Monday, May 15, 2017

Is Undoing Financial Reform In Line With Free-Market Ideology?

Legislating on the basis of an aversion to government intervention in financial markets can paradoxically result in more massive intervention. The latter can come to pass even amid an anti-interventionist ideology on account of the emergency conditions that call for the extraordinary incursion of government into a market. Undoing the Orderly Liquidation Authority of the Dodd-Frank Act in the U.S. is a case in point.

In May, 2017, the U.S. House Financial Services Committee approved the Financial Choice Act, which would replace Title II of the Dodd-Frank Act—its orderly liquidation authority of banks going under. Rather than having “orderly liquidation authority backing up the bankruptcy code in times of extreme financial stress,” the Choice Act “would rely on bankruptcy only.”[1] Like Chapter 11 bankruptcy, the proposed Chapter 14 of the Choice Act would rely on private debtor-in-possession financing to keep a bank operating during bankruptcy. In a major financial crisis, such as that in September, 2008 when the commercial paper market ceased to function, “the debtor-in-possession lenders would be the ones in trouble” so they would not be willing or able to provide the funding.[2] This is because in a condition of systemic risk, multiple financial institutions face going under. In terms of bankruptcy, in other words, the financial sector is a unique bird. The funding needed to keep one or, more likely, several large banks operating during their respective bankruptcy proceedings would be more likely to come from the U.S. Government—that is, bailouts.

From the standpoint of the laissez-faire ideology of political economy, government intervention in a financial institution’s bankruptcy process—to keep it going in an orderly manner—is less intrusive than in a bailout. Yet in a period of severe stress on a financial system, “free-market” advocates in Congress may have little choice if the alternative is a defunct financial system in a matter of days. In headier days, the ideologically-driven lawmakers face little headwind in taking out a relatively less invasive incursion of the government—the proposed Chapter 14—yet with scant anticipation of the massive intervention that may be more likely in the long term during a financial crisis or panic. Hence Paul Volcker, who was President Reagan’s Chairman of the Federal Reserve, urged policymakers to preserve the Orderly Liquidation Authority precisely because under it “there is no taxpayer bailout.”[3] Volcker’s advice is in sync with the ideology that prefers as little government intervention in an economy as possible. In fact, breaking up the largest five U.S. financial institutions would also be in line with the ideology, for not only would more competition be possible, not even the orderly liquidation authority would likely be needed because the fall of one (smaller) bank would not be catastrophic. In other words, one bank in bankruptcy would not be as likely to involve systemic risk—in particular, the risk that other banks would also face ruin as a result and thus would not be able to provide financing for the bank as it goes through bankruptcy.

Perhaps the underlying problem behind the legislative proposal being entertained in the U.S. House of Representatives goes along with ideology itself—namely, the failure of the human mind ensconced in an ideology to accurately anticipate even in line with the ideological preference. Hence the failure of George W. Bush’s administration to apply anti-trust law to the largest U.S. banks may have precipitated Treasury Secretary Henry Paulson having to swallow proposing an $800 million financial bailout—something that could only be anathema to a conservative Republican. Looking on as the financial markets consolidated may not have been the best way to uphold the laissez-faire ideology in retrospect. Generally speaking, using governmental power to keep markets competitive in their structure (i.e., many small producers rather than an oligarchy or even a monopoly) may thus pay off in ideological dividends down the road.

[1] Stephen J. Lubben, “A Dodd-Frank Rewrite That Would Increase the Chance of Bailouts,” The New York Times, May 9, 2017.
[2] Ibid.
[3] The Volcker Alliance, “Volcker Urges Global and U.S. Policymakers to Stay Committed to Financial Reform,” PR Newswire, April 19, 2017.