Why is Paul Ryan’s Budget Trying to Dismantle Financial Reform?

The budget Paul Ryan released yesterday has huge cuts that are likely to fall on the poorest Americans while offering all kinds of bonuses to the top 1%. Others will be talking about how it eliminates Medicare and Medicaid. I want to talk about how it dismantles one of the few regulations put on Wall Street post-crisis.

Recap: Living Wills

Let’s back up with a high-level overview. During the financial crisis of 2008 regulators found that they were lacking necessary legal powers for unwinding and resolving large financial institutions. We can debate whether they actually lacked these powers, but they had an argument that they didn’t have them which was more than enough for them to shirk from having to do anything. They also found that when they went to collapsing institutions like Lehman, there was little prep done at the firm by either regulators or staff for what it would mean to unwind itself, so the only option was to send it flying into bankruptcy in the most awkward way or do an extensive bailout. These were the options.

How to solve it? Give regulators the powers they need, and then make a very public showing of prepping firms for resolution when they fail. Have records of “living wills”, so it is clear that no firm is too big to fail. It’s not enough to say “We’ll never bail anyone out again.”  We need to do a few simple things to make sure a crisis or a failure goes more smoothly. Seems fair, right?

Well a funny thing happened on the way to writing living wills. Wall Street has decided that they can’t be bothered and are lobbying against it. From Bloomberg, March 24th, 2011, Banks, Insurers Resist U.S. ‘Funeral Plan’ Crisis Breakup Rules:

Lobby groups including the American Bankers Association are voicing concern to regulators in a series of comment letters seeking to limit the impact of the new rules. JPMorgan Chase & Co. and New York-based insurer MetLife Inc. have discussed so-called resolution, or the unwinding process, with FDIC officials….

Since November, representatives from companies including JPMorgan, Citigroup Inc., Goldman Sachs Group Inc., Morgan Stanley, Fidelity Investments, BlackRock Inc., Barclays Plc, Credit Suisse Group AG and Deutsche Bank AG have met with Fed or Treasury Department officials to discuss issues related to systemic risk, according to records released by regulators.

A living will is an “enormous burden” that puts banks on a course “that differs dramatically from the way they currently look at their business,” said Mark Tenhundfeld, senior vice president at the American Bankers Association.

So here’s a sensible, necessary (but not sufficient) part of taking down a large, failing financial reform. Wall Street hates it because it requires work, and it requires them to think of their business as something that could in fact fail. Who can they turn to?

Republican Budget

Cue Paul Ryan and the new Republican budget. Pat Garofalo at Wonkroom finds the following in the new budget:

Although the bill is dubbed “Wall Street Reform,” it actually intensifies the problem of too-big-to-fail by giving large, interconnected financial institutions advantages that small firms will not enjoy. While the authors of Dodd-Frank went to great lengths to denounce bailouts, this law only sustains them.

The Federal Deposit Insurance Corporation (FDIC) now has the authority to access taxpayer dollars in order to bail out the creditors of large, “systemically significant” financial institutions. CBO’s expected cost for this new authority is $26 billion, although CBO Director Douglas Elmendorf recently testified that “the cost of the program will depend on future economic and financial events that are inherently unpredictable.” In other words, another large-scale financial crisis in which creditors are guaranteed to get government bailouts would cost taxpayers much, much more. This budget would end the regime now enshrined into law that paves the way for future bailouts.

Wall Street really likes the status quo. Resolution authority requires a series of actions, from having to make funeral plans, to being subject to prompt corrective action, that begin to make it credible to resolve firms and move us away from the status quo.

These are not radical proposals. Here’s the Squam Lake Working Group on the topic. This is a group that includes Greg Mankiw, John Cochrane and Frederic Mishkin, so a fairly conservative bunch.  Their recommendation:

We endorse legislation that would give authorities the necessary powers to effect an orderly reso- lution. As part of this authority, every large complex financial institution should be required to create its own rapid resolution plans, which would be subject to periodic regulatory scrutiny. These “living wills” would help authorities anticipate and address the difficulties that might arise in a resolution. Required levels of capital should depend in part on what the living wills imply about the time re- quired to close an institution. This will create an incentive for financial institutions to make their or- ganizational and contractual structures simpler and easier to dismantle.

The GOP’s budget is far more radical than people like Greg Mankiw see as the role of regulation for the financial sector. There are problems with resolution authority that need to be addressed, particularly its international components. But the idea that the legal structure of summer 2008 is ideal – the idea that “let’s do it over, but mean it this time” is the strategy, is horrific.

Remember – Paul Ryan voted for TARP. And now he wants to say “no problems here” and simply set the dial back. What more could Wall Street want – someone who votes for bailouts in TARP and then fights any and all accountability and reform mechanisms after the fact? In a budget that skews so strongly towards the top 1% it’s telling that it tries to break apart one of the few mechanisms for holding Wall Street accountable post-crisis.

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3 Responses to Why is Paul Ryan’s Budget Trying to Dismantle Financial Reform?

  1. I agree with you on living wills, but I’m curious why you think there’s some debate over whether regulators had the legal authority to resolve large financial institutions in 2008. There’s no debate. Regulators did *not* have the authority to resolve bank holding companies, or investment banks like Lehman. The FDIC had the authority to resolve depository institutions only, and even then only in defined circumstances, which the big banks never came close to. So any claim that regulators had the authority to resolve the big financial institutions in 2008, but chose not to, is unequivocally false.

    Are there people who are still claiming that regulators had the authority to resolve the big BHCs in 2008?

  2. “They also found that when they went to collapsing institutions like Lehman, there was little prep done at the firm by either regulators or staff for what it would mean to unwind itself, so the only option was to send it flying into bankruptcy in the most awkward way or do an extensive bailout.”

    Why on earth would ANYONE on Wall Street or at the Fed/Treasury have had any plans for the bankruptcy of a major banking institution? They’d all witnessed the Feds bailing out failed institutions since the collapse of Continental Bank of IL in the late 1980s. LTCM got the bailout. Bear Stearns, Fannie, Freddie, etc.. So why would Lehman have wasted a minute of time developing a bankruptcy plan when no bank of its size had been allowed to fail up until September 2008, when Lehman was not granted the bailout given to every other financial institution?

    The bankers are fighting the “living will” today because it’s an acknowledgement that their whole approach must change – they now(hopefully!) will be held accountable for miserable business practices that lead to catastrophic failure. For a sector accustomed to – and comfortable with – being bailed out and bonused when they fail, that’s a radical shift in how they’ll have to run their business.

  3. chris says:

    Why is Paul Ryan’s Budget Trying to Dismantle Financial Reform?

    Because Paul Ryan is an extreme conservative with a friendly-looking face, like Ronald Reagan. Whatever is good for the very rich is good enough for him.

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