On Monday, a regulatory body created by the Dodd-Frank reforms of 2010 named the first set of non-bank financial companies that will face the most stringent provisions of the Wall Street reform package. Since the so-called “shadow banking” sector was the epicenter of the complex and risky behavior that caused the financial crisis to spill over into the broader economy, the announcement constitutes significant progress for meaningful Wall Street reform. The news means that three major financial companies that do not take deposits – AIG, Prudential Financial, and GE Capital – will be unraveled by the government rather than bailed out should they go bankrupt in the future.
But the Financial Stability Oversight Council’s (FSOC) announcement was immediately mischaracterized as making bailouts more likely by Rep. Jeb Hensarling (TX), Chairman of the House Financial Services Committee. In a statement, Hensarling claimed that “hardworking taxpayers are at greater risk of being forced to fund yet another Wall Street bailout as their government officially designates more large companies as being ‘too big to fail’.”
Hensarling’s statement is premised on a misconception of the Dodd-Frank provision known as Orderly Liquidation Authority. That misconception is hardly limited to Hensarling. It was included in the GOP’s budget last year, and it dates back to industry-funded talking points drafted by Republican strategist Frank Luntz back when Dodd-Frank was being written.
The Orderly Liquidation Authority is the government’s tool to take over and unwind a failing financial company, rather than bailing it out. Federal Reserve Chairman Ben Bernanke has said such a policy could have forestalled the 2008 bailouts, and the Treasury Secretary who oversaw those bailouts agrees. Experts disagree about whether or not the system is sufficient to remedy the too-big-to-fail problem, with many arguing that further restrictions on the size and behavior of giant financial firms are necessary. But the GOP claim that Dodd-Frank enshrines bailouts and too-big-to-fail in law gets a complicated policy backwards.
Meanwhile, the announcement about AIG, Prudential, and GE Capital means that they will also be subject to stricter regulations than smaller, less systemically risky firms. “Systemically important financial institutions,” a list the three now find themselves on, will be subject to new Federal Reserve oversight and required to draft a “living will” to be used in dismantling them should they fail. Other specifics of the requirements they face have yet to be settled. They have 30 days to appeal the decision.