Senate Banking on the GAO Report on Government Support for Bank Holding Companies
At
January 8th’s Senate Banking Subcommittee on Financial Institutions and Consumer
Protection hearing entitled, “Examining the GAO Report on Government Support
for Bank Holding Companies,” lawmakers discussed the potential government
funding subsidy for large banks as considered in a report by the Government
Accountability Office.
Opening
Statements
Subcommittee
Chairman Sherrod Brown (D-Ohio) stated that the vote on the Troubled Asset
Relief Program (TARP) was both the best vote of his career, as it prevented the
economy from being destroyed, as well as the worst because “we allowed Wall
Street to run wild for too long, and the only option presented was a $700
billion bailout.”
Brown
expressed concern that the four largest banks today “control about 42 percent
of the banking industry” and the top six banks hold assets equal to more than
60 percent of GDP. He stated that the GAO’s first report “shows that the
largest Wall Street banks borrow on favorable terms directly from the federal
government during turbulent times” and expected that the second report “will
show that the government’s implicit support enables Wall Street banks to borrow
on favorable terms from the market in ordinary times.”
Subcommittee
Ranking Member Pat Toomey (R-Penn.), in his remarks, expressed consternation
that with the dearth of new community banks being established in the U.S., explaining
that the regulatory burden does not make it feasible to enter the industry. He
then said he looked forward to seeing the results of the next GAO study and if
the subsidy is “implied or not,” noting that funding costs are a function of
many different factors.
Toomey
added that if there is a subsidy, it likely results from Title II of the
Dodd-Frank Act which grants the Federal Deposit Insurance Corporation (FDIC)
the authority to use Treasury funds to support bank creditors. He called
Title II “one of the biggest flaws of Dodd-Frank” and noted legislation he
co-sponsors, S.
1861, which seeks to repeal this provision.
Witness
Testimony
Lawrance
L. Evans, Director, Financial Markets and Community Investment at the GAO, stated
that Congressional action during the crisis, including granting bank holding
company (BHC) status to certain firms and providing liquidity, raised concerns
about moral hazard and could create an expectation of future government
support. He noted however, that Dodd-Frank contained provisions to restrict
future government assistance and subjected banks to heightened prudential
standards and oversight, but that the effectiveness of these provisions is
uncertain as implementation is incomplete.
Evans
said that figuring out where financial firms receive benefits or a subsidy is
“largely an empirical question” and noted that the GAO will conduct an
empirical analysis and include the results in a report to be published later
this year.
Luigi
Zingales, Professor at the University of Chicago Booth School of Business, stated
that “the only effective tool to eliminate a subsidy to large BHCs is to design
a mechanism of prompt intervention, which is triggered much before a BHC
becomes insolvent.” He said that such a tool can be implemented using the
authorities contained in Dodd-Frank to have the Federal Reserve impose a
maximum price for a credit default swap (CDS) of a BHC’s junior debt. He
explained that if the price of a CDS exceeds a certain threshold or ceiling, a
firm would be required to issue equity to raise capital and “if it does not, it
should be taken over by the regulator and liquidated using the Ordinary
Liquidation Authority under Dodd-Frank.”
Simon
Johnson, Professor at the MIT Sloan School of Management, stated
that he agrees, “roughly speaking,” with the GAO report and added that the cost
on the country’s budget, in terms of the increase in public debt levels, should
be taken into consideration when considering reforms.
Johnson
agreed with the goals of limiting the size of banks to a certain percentage of
GDP and shared concerns of Sen. Toomey that community banks have been harmed
since the crisis. He did, however, raise issue with Toomey’s legislation
and its lack of back-up “debtor in possession” financing, saying he worried
about contagion effects without such a measure.
Harvey
Rosenblum, retired Director of Research, Federal Reserve Bank of Dallas, stated
that the “too big to fail” (TBTF) subsidy equals about $50-100 billion a year,
and that it distorts economic behavior and “will go on into perpetuity” without
corrective action. He said this subsidy is essentially an expenditure
made by Congress which has never been voted on.
Rosenblum
explained that the recommendations of the Dallas Fed to eliminate this subsidy
include: 1) restricting the federal safety net to traditional commercial banks;
2) requiring that counterparties at non-bank subsidiaries acknowledge there is
no federal backstop at these entities with a formal document; and 3)
implementing government policies to streamline and right-size the largest
banks.
