In a series of recent client reports (here and here) and a new Economic Equality blog post, we’ve observed that the agencies’ actions to deconstruct the rules demanded in part by Section 165 of the Dodd-Frank Act suffer from the same problem that doomed the rules as they were erected after 2010: failure then and now to understand the sum total impact of the prudential rules and, even more importantly, to recognize that the best bulwark against big-bank systemic risk is realistic big-bank resolution at cost only to those who should have done or known better. However, there’s an important protection ahead of ready resolvability without taxpayer risk or collateral damage and it’s to be found also in the Dodd-Frank Act. Section 166 of the law demanded not only that the Fed mandate a lot of tough rules for large banking organizations, but also that the Fed must demand of itself the discipline to intervene – Congress called it early remediation – when a big bank starts to fall apart. Would we need as many rules as the regulators propose to leave in place if we had what really protects financial stability: regulators with the courage to intervene ahead of failure that can be meaningfully threatened and effectively ensured?
So mesmerized by Section 165’s rules that you haven’t heard of Section 166’s early remediation? It was in fact among the Dodd-Frank provisions thought most important at the time. In 1991, Congress demanded that federal banking agencies take “prompt corrective action” (since dubbed PCA) when banking organizations show signs of trouble, doing so because too much regulatory forbearance made the S&L and banking crises of the time far worse. Distraught because none of the agencies took prompt corrective action as banks began to crack ahead of the 2008 crisis, Congress added the early-remediation language to Dodd-Frank to demand – again – that a Fed then endowed with far more power than ever before also take responsibility for troubled BHCs and intervene quickly either to turn the company around or shut it down before one bank’s failure proved the financial system’s undoing.
What is it about PCA and early remediation that gives regulators willies so debilitating that they won’t even formalize the latest congressional directive that they do their jobs? It’s not that they’ve so sterling a record of early, effective supervision that this added tool is unnecessary and thus can stay safely ensconced in the law books. Every case at which I’ve looked as an expert witness since 2008 shows that PCA went unused and early remediation would have been a critical backstop. Years of supervisory pleading for bank boards of directors to fix glaring problems went unaddressed until, immediately before failure, stern actions were demanded when banks were no longer in any position to take them.
The Financial Crisis Inquiry Commission and much post-crisis commentary shows case after case of banking organizations with remarkably high CAMELS ratings and no corrective measures taken on either a voluntary or mandatory basis until, again, it was too late. Think the agencies now wield not only the mighty sword given them in Section 165, but also a swift one? Just yesterday, Treasury’s inspector general sanctioned the OCC for a 2017 failure far less likely to have cost the FDIC $82.6 million had OCC examiners stepped in fast and forcefully.
Congress is not unreasonably tired of this and thus instructed the Fed to step in when capital levels falter, operational risks are growing, deals are coming undone, loans are going unpaid, or management is showing signs of dissolution or distraction. Still, the fact that the early-remediation rule is as theoretical today as it was in 2007 suggests that regulators simply don’t trust themselves to take rapid, flexible, and sensible action. Instead, they want a giant rulebook to throw at banks so that banks are forced to become so bullet-proof that examiners have little more to do than say thanks. That the new rules undermine financial intermediation, monetary-policy transmission, and economic equality seems a large price to pay for a supervisory system that, to this day, is as unaccountable as it was in 1989.
I asked last week if federal banking agencies know what they want large banks to be. The new proposals echo the rules they would dismantle to say that the biggest banks are to be bastions of capital and liquidity buffers dictated by regulatory fiat based on uncertain models and dubious data. Would it be possible instead to allow banking organizations to operate more freely at the cost first of early remediation that cut dividends, slashed bonuses, or forced divestitures? What about allowing banks considerably more flexibility if they can demonstrate ready resolvability even in the face of an anachronistic Bankruptcy Code? So far, we’ve the worst of both worlds: big banks increasingly redefining their business models as wealth managers, not intermediaries, even as remaining risks – and there always are – could first be tolerated by regulators and then borne by taxpayers.