Net Net: Promoting innovation and managing change
Net Net: Promoting innovation and managing change

A Few More Questions About Resolution Authority

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My concerns about the effectiveness of the authority to resolve the failure of an important financial company granted under Title II of the Dodd-Frank still isn’t understood by some readers.

So let’s back up.

Does this sound like a realistic scenario?

In the various accounts of the failure of Lehman it is noteworthy that senior management discounted the possibility of failure until the very last moment. There was apparently a belief, following the government’s actions in respect of Bear Stearns, that the government, despite statements to the contrary, would step in and provide financial assistance and Lehman would be rescued. If Title II of the Dodd-Frank Act had been in effect, the outcome would have been considerably different. Lehman’s senior management would have understood clearly that the government would not and could not extend financial assistance outside of a resolution because of the clear requirements in the Dodd-Frank Act that losses are to be borne by equity holders and unsecured creditors, and management and directors responsible for the condition of the failed financial company are not to be retained.

That's how the FDIC describes the likely attitude of the management of Lehman to the news that the FDIC was going to start considering implementing its resolution authority.

Do you believe that if Title II of Dodd-Frank had been enacted prior to September 2008—but never, ever utilized—that Dick Fuld would have “understood clearly that the government would not and could not extend financial assistance out side of resolution?”

Or would he have treated the existence of this law the same way he treated statements from then-Treasury Secretary Hank Paulson and others about the unavailability of a bailout?

Would Fuld have passively accepted the implementation of resolution authority, or would he have fought it with every last fiber of his being?

Do you believe that the senior managers of our biggest banks right now believe that the government cannot and will not extend financial assistance outside of resolution?

Let’s take this a step further. What do you think would happen if a bank like Bank of America or Citigroup that was still able to borrow short-term paper and still had a stock price above $5 a share was deemed in need of “resolution?” Would the process move ahead smoothly—or would we see markets panic, Congressmen call for impeachment of the officials involved and other firms immediately shut off all access to credit markets?

The basic point is that the model used for failing commercial banks probably just won’t work for systemically important, politically powerful financial institutions. The legal framework is built around a model that just is not practical for the financial and political reality of Too Big To Fail banks.

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