Allan
Meltzer, Professor at Carnegie Mellon University’s Tepper School of Business, stated
that legislation should increase the incentive of banks to act prudently and
require owners and managers to bear the costs of errors and mistakes, while
also ensuring that single bank failures will not harm the overall system.
Meltzer also said that banks should have more equity to absorb losses and be
required to mark their money mutual funds (MMFs) to market.
Question
and Answer
Sen.
Brown noted that the Treasury department has said they made profits of over
$120 billion on repayments from TARP and asked the panel how a subsidy can
exist if the government is profiting.
Johnson
replied that the Treasury “got lucky” with the money it was able to receive
back from the program, but that on a forward looking basis, returns need to be
risk-adjusted.
Sen.
Toomey asked if Dodd-Frank perpetuates TBTF and if Title II contributes to any
government subsidy for these institutions.
Rosenblum
said yes, and that labeling firms as systemically important financial
institutions (SIFIs) “compounds the problem.”
Johnson
responded, saying that there are some scenarios where the FDIC’s “single point
of entry” process can be helpful, but it will not work with the largest firms
because there is no cross-border resolution process.
Toomey
then asked Zingales about his suggestion that the Fed monitor the price of CDSs
on subordinated debt, and impose, basically, a margin call where new capital
would have to be raised. He asked if something like this were in place, if
there would be need for restrictions on certain activities, such as the Volcker
Rule which restricts banks’ profitability.
Zingales
replied that if this mechanism was in place, then the need to restrict certain
activities “would be much less” and that the focus should be on leverage and
riskiness.
Sen.
Jack Reed (D-R.I.) stated that the aspect of Dodd-Frank pertaining to warrants
resulted in $9 billion of proceeds going back to taxpayers and asked if this
should serve as a template for future reforms.
Johnson
said that the warrant language was a sensible and good idea because the if the
government is providing support it should have upside potential for its
capital.
Reed
then stated that some of the risky behavior seen in banks is due to incentives
in the tax code and asked how this should be addressed.
Metzler
replied that “the way to get change is not doing piecemeal” fixes on
compensation, as firms will “find ways to circumvent” these steps, but that
something similar to the Brown-Vitter legislation, S. 798, should be
implemented so that employees bear the costs of their errors.
Sen.
Jeff Merkley (D-Ore.) stated that the cross-border complexity of BHCs is a “key
piece of the puzzle” and asked the panel how satisfied they are with the
current regime.
Johnson
replied that cross-border resolution “remains a huge problem” and is the
“Achilles heel of the entire approach.” He said not only do cross-border
resolutions remain a problem under Title II of Dodd-Frank; they are an
“insurmountable option” for the bankruptcy process.
Metzler
suggested that banks be separated from their holding companies so that
subsidiaries can be separate entities subject to the laws applicable in the
jurisdiction where they are operating.
Sen.
Elizabeth Warren (D-Mass.) asked if the Volcker Rule solves the problem of
TBTF.
Johnson
stated that the rule is helpful but, taken by itself, even if it is implemented
“in the most forceful fashion,” it will not end TBTF. The rest of the
panel agreed with this assessment.
Warren
then asked if enforcing all of the rules spelled out in the Dodd-Frank Act
would be enough to end TBTF.
Rosenblum
sternly stated that they would not solve the problem, and said that Dodd-Frank
is “mindboggling and unenforceable” and “does more harm than good.” He stressed
that rules need to be more simple and straightforward and legislators should
“go back to the drawing board” to come up with something more “do-able.”
Johnson
said that Dodd-Frank could end TBTF through Title I but not under its current
interpretation.
When
Warren asked the panel if it would make sense to wait until all of the
Dodd-Frank rules are in place before considering more legislative action to
address TBTF, they all said no.
Second
Round – Question and Answer
In
a second round of questioning, Sen. Brown stated that Section 23A of the
Federal Reserve Act, which is
intended to protect banks from suffering losses arising from transactions with
affiliates, was ineffective in the crisis and asked how it could be strengthened
to improve legal firewalls.
