill stipulates that most large financial companies are expected to be resolved through the normal bankruptcy process. This is the key. However, it is not an airtight case for bankruptcy. It is possible that a government-resolution process could keep big banks alive or in conservatorship, such as with Fannie and Freddie. That would be wrong. Very wrong. In fact, one of the flaws in the Dodd bill is that there is no mention of Fannie and Freddie.

But the strict language on bankruptcy judges and shutdowns, and the line stating that most large failed financial firms are expected to be resolved through the normal bankruptcy process, is very hopeful.

The biggest flaw in the Dodd bill is that it gives the Consumer Financial Protection Agency (CFPA) far too much free reign. The agency will be housed in the Federal Reserve. But it will be independent inside the Fed, with a director appointed by the president and financed by the Fed's own profits.

The Fed itself apparently would have no say on CFPA rule-making, which is sort of like giving Elizabeth Warren her own wing at the central bank in order to make mischief. At a minimum, she'll need grown-up supervision. Many smaller community bankers and non-bank Main Street lenders -- such as stores with layaway plans, check-cashing companies, pay-day lenders, and even car dealers -- could be put out of business by Elizabeth Warren. (Hat tip to Capitol Confidential of Andrew Breitbart's

Another issue is the so-called "Volcker rule," set forth by the White House, which would limit proprietary trading for Wall Street banks, a big source of revenue and profits. Under the rule, it looks like the Federal Reserve or other regulators would supervise any trading limits, but not necessarily eliminate proprietary trading. I think TBTF is terminated under the threat of a true bankruptcy-court liquidation. That's enough of a disincentive for excess risk-taking to obviate the need for a Volcker rule.

Ditto for the trading of derivatives and other counter-party activities such as credit-default swaps. These are useful hedging devices, although they should be fully collateralized, with clearly valued assets and cash behind them.

Back to the Dodd plan, it also stipulates that the U.S. president appoints the New York Fed president. That's another flaw. It politicizes the Fed big time. Right now, reserve-bank presidents are chosen and appointed by their boards of directors.

And then there's a "proxy access" provision that would force public companies to list rival slates for election to their boards of directors. This goes way beyond "say on pay." And it would permit a bunch of liberal-left, union-type interest groups to spread their anti-business opinions.

However, with the Dodd plan, the possibility remains that a true bankruptcy process will replace government bailouts.

This is vital, since TBTF and government bailouts are among the root causes of the banking crisis, where large financial companies have a moral hazard to take too much risk at taxpayer expense.

The devil will be in the details. And of course, Dodd's Senate bill will have to reconcile with Barney Frank's bill in the House. But Chris Dodd conceivably may have opened the door to ending TBTF and bailout nation.

Maybe retirement is the key to good policymaking.

This article first appeared on Kudlow's Money Politic$.


another 'independant' agency
He says this newest govag, the CFPA, will have 'free reign', and 'will be independant', yet like the post office and others will have a directory appointed by the prez.

It's not clear though if the author means it will be as independant as the FED itself, or does he mean sort of like Freddie/Fannie are supposed to be independant?

Can we imagine any govag set up to serve the govenments own interests, allowing it to be really independant?

A good test would be to what would happen if any of them actually did somethibg really opposed to what the government elites wanted.

It will probably morph into just another dysfunctional govag whose mains interest is to survive, and expand it's own little empire, just like all the rest.

But of course it could be possible that it will become just as critically important as, say the ATF, or FEEMA or the USPS.

Imagine the nitemare scenario if the Post Office were not 'too big to fail'. Or even worse, what if it were privatized like the post offices in so many other countries?

At least we have the satisfaction of knowing this newest of agencies will be financed right from the FED; after all, they can print as much fiat currency as they like right?

Here's a newsflash about the FED and its taking off the 'IN god we trust' from the money. Apparently they did a market survey and found out the main constituency against having god's name used in vain like that was.....God himself! He said he didn't want to be associated with a dollar that has lost 98% of its value since the the FED was brought in by stealth.

Riiighht...I'd like to see what else is in it
As for bankruptcy, it doesn't matter when the Administration can turn over on its head the law (along with hundreds of years of English Common Law) by screwing with the order of receivers (as in, bondholders should always come first) like they did with the GM 'restructuring'.

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