Five Prime Advisors
Five Prime Advisors


Some thoughts on valuation, regulation, development, & investment

Memories Are Short

Between November 2008 and April 2009, the United States suffered its worst economic crisis since the Great Depression. Nine million jobs disappeared. Unemployment rose to over ten percent. Eight million Americans lost their homes to foreclosure.  The impact of the crisis was widespread and devastating.

As a result, Congress enacted legislation and in July 2010 President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act.  The legislation significantly reduced the risk that regulators would be forced to rescue a failing financial institution or risk collapse of the entire sector.  If the Fed had thrown Lehman Brothers a lifeline, it is quite possible that the contagion that swept through the financial system and ultimately engulfed the real sector, where most of those nine million jobs were lost, would have been avoided.

The Hobson's choice that the Fed faced in choosing not to rescue Lehman had catastrophic consequences.  When the dust settled, American corporate icons many believed would be immune to collapse had received taxpayer funds.  If not for the Obama Administration's aggressive intervention, General Motors and thousands of jobs it supports, wouldn’t exist today.  There are few serious economists who believe that massive government intervention wasn’t needed to keep the economy from slipping into a 1930s style depression. Yet memories are short. Michigan went Trump in 2016 and the Republicans are dismantling Dodd-Frank.

A bill sponsored by Jeb Hensarling (R-Texas) that largely guts Dodd-Frank is ready to be brought to a vote of the House. The Financial CHOICE Act of 2017 repeals many of the safeguards created under Dodd-Frank, including the important Volker Rule.  Most troubling, the bill removes the Financial Stability Oversight Council’s authority to designate non-bank financial institutions and financial market utilities as “too big to fail,” or “systematically important,” in the language of Dodd-Frank.

Reforms under Dodd-Frank ensured that financial institutions deemed systematically important would have the capital and liquidity to weather economic and self-created storms, and in the event of failure, that there exists a process ensuring an orderly liquidation that doesn’t buffet the financial system or require taxpayer assistance.  CHOICE eliminates the FDIC’s orderly liquidation authority under Title II of Dodd-Frank and creates a new chapter in the bankruptcy code providing for the winding down of a failed institution. MetLife has successfully sued in Federal court to have its “too big to fail” designation removed.  Suits brought by other companies designated as such, including AIG and GE’s financial unit, are winding their way through the courts.

In a bankruptcy process, an announcement of restructuring by a systematically important bank or market utility has the potential to significantly destabilize the financial system. Without a credible liquidity backdrop which doesn’t exist in bankruptcy, counterparties run for the exits, turning restructuring into a liquidation with losses that could exceed hundreds of billions of dollars.  Moreover, Section 23A of the Federal Reserve Act restricts a commercial banking subsidiary of a bank holding company from lending funds borrowed from the Fed to a broker-dealer affiliate.  At present, Title II of Dodd-Frank enables the Fed to act as such a backdrop giving it the authority to provide the liquidity required for an orderly winding down.  The Republican plan to repeal Title II will have dire consequences in the next financial meltdown.

Peter Meyers