Dodd-Frank and Too Big To Fail

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The drafters of the Dodd-Frank financial reform law got an important thing right. Despite fierce pushback from the banks – and lackluster support from the White House at critical moments – the legislators communicated a key new intent: megabanks must be able to fail, and the Federal Deposit Insurance Corporation should be in charge of that liquidation process.

The F.D.I.C. was an inspired choice for this role, because it is less captivated by the “magic” of Wall Street and less captured by its money and influence than any other group of officials.

The F.D.I.C. has also long been in the business of shutting down banks while limiting the damage to taxpayers, although it did not previously have complete jurisdiction over the largest banks when they got into trouble. It could only deal with those parts that had federally insured “retail” deposits, and this turns out not to be where the biggest problems have occurred in recent times.

Charged with this mandate involving the too-big-to-fail banks and with the difficult task of potentially shutting one or more of them without disrupting the economy, the F.D.I.C. took the remarkable step of opening up its decision-making process.

By creating a Systemic Resolution Advisory Committee of informed outsiders and by Webcasting the deliberations of that group, the agency has brought perhaps an unprecedented degree of transparency to public policy for banks – a point made forcefully by Dennis Kelleher; his blog at Better Markets is a must-read for anyone who cares about financial regulatory reforms. (Disclosure: I’m a member of the committee, an unpaid position.)

Committee members hold a wide range of views. Some are quite sympathetic to our existing financial structures, some much more skeptical. You can look over the list and make up your own mind as to who is on which side, and you might want to review the recording of the Jan. 25 meeting.

There is no question that the senior leadership of the F.D.I.C. is paying attention to the committee – and at the meetings, key people are put on the spot to discuss all relevant details with well-informed committee members, who can ask a lot of follow-up questions.

It is inconceivable that any other part of our financial regulatory apparatus will ever open itself up in the same way – for example, the Federal Reserve (in both Washington and New York), the Treasury Department and the Federal Stability Oversight Council are likely to be forever opaque. They, too, should open themselves up in public to tough cross-examination by experts, but that goes directly against their aloof and perhaps arrogant culture.

The history of American public administration is littered with examples of policy gone wrong – and actions misdirected – because informed and well-meaning critics were kept at arm’s length. Information is withheld even from other agencies. Powerful special interests work their influence; the rest of society has no effective voice. Even the most energetic Congressional oversight is unlikely to work when expert critics are kept so far from the real policy action.

Within the financial sphere, if the F.D.I.C. really manages to convince the markets that big banks can and will fail – meaning that creditors face the genuine prospect of losses – that changes everything.