Choice: OLA versus BOLA
This morning, I enjoyed being part of a panel at Brookings discussing the Orderly Liquidation Authority (OLA) in Title II of Dodd-Frank. This piece of Dodd-Frank has drawn a lot of criticism (including from me), and the Dodd-Frank repeal-and-replace bill that is under consideration in the House would replace OLA with BOLA — Bankruptcy Only Lifeline Available. OK, I made up the acronym, but the House bill focuses on making bankruptcy work better for financial companies, rather than on refining the OLA. The panel discussion raised a number of interesting questions related to the OLA.
First, which way does the OLA cut in terms of financial stability? Proponents of the OLA argue that it is necessary for financial stability because taking away the OLA would hamstring regulators facing a similar crisis in the future. They want the OLA to stay on the books as the go-to mechanism for dealing with future crises. But, contrary to good intentions, the OLA could make another financial crisis more likely to occur and worse if it does happen. The OLA’s ambiguity and lack of transparency are conducive to bailouts. Shareholders, creditors, other counterparties, and regulators of large financial companies know that the OLA is there just in case something goes really wrong, and this enables them to be a little less careful as they interact with these companies.
Second, will the OLA change the way financial companies are financed? The OLA, as envisioned by the FDIC, would protect short-term creditors to prevent them from running away from distressed financial companies. Shareholders and long-term creditors of the holding company in question are the ones regulators hope will bear any losses. It seems then that the OLA encourages more reliance on short-term funding at the subsidiary level, which may not be the result we want.
Third, is the OLA the taxpayer’s friend? The FDIC is allowed to borrow from Treasury an amount equal to ten percent of the company’s total assets in the first thirty days and ninety percent thereafter. The goal is to have the company repay the borrowed money, but the OLA also allows for repayment of any shortfall through assessments on systemically important financial companies. Regulators might be reluctant to impose large assessments on financial firms trying to keep their heads above water after another financial crisis.
Fourth, is the FDIC the right entity to manage financial company resolutions under the OLA? Sure, the FDIC has experience resolving banks of all sizes, but, even there, its track record is spotty and costs can be high (consider this recent resolution of a small bank which is anticipated to carry a nearly $1 billion loss to the deposit insurance fund). Moreover, the expertise in resolving failing banks, which usually are sold to a larger bank, may not be transferable to other types of financial institutions.
Fifth, does the OLA aid international cooperation in the oversight of financial institutions? My fellow panelists thought it would, but a clear commitment to rely on a revamped bankruptcy regime could be provide even more certainty to our foreign counterparts.
Sixth, how, if at all, should the OLA apply to central counterparty clearinghouses? These entities, particularly after Dodd-Frank’s derivatives reforms, are at the center of many financial transactions’ worlds, and a failure would reverberate widely. The panelists generally agreed that clearinghouse resolution and recovery is an issue that needs further consideration, but Chairman Bernanke suggested that a clearinghouse wouldn’t need to go through the OLA since its members could be resolved through the OLA. That gets us back to the question of whether the OLA would work for the member firms.
The OLA debate raises these and many other questions that are relevant as we consider how best to secure our financial stability, while ensuring that the financial system is dynamic, effective at serving the rest of the economy, and unsubsidized by taxpayers.
The entire event video is available on the Brookings website.