Rosenblum
replied that the ability of non-bank subsidiaries to put assets in banks and be
eligible for deposit insurance and the Fed’s discount window is “abhorrent” and
that 23A should be “tightened up” to require advance notice from the Fed for
any exceptions that they grant for firms.
Brown
then noted that regulators have given firms a compliance extension for Section
716 of the Dodd-Frank Act, also known as the “swaps push-out rule,” and asked
if this is a problem.
Metzler
stated that this could be viewed as an instance of regulatory capture and that
any problems seen with regard to derivatives should be addressed through
putting cash requirements directly on banks for their derivatives
holdings. He continued that arguments saying such actions will reduce
lending in the industry are “baloney” as banks only decide who gets credit,
while the Fed decides how much credit there is in the system.
Next,
Brown asked if U.S. regulators should move ahead now on their supplemental
leverage ratio plan or wait until other jurisdictions advance their own rules.
Johnson
said he was disconcerted with the news that the Fed plans to wait for the Basel
plan to come out before finishing their rules, and said he did not see “how
this deferral is helpful.”
Rosenblum
agreed with Johnson and said that the U.S. should take the lead because it is
the most important economy and financial system in the world. He added the U.S.
system should be the safest and regulators should “not wait for the least
common denominator.”
Brown
then raised issue with the fact that the GAO weighs the expert opinions they
receive in their studies equally and said they should take into account if the
opinion is being funded by the industry.
Evans
replied that the GAO is fair and balanced in their approach and they talk to
all stakeholders, but are aware of industry lobbying power and conflicts of
interest.
Lastly,
Brown referenced Securities and Exchange Commission (SEC) Rule 501-6-c and its
requirement to make disclosures to investors about material impacts on a firm’s
financial condition. Brown said that many firms do not include information or
are vague about any capital injection received from the Treasury and asked how
to address this lack of disclosure.
The
panel agreed that this type of disclosure could be helpful, but cautioned that
there should be a two to three year delay on these disclosures in order to
avoid market and economic instability.
For
more information on this hearing and to view a webcast, please click here.
,Blog Tags:,Blog Categories:,Blog TrackBack:,Blog Pingback:No,Hearing Summaries Issues:Capital/Resolution Authority/SIFIs,Hearing Summaries Agency:Senate Banking Committee,Publish Year:2014
At
January 8th’s Senate Banking Subcommittee on Financial Institutions and Consumer
Protection hearing entitled, “Examining the GAO Report on Government Support
for Bank Holding Companies,” lawmakers discussed the potential government
funding subsidy for large banks as considered in a report by the Government
Accountability Office.
Opening
Statements
Subcommittee
Chairman Sherrod Brown (D-Ohio) stated that the vote on the Troubled Asset
Relief Program (TARP) was both the best vote of his career, as it prevented the
economy from being destroyed, as well as the worst because “we allowed Wall
Street to run wild for too long, and the only option presented was a $700
billion bailout.”
Brown
expressed concern that the four largest banks today “control about 42 percent
of the banking industry” and the top six banks hold assets equal to more than
60 percent of GDP. He stated that the GAO’s first report “shows that the
largest Wall Street banks borrow on favorable terms directly from the federal
government during turbulent times” and expected that the second report “will
show that the government’s implicit support enables Wall Street banks to borrow
on favorable terms from the market in ordinary times.”
Subcommittee
Ranking Member Pat Toomey (R-Penn.), in his remarks, expressed consternation
that with the dearth of new community banks being established in the U.S., explaining
that the regulatory burden does not make it feasible to enter the industry. He
then said he looked forward to seeing the results of the next GAO study and if
the subsidy is “implied or not,” noting that funding costs are a function of
many different factors.
Toomey
added that if there is a subsidy, it likely results from Title II of the
Dodd-Frank Act which grants the Federal Deposit Insurance Corporation (FDIC)
the authority to use Treasury funds to support bank creditors. He called
Title II “one of the biggest flaws of Dodd-Frank” and noted legislation he
co-sponsors, S.
1861, which seeks to repeal this provision.
