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Even before President Trump sent his memorandum to Treasury ordering an OLA review, the global regulators to whom I talked at the IMF spring meetings were worried. As a Bloomberg article today notes, “crises aren’t confined by national borders.” Reflecting the bank focus of these sessions, the regulators were particularly perturbed about the impact of any OLA rollback on the cross-border resolution of internationally-active banks. Not surprising – the White House order and Secretary Mnuchin’s accompanying statements were all about too-big-to-fail banks. However, there’s more to ending TBTF than rewriting the Bankruptcy Code – useful though that is – or realigning what’s in or out of an insured depository. Think Fannie, Freddie, AIG, Lehman, Bear Stearns, and Reserve Primary Fund and remember – systemic risk doesn’t just come from banks. Think all of these plus Herstatt, 9/11, and Fukushima and remember something else – systemic failure isn’t always the result of miscreant financiers. Remember all of this and then be afraid if OLA – untried, untested, and still incomplete as it is – is eliminated in the absence of stringent resolution standards for companies that threaten financial stability, especially in the absence of sufficient Federal Reserve emergency-liquidity authority.

The focus on OLA as a remedy to TBTF banks is in fact ironic. Of all the systemically-important financial institutions, giant U.S. banks have been subject to the greatest resolution preparation: a raft of new rules designed to cure their “negative externalities,” total loss-absorbing capacity, living wills often subject to unflattering scrutiny, and contractual automatic stays. Even far smaller banking organizations are given the SIFI once-over in the U.S., at least when it comes to many of the prudential rules and resolution requirements. The experience of the FDIC and its sweeping authority to shutter an insured depository should also go a long way to ending the backdoor bailouts of subsidiary banks we saw during the last financial crisis.

Is the bank-resolution framework perfect? Of course not. But something still beats nothing. What of the rest of the financial institutions that could quickly assume systemic dimensions in a crisis?

Many of them are exempt not only from prudential rules, but also anything like resolution-planning, stress-test, and contingency-planning requirements. It’s widely assumed that OLA only applies to big bank holding companies and designated SIFIs, but the law in fact is clear: any entity found to pose a systemic threat by its primary regulator can be resolved under OLA as long as Treasury concurs with this determination. The President need not agree, but Treasury must consult him or her and probably would not act without concurrence.

Given the lack of like-kind prudential and resolution rules and the inability of non-banks to access non-emergency Fed liquidity, OLA is actually far more of a safety net for non-banks than it is for the largest banking organizations. And, since they needn’t pay for it in advance with all of the rules applied to big banks, it’s not only a safety net, but also a very cost-effective one for any U.S. financial company whose counterparties get the willies.

What would we do next time around for an AIG? The Fed certainly couldn’t come to its aid given the Dodd-Frank constraints on its 13(3) powers, let alone those contemplated in the Hensarling bill. Assume that it’s no longer a SIFI subject to FRB regulation – another memo from President Trump presses for this. Freed from all of its living-wills and related SIFI standards and in the absence of OLA, the AIG next time would come under state guaranty associations. These have been working hard since the crisis to coordinate better and ready themselves for systemic distress, but it’s far from certain that these industry-funded backstops could handle an interstate failure – let alone an international one – that isn’t quickly resolved by acquisition.

What about the Bear Stearns next time? Forget about JPMorgan coming to the rescue. Even if it wanted to, the new rules essentially say it can’t. A Lehman redo? Same old systemic crisis although here changes to the Bankruptcy Code could make a big difference. As with a Bear Stearns rerun, changes to the Code would avoid the counterparty meltdown feared in the first case and all too evident in the second. Still, there isn’t a systemic-resolution framework for U.S. securities firms outside the SIPC backstop for small investors never intended to handle systemic risk. The real systemic bulwark for U.S. securities firms isn’t a prudential or resolution framework – it’s the fact that most of them were assumed by big banks during the crisis and none has yet emerged to take their place.

Giant asset-management companies pose an array of resolution risks despite the new liquidity standards imposed on MMFs. Many of these derive from operational risk because, as these companies are prompt to point out, investors bear solvency risk. Central counterparties are increasingly indispensable hubs of global finance but, as with major asset-management companies, they are also beyond the reach of the Fed and most of the resolution rules governing their big-bank members.

OLA isn’t ideal and it isn’t cheap and it isn’t even finished for big banks, let alone any of these non-banks. But, without it, what have we got? A U.S. financial system that had better hope for the very best.

After months of discussion on his initial “Choice Act” (see Client Report REFORM119) and a new discussion draft of what has become known as Choice 2.0, Chairman Hensarling (R-TX) today convened the Financial Services Committee for a marathon session.  Witnesses were almost uniformly supportive of the chairman’s bill, leading Ranking Member Waters (D-CA) to announce that Democrats will convene their own hearing on the measure.  This is unlikely to sway GOP views or deter Rep. Hensarling from pursuing rapid floor action after the mark-up now set for May 2.

The full report is available to retainer clients. To find out how you can sign up for the service, click here.

We have reviewed the new GSE-position paper from the Independent Community Bankers of America (ICBA), the small-bank trade association that packs a far bigger punch on Capitol Hill than the behemoths of the banking, asset-management, and hedge-fund world.  This is particularly true for Senate Banking Chairman Crapo, whose Idaho constituency is of course far more ICBA-focused than Wall Street.  With Crapo prioritizing GSE reform, the ICBA’s demands warrant watching.

The full report is available to retainer clients. To find out how you can sign up for the service, click here.

In this report, we build on our Friday assessment to go in depth into the President’s memorandum to Treasury on SIFI designations.  As noted, it covers not only designation of non-bank SIFIs, but also financial market utilities (FMUs).  The new Treasury study is to look at many of the issues raised in the MetLife decision (see Client Report SIFI19), for example at the value of determining not just if a company’s distress would be systemic, but also the likelihood that it would fail.  We expect the Administration to rewrite current FSOC designation criteria (see FSM Report SYSTEMIC60), but not to withdraw from the appeal now reconsidering the MetLife action.  Even if the Administration wished to do so – as these study criteria suggest – the procedure for actively withdrawing from the case is complex, doubtless dissuading Secretary Mnuchin from pursuing it.

The full report is available to retainer clients. To find out how you can sign up for the service, click here.