If banks can delay, pray

November 24, 2009

The “too-big-to-fail” amendment offered by Representative Paul Kanjorski has good intentions, but fatal flaws.

One I wrote about on Monday. Another is a section (see page 7) that gives systemically dangerous institutions (SDIs) the right to appeal regulatory orders in a federal district court. If they don’t like the corrective actions that regulators instruct them to take, they could delay them indefinitely.

With bank resolutions, the key issue is speed. We learned that the hard way during the savings and loan debacle. Allowing banks to deteriorate until they have no capital left is like waiting for an infection to turn gangrenous before treating it.

With most companies, that’s not a problem for anyone but shareholders and creditors. But banks aren’t like other firms. Society provides them a strong, and expensive, safety net. And that safety net has expanded significantly in the last year.

In exchange, we rightly subject them to more stringent regulations. We guarantee their liabilities, after all, so we’ve the responsibility to control their assets.

As Ed Kane of Boston College told me: “We support them the way parents support children. It’s our responsibility to discipline them.”

So that regulators have the power to act quickly against plain-vanilla banks, Congress established the Prompt Corrective Action doctrine in 1991. It gives bank regulators extraordinary power to put the screws to banks before they dig themselves too deep a hole.

Banks may consult with regulators on what needs to be done. But the only judicial review available to them is through the court of appeals, which must review the administrative record of corrective actions that regulators have already instructed banks to take. And it must do so in an expedited manner, typically 30 days.

A similar doctrine to break up SDIs proactively is what many had hoped Kanjorski would propose. But the judicial review process it envisions would turn corrective actions into the SDIs’ shield, rather than the regulator’s sword.

For one thing, it would allow SDIs to challenge their regulator in a district court, not the court of appeals. A district court’s review wouldn’t be limited to the administrative record; it would likely include a trial by jury. First of all, this would involve a lengthy discovery process. And systemically dangerous institutions typically have the best, most expensive lawyers in the world. While regulators are tied up, they would have an even stronger incentive to engage in morally hazardous behavior, to shift losses to the safety net while looting whatever value is left in the institution.

Just look at the billions in bonuses that Wall Streeters paid themselves last year after their balance sheets were rescued by taxpayers.

Professor Bill Black of the University of Missouri Kansas City worries Kanjorski’s judicial review process would effectively turn the district judge and jury into the regulator, a position for which they have no expertise. Would a North Carolina jury instruct Bank of America to take corrective actions that could lead to thousands of lost jobs in their area? Probably not.

Black says Kanjorski can improve his amendment by limiting SDIs’ judicial recourse to an expedited review of the administrative record in front of the court of appeals.

Kanjorski’s head is in the right place, even if his legislation is flawed. We need a new regime that encourages regulators to break up big banks before they threaten to bring down the system.

But his amendment makes the process too difficult. Already it erects a big roadblock by telling regulators they can only take action if an SDI “poses a grave threat to the (nation’s) financial stability or economy.”

By the time regulators realize a firm poses a grave threat, it’s probably too late to do much about it. And if the firm can delay action indefinitely by going to a district court, then what’s the point?

Comments

I like Ed Kane’s comment, but it should be expanded to note that we support banks like parents who give their kids candy all day every day and then whine about the dentist bills. In other words: like bad parents.

Posted by Andrew | Report as abusive
 

“And if the firm can delay action indefinitely by going to a district court, then what’s the point?’That’s the point. Believe it or not, Jacob Viner thought that the 1933 & 1935 Banking changes were just the beginning of more changes. Deposit Insurance, which FDR opposed and the Chicago Plan economists thought was a good temporary measure, was supported by many banks because they thought it would ease the support for more change. It was a good idea, but fell short of what many people believed was needed.It’s the same deal here. Things will be better for a time, but eventually worsen. I’ve got all my Narrow/Limited/Utility Banking sources ready for the next financial crisis.

 

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