Witness
Testimony
Lawrance
L. Evans, Director, Financial Markets and Community Investment at the GAO, stated
that Congressional action during the crisis, including granting bank holding
company (BHC) status to certain firms and providing liquidity, raised concerns
about moral hazard and could create an expectation of future government
support. He noted however, that Dodd-Frank contained provisions to restrict
future government assistance and subjected banks to heightened prudential
standards and oversight, but that the effectiveness of these provisions is
uncertain as implementation is incomplete.
Evans
said that figuring out where financial firms receive benefits or a subsidy is
“largely an empirical question” and noted that the GAO will conduct an
empirical analysis and include the results in a report to be published later
this year.
Luigi
Zingales, Professor at the University of Chicago Booth School of Business, stated
that “the only effective tool to eliminate a subsidy to large BHCs is to design
a mechanism of prompt intervention, which is triggered much before a BHC
becomes insolvent.” He said that such a tool can be implemented using the
authorities contained in Dodd-Frank to have the Federal Reserve impose a
maximum price for a credit default swap (CDS) of a BHC’s junior debt. He
explained that if the price of a CDS exceeds a certain threshold or ceiling, a
firm would be required to issue equity to raise capital and “if it does not, it
should be taken over by the regulator and liquidated using the Ordinary
Liquidation Authority under Dodd-Frank.”
Simon
Johnson, Professor at the MIT Sloan School of Management, stated
that he agrees, “roughly speaking,” with the GAO report and added that the cost
on the country’s budget, in terms of the increase in public debt levels, should
be taken into consideration when considering reforms.
Johnson
agreed with the goals of limiting the size of banks to a certain percentage of
GDP and shared concerns of Sen. Toomey that community banks have been harmed
since the crisis. He did, however, raise issue with Toomey’s legislation
and its lack of back-up “debtor in possession” financing, saying he worried
about contagion effects without such a measure.
Harvey
Rosenblum, retired Director of Research, Federal Reserve Bank of Dallas, stated
that the “too big to fail” (TBTF) subsidy equals about $50-100 billion a year,
and that it distorts economic behavior and “will go on into perpetuity” without
corrective action. He said this subsidy is essentially an expenditure
made by Congress which has never been voted on.
Rosenblum
explained that the recommendations of the Dallas Fed to eliminate this subsidy
include: 1) restricting the federal safety net to traditional commercial banks;
2) requiring that counterparties at non-bank subsidiaries acknowledge there is
no federal backstop at these entities with a formal document; and 3)
implementing government policies to streamline and right-size the largest
banks.
Allan
Meltzer, Professor at Carnegie Mellon University’s Tepper School of Business, stated
that legislation should increase the incentive of banks to act prudently and
require owners and managers to bear the costs of errors and mistakes, while
also ensuring that single bank failures will not harm the overall system.
Meltzer also said that banks should have more equity to absorb losses and be
required to mark their money mutual funds (MMFs) to market.
Question
and Answer
Sen.
Brown noted that the Treasury department has said they made profits of over
$120 billion on repayments from TARP and asked the panel how a subsidy can
exist if the government is profiting.
Johnson
replied that the Treasury “got lucky” with the money it was able to receive
back from the program, but that on a forward looking basis, returns need to be
risk-adjusted.
Sen.
Toomey asked if Dodd-Frank perpetuates TBTF and if Title II contributes to any
government subsidy for these institutions.
Rosenblum
said yes, and that labeling firms as systemically important financial
institutions (SIFIs) “compounds the problem.”
Johnson
responded, saying that there are some scenarios where the FDIC’s “single point
of entry” process can be helpful, but it will not work with the largest firms
because there is no cross-border resolution process.
Toomey
then asked Zingales about his suggestion that the Fed monitor the price of CDSs
on subordinated debt, and impose, basically, a margin call where new capital
would have to be raised. He asked if something like this were in place, if
there would be need for restrictions on certain activities, such as the Volcker
Rule which restricts banks’ profitability.
Zingales
replied that if this mechanism was in place, then the need to restrict certain
activities “would be much less” and that the focus should be on leverage and
riskiness.
Sen.
Jack Reed (D-R.I.) stated that the aspect of Dodd-Frank pertaining to warrants
resulted in $9 billion of proceeds going back to taxpayers and asked if this
should serve as a template for future reforms.
Johnson
said that the warrant language was a sensible and good idea because the if the
government is providing support it should have upside potential for its
capital.
