Konczal on Too Big To Fail

Mike Konczal has a very good post on the announcement of JP Morgan Chase’s multi-billion trading loses and what it means for our legal ability to deal with Too Big To Fail banks. Konczal writes:

There are two ways to look at the relationship between the Dodd-Frank financial reform framework and JP Morgan’s loss disclosure. One is that it shows the need for a strong implementation of Dodd-Frank broadly and the Volcker Rule specifically, which is designed to separate prop trading from large, risky financial firms. Marcus Stanley of Americans for Financial Reform has a great post up discussing what happened, how the principle of the Volcker Rule should work in this situation, and the threats it faces. Dodd-Frank is designed to make the financial markets more transparent and robust to shocks through such mechanisms as expanding clearing requirements for derivatives and reducing interconnectedness between large financial firms. It is also designed to make it less likely that any individual firm will collapse by having stronger capital requirements for larger financial firms and eliminating certain business lines they can participate in through the Volcker Rule. This is crucial for a Too Big To Fail firm like JP Morgan.

But the second is to acknowledge that businesses run profits and they run losses. There is something to a conservative like Kevin Williamson’s remark that “The odd thing about this is that it is now considered somehow scandalous when a business loses money. It’s a scandal when banks make profits, and it’s a scandal when they make losses.” On a long enough timeline, the survival rate for everyone drops to zero. Though it was clear quickly at 5 p.m. Thursday that JP Morgan wasn’t in danger of collapsing, if things had been different it could have failed.

This illustrates the need for a mechanism to allow firms to fail in a way that fairly allocates losses to the right parties. The way corporations fail in this country is a series of legal choices we’ve made, and we found in the fall of 2008 that the mechanism we have for a shadow-bank financial firm failing — Chapter 11 bankruptcy — dragged down the entire system with it. Hence the move to bring in the FDIC to make sure a financial firm fails in a way compatible with fairness. The FDIC has special powers — advance planning and living wills, debtor-in-possession financing and liquidity, making payments to creditors based on expected recoveries, keeping operations running, the ability to transfer qualified financial contracts without termination, and the ability to turn up or down regulations going into a potential resolution based on prompt corrective action — appropriate to what our 21st century financial system needs.

I think it’s worth noting, though, that these aren’t “legal choices.” They are political choices and they are choices in morality. Fundamentally these laws speak to the question of who government serves at a time when large corporations fail. What we saw in 2008 and 2009 (and, really, since then too) is that political elites have by and large chosen to serve financial elites first and foremost. Not only are the interests of banks protected, but they are protected through the public treasury. What we have now with Title II of Dodd-Frank, which governs the winding down of TBTF banks and who pays for it, is the perfect example. Matt Taibbi recently covered how Wall Street helped achieve weak financial regulatory reform, particularly around who pays for future bailouts for failed banks.

In a nod to FDR, Title II would have forced major financial companies to pay $19 billion into an FDIC-style fund that would cover the cost of any future bailouts. But then the balance of power in the Senate was upset by the election of Republican Scott Brown to Ted Kennedy’s seat in Massachusetts. As the clock wound down toward the bill’s passage, Brown insisted on a change: Instead of making ginormous companies pay $19 billion in advance, the FDIC would first use taxpayer money to pay for any bailouts, and then spend years trying to recover that money from Wall Street by means of an assessment process so convoluted that you could grow a four-foot beard in the time it would take to understand it. Republicans managed to wrangle support, in conference, for the “bailout now, pay later” idea, and it made its way into the final bill.

Fast-forward to 2012. Rep. Paul Ryan, the self-styled Edward Scissorhands of Republican budget slashing, gathers the GOP leadership together and tells the chairman of each committee that he wants them, collectively, to come up with $261 billion in cuts. Ryan demands $35 billion of the cuts come from the Financial Services Committee, which oversees much of the regulatory apparatus that would enforce Dodd-Frank. The committee is now chaired not by the reform bill’s namesake, Rep. Barney Frank, but by median-intellected Spencer Bachus of Alabama, who last year voted to delay Dodd-Frank reforms designed to prevent swaps disasters like the one that drove his home turf of Jefferson County into bankruptcy.

Bachus’ solution to coming up with massive budget cuts? Eliminate the entire Title II section of Dodd-Frank. If another­ bank failed, Bachus argued, it would take way too long to recoup the bailout money from Wall Street through that crazy assessment process that Republicans themselves had insisted on only two years earlier. In the end, the logic went, taxpayers would wind up footing the bill anyway, so better just to scrap the entire plan to have the FDIC pay for the bailouts upfront – thus “saving” taxpayers some $22 billion.

The logic, of course, is complete nonsense. Without Title II, we’d be right back where we started – rushing to implement an expensive bailout in the midst of a crisis, without any way to make Wall Street repay the money. But because Democrats had preemptively surrendered on the original idea of forcing Wall Street to pay into an FDIC-style kitty ahead of time, Republicans were now in a position to push the whole bailout plan off the pier via a simple budget resolution.

Title II of Dodd-Frank is also something, as Konczal notes, that Republicans in the House of Representatives voted to repeal last week. A weak and ineffective provision that had meager measures to actually make the banks pay for a bailout and would likely cost taxpayers (at minimum) billions was supported by Democrats. And even that is too much for Republicans.

It’s great that the JP Morgan Chase Fail Whale trade is re-surfacing discussion of financial regulatory reform. But to this point we’ve only seen political elites at the service of financial elites, deploying regulations in a way that shows their preference for wealth to be preserved in the hands of a few bankers (regardless of how often those bankers fail in their business operations). I don’t expect that to change any time soon, at least without the actual crisis of another Too Big To Fail bank failing and being bailed out with hundreds of billions of dollars from the public’s coffers.

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