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The Ruling Ad-Hocracy
So much for Dodd-Frank's promise of no more bailouts.
The Wall Street Journal, Friday, January 21, 2011
Federal regulators have made it official: The 2010 Dodd-Frank law to reform Wall Street has already failed on its most fundamental promise. That was quick.
Over the last week, the new overseers of American finance have confirmed that there could be more "exceptional" market interventions and that regulators will continue to exercise their own discretion to identify "systemic risks." Regulators will also be able to discriminate among creditors and bail out short-term lenders to too-big-to-fail firms, which will be protected from bankruptcy.
A new report from Neil Barofsky, Special Inspector General for the Troubled Asset Relief Program (TARP), underlines the fact-free analysis behind the bailout judgments of 2008. Focusing on one of the biggest of the too-big-to-fail firms, Mr. Barofsky reports that the process by which federal officials decided that Citigroup had to be saved in late 2008 "was strikingly ad hoc. While there was consensus that Citigroup was too systemically significant to be allowed to fail, that consensus appeared to be based as much on gut instinct and fear of the unknown as on objective criteria."
One could make a case that Citigroup was too big to fail, but nobody seems to have made it. Before voting on November 23, 2008 to recommend that Treasury invoke the systemic-risk exception, which allows the Federal Deposit Insurance Corporation to assist an open bank, the FDIC board seems to have relied largely on the judgment of others.
Mr. Barofsky quotes FDIC Chairman Sheila Bair: "We were told by the [Federal Reserve Bank of New York] that problems would occur in the global markets if Citi were to fail. We didn't have our own information to verify this statement, so I didn't want to dispute that with them."
Office of Thrift Supervision Director John Reich voted along with the rest of the FDIC board to help Citi and agreed that it was "obviously a systemic risk situation," but he expressed concern that there had been "some selective creativity exercised in the determination of what is systemic and what's not."
As a result of the FDIC vote and similar judgments at the Fed and Treasury, Citigroup received its second round of federal aid in the space of two months. Having received $25 billion via TARP in October, the company in November received a federal guarantee on some $300 billion of its toxic assets plus another $20 billion from TARP.
Why $20 billion? The company had only asked for the asset guarantee, not the new TARP funds. Henry Paulson, then Secretary of the Treasury, told Mr. Barofsky that he made the decision but "stated that he did not perform any analysis specific to Citigroup in arriving at the $20 billion figure. Rather, he took into consideration the limited amount of TARP funds still available, as well as the prospect that another bank could soon need assistance."
But that was 2008, when according to the Beltway narrative, seat-of-the-pants judgments were needed because regulators had insufficient powers to manage crises. Surely Dodd-Frank fixed all that, right?
Well, not necessarily, according to current Treasury Secretary Tim Geithner, who told Mr. Barofsky that, "In the future we may have to do exceptional things again if we face a shock that large. You just don't know what's systemic and what's not until you know the nature of the shock. It depends on the state of the world—how deep the recession is. We have better tools now, thanks to Dodd-Frank. But you have to know the nature of the shock."
Taxpayers may notice that this message has evolved since last July, when President Obama signed Dodd-Frank and proclaimed, "There will be no more tax-funded bailouts—period."
It's not merely a shift in rhetoric. The new old ad-hocracy was also on display this week in two regulatory decisions. The new Financial Stability Oversight Council chaired by Mr. Geithner once again refused to define exactly what it means to be a systemically significant firm.
In a draft rule, the council said it will take into account things like the size, leverage and "interconnectedness" of firms, but didn't say how big or how leveraged, or what a high degree of interconnectedness means. Oh, and "In addition, the Council would consider any other risk-related factors that the Council deems appropriate, either by regulation or on a case-by-case basis . . ."
So systemically risky will be whatever unelected officials say it is. A financial market in need of bright lines will get only more shades of regulator gray.
Over at the FDIC, meanwhile, the regulators enacted an "interim final" rule on how to manage the failure of systemically significant firms. "Interim" means the FDIC will still accept comments about it from the public, but "final" means the rule is now binding. And the final decision is that when too-big-to-fail firms are handed over to the FDIC instead of to a bankruptcy court, the FDIC can discriminate among creditors and can keep payments flowing to short-term creditors that the agency believes are essential to the operation of the firm.
We think Mr. Barofsky is performing a public service by excavating these 2008 bailout ruins because the time to tighten the rules on too-big-to-fail firms is when the market is calm, not amid a panic. Dodd-Frank was supposed to reduce the odds of back-pocket rescue decisions, but now even its main promoters are admitting that the law gives them enormous discretion to do it all over again, based on little more than their own ad-hoc judgments.
Any Republicans tempted to accept Dodd-Frank as settled law should dig into the details and work to restore the freedom to fail in American finance.