Reed
then stated that some of the risky behavior seen in banks is due to incentives
in the tax code and asked how this should be addressed.
Metzler
replied that “the way to get change is not doing piecemeal” fixes on
compensation, as firms will “find ways to circumvent” these steps, but that
something similar to the Brown-Vitter legislation, S. 798, should be
implemented so that employees bear the costs of their errors.
Sen.
Jeff Merkley (D-Ore.) stated that the cross-border complexity of BHCs is a “key
piece of the puzzle” and asked the panel how satisfied they are with the
current regime.
Johnson
replied that cross-border resolution “remains a huge problem” and is the
“Achilles heel of the entire approach.” He said not only do cross-border
resolutions remain a problem under Title II of Dodd-Frank; they are an
“insurmountable option” for the bankruptcy process.
Metzler
suggested that banks be separated from their holding companies so that
subsidiaries can be separate entities subject to the laws applicable in the
jurisdiction where they are operating.
Sen.
Elizabeth Warren (D-Mass.) asked if the Volcker Rule solves the problem of
TBTF.
Johnson
stated that the rule is helpful but, taken by itself, even if it is implemented
“in the most forceful fashion,” it will not end TBTF. The rest of the
panel agreed with this assessment.
Warren
then asked if enforcing all of the rules spelled out in the Dodd-Frank Act
would be enough to end TBTF.
Rosenblum
sternly stated that they would not solve the problem, and said that Dodd-Frank
is “mindboggling and unenforceable” and “does more harm than good.” He stressed
that rules need to be more simple and straightforward and legislators should
“go back to the drawing board” to come up with something more “do-able.”
Johnson
said that Dodd-Frank could end TBTF through Title I but not under its current
interpretation.
When
Warren asked the panel if it would make sense to wait until all of the
Dodd-Frank rules are in place before considering more legislative action to
address TBTF, they all said no.
Second
Round – Question and Answer
In
a second round of questioning, Sen. Brown stated that Section 23A of the
Federal Reserve Act, which is
intended to protect banks from suffering losses arising from transactions with
affiliates, was ineffective in the crisis and asked how it could be strengthened
to improve legal firewalls.
Rosenblum
replied that the ability of non-bank subsidiaries to put assets in banks and be
eligible for deposit insurance and the Fed’s discount window is “abhorrent” and
that 23A should be “tightened up” to require advance notice from the Fed for
any exceptions that they grant for firms.
Brown
then noted that regulators have given firms a compliance extension for Section
716 of the Dodd-Frank Act, also known as the “swaps push-out rule,” and asked
if this is a problem.
Metzler
stated that this could be viewed as an instance of regulatory capture and that
any problems seen with regard to derivatives should be addressed through
putting cash requirements directly on banks for their derivatives
holdings. He continued that arguments saying such actions will reduce
lending in the industry are “baloney” as banks only decide who gets credit,
while the Fed decides how much credit there is in the system.
Next,
Brown asked if U.S. regulators should move ahead now on their supplemental
leverage ratio plan or wait until other jurisdictions advance their own rules.
Johnson
said he was disconcerted with the news that the Fed plans to wait for the Basel
plan to come out before finishing their rules, and said he did not see “how
this deferral is helpful.”
Rosenblum
agreed with Johnson and said that the U.S. should take the lead because it is
the most important economy and financial system in the world. He added the U.S.
system should be the safest and regulators should “not wait for the least
common denominator.”
Brown
then raised issue with the fact that the GAO weighs the expert opinions they
receive in their studies equally and said they should take into account if the
opinion is being funded by the industry.
Evans
replied that the GAO is fair and balanced in their approach and they talk to
all stakeholders, but are aware of industry lobbying power and conflicts of
interest.
Lastly,
Brown referenced Securities and Exchange Commission (SEC) Rule 501-6-c and its
requirement to make disclosures to investors about material impacts on a firm’s
financial condition. Brown said that many firms do not include information or
are vague about any capital injection received from the Treasury and asked how
to address this lack of disclosure.
The
panel agreed that this type of disclosure could be helpful, but cautioned that
there should be a two to three year delay on these disclosures in order to
avoid market and economic instability.
For
more information on this hearing and to view a webcast, please click here.