With the appointment of Jay Powell as Fed chairman, we’ve still got a lot of seats on the Board to fill. Looming high-level vacancies at the OCC and FDIC also throw the future of inter-agency rulemaking into doubt. Still, with Mr. Powell at the helm and confirmation likely, the future of U.S. financial regulation is taking shape. A new FedFin report goes in detail into our forecast for key rules, but there’s one over-arching theme: continuity that reinforces the stability of U.S. finance under stress. Mr. Powell is sure to be a strong, if quiet, supporter of the orderly-liquidation authority (OLA) provisions in Dodd-Frank, pushing the Trump Administration firmly away from Treasury’s initial plans to abandon OLA and making it still more crucial that Congress not repeal this part of Dodd-Frank as a tax-cut offset. I wish it weren’t so, but modern finance is too complex, too interconnected, and frankly too scary to go without OLA’s system-saving capacity.
When the president initially laid out his financial-reform agenda, he clearly sided with many Republicans who call OLA a TBTF bail-out. Treasury was similarly ill-disposed to OLA, with Secretary Mnuchin arguing that OLA is drafted so that, even where he inclined to trigger it in a crisis, the conditions for doing so make using OLA essentially impossible. The GOP and Administration position is premised on a preference for resolution via the Bankruptcy Code. No wonder – OLA does require government intervention, a temporary expenditure of taxpayer goodwill if not dollars, and discretion for resolution authorities to make some calls others may later call political.
But, even if the Bankruptcy Code worked for large financial firms (which it doesn’t in current form), the ability of the courts to handle more than one huge, complex company at a time is at best questionable. The Code is also ill-suited for CCP resolution absent changes not yet even on Congress’ drawing board. Without OLA, the U.S. financial system is riding with its wheels atop the guard rail poised either for cataclysm or yet another round of taxpayer bail-outs.
One more reason why OLA matters that Mr. Powell well understands: with it, foreign governments are less likely to use their host-authority power to seize U.S. firms’ operations, simultaneously depriving the parent company and the bankruptcy courts of urgently-needed resources that may precipitate otherwise-avoidable failure and signaling to counterparties around the world that the financial company is in distress, at least in the host authority’s view. OLA isn’t perfect – like the Bankruptcy Code, it’s still a hopeful approach to qualified financial contracts, not a bullet-proof solution to run risk. But with it, host regulators and counterparties expect an orderly resolution likely to protect their interests. Without it, they will save themselves if they can, precipitating the mother of all collective-action problems.
What else does Mr. Powell understand that the Trump Administration is just learning? It’s one thing to be a titan of Wall Street, or at least profit by knowing them. It’s another to be in the Treasury hot seat during a financial crisis. When Mr. Powell was at Treasury in the early 1990s, he watched one seemingly-impregnable company – Salomon Brothers – collapse under its own weight. A large hedge fund also threatened systemic ruin for a while and there was, of course, still the S&L and New England banking crises to clean up. Once in charge of post-debacle, twice shy about eliminating both the prudential standards essential to systemic resilience and the clean-up instruments vital if economic growth sputters, geopolitical risk flares, or financial contagion risk reignites.