Too Big To Fail, Part VIII: Some Final Words

Before (finally) setting aside the House's financial stability regulatory proposal (.pdf) that I've now spent seven eight posts analyzing, I'd like to provide some summarizing thoughts. (See the end of this post for links to the others.) Like with most drafts of legislation, there's some good, some bad and some ugly.

What I Left Out

As you can probably guess, I didn't cover the entire 253-page document, but I did cover what I believe were the most important parts. With that said, I left out four sections:

Improvements To Supervision And Regulation Of Federal Depository Institutions

The major highlight from the section is abolishing the Office of Thrift Supervision. It divides up its people, assets and authority between the Federal Deposit Insurance Corporation and the Comptroller of the Currency. It then takes time to work through logistics and eliminate regulatory overlap in banking. For about 50 pages.

Further Improvements To The Regulation Of Bank Holding Companies And Depository Institutions

This serves mostly to make regulatory authority clearer. It also contains some detail for the heightened regulatory requirements I covered.

Payment, Clearing, and Settlement Supervision

This section seeks to facilitate more efficient and effective financial transactions.

Additional Improvements For Financial Management

This was the last page of the document. It says that in extenuating circumstances, with the Treasury's permission, the Federal Reserve can discount notes, drafts and bills of exchange for individuals, partnerships or corporations. So it gives the Fed more flexibility to rescue banks. This sounds an awful lot like a license to bail out damaged firms.

Who Gets What?

What government authorities came out the winners and losers in this regulatory proposal?

Federal Reserve

I think this framework will result in a much more powerful Federal Reserve. Make no mistake: it would be the systemic risk regulator. It sets all of the regulatory rules. It enforces those rules as well. It sets capital requirements. Finally, it recommends when a firm should be resolved. It even appears to have the power to break up firms or altar a business' strategy, if it believes systemic risk is threatened. Finally, as I just noted above, it has a little more flexibility to rescue firms in a time of financial instability. Of course, it already had quite a bit of power in that regard.


It makes out fairly well, since it gets to resolve the non-bank financial institutions. It also gets some input in some important decisions. I'm not sure it would make much sense for the FDIC to get any power beyond this.

The Treasury

I'd characterize the Secretary of Treasury as having immensely more decision-making power under this regulatory framework. He or she will make a lot of important calls, including ultimately deciding which firms should be resolved. The Secretary also leads the Oversight Council.

The Oversight Council

Speaking of the Oversight Council, it doesn't do as much as you might think. It meets and attempts to foresee financial calamity. Good luck with that. Its most significant charge will be to identify firms that pose systemic risk. It also will suggest some regulatory changes to various agencies. But it mostly serves as a forum for regulatory leaders to discuss the market.

The Good

My favorite part, as expected, is the resolution authority for non-bank financial institutions. We need it. Capitalism can't work unless the risk of failure is real. No firm should be protected because deemed too big to fail.

The Bad

I'm quite skeptical that an Oversight Council can anticipate sudden, severe market shocks. I'm also not thrilled that the resolution authority will impose assessments on other firms when one fails if the costs of failure exceed a loss to shareholders and/or creditors.

I also feel a little uncomfortable with how much regulatory power this proposal gives to the Fed. If strict and transparent oversight of that power is provided to Congress, it wouldn't bother me as much. But I didn't notice such language in the doc.

The Ugly

I'm extremely bothered by the treatment of securitization. It remains the scapegoat for the financial crisis. I can hardly believe the proposal intends to restrict banks from hedging their risk regarding what it forces them to retain from their securitized pools.

I also don't like that there appears to be opportunities for sort-of bailouts through the FDIC and Fed, separately, for non-bank financial firms. Although the FDIC and Fed have historically had some leeway to help out ailing firms, these provisions appear to enable them to provide assistance even outside receivership.

The reality is that, even in this new regulatory framework, the government would still be able to assist a firm if it wants, rather than resolving it. I guess we just need to hope it generally opts to let firms fail so the climate of moral hazard doesn't endure.

Prior posts on this draft:

Oversight Council
Determining Systemically Risky Firms
Heightened Regulation
Capital Requirements
Emergency Stabilization
Resolution Authority