Dodd-Frank Title II is Incomplete and Misleading?

by the Curmudgeon with Victor Sperandeo



This is an update of our Sunday evening, August 16th research paper titled Are Americans Now Slaves of Their Banks?


The Curmudgeon contacted the American Banking Association (ABA) in an attempt to get some answers as to why the various “bail-in” and GLAC bond proposals have not been finalized as part of the Dodd-Frank Title II (or other) law.  Moreover, we were concerned there was little or no Congressional oversight nor co-operation with the FDIC and U.S. Treasury Secretary, whom together have to implement the methods and procedures when a “structurally significant” bank fails.  Here's what I wrote to the ABA:


We are concerned about the incompleteness of Dodd-Frank Title II in light of all the "Bail-In & GLAC bond" proposals floating around for the last two years.  The key issue is preventing taxpayer bailouts of busted "too big to fail" banks.  The entities are described, but there are no methods, procedures, mechanism or PLAYBOOK to execute the various scenarios that have been described by Federal Reserve Board members, academics, and lawyers.  The actual "bail-in" methods and procedures for failed "structurally significant" banks are to be executed by the FDIC in conjunction with the U.S. Treasury Secretary.  However, they are NOT described in Dodd-Frank Title II or anywhere else.   Hence, Title II is incomplete and misleading (check references included in article).


As a result, we believe that "all hell will break loose" if a too big to fail bank goes bust anytime soon, e.g. because its derivative trading department blows up.  We also are concerned that there is insufficient Congressional oversight for the writers of the Dodd-Frank law.  Finally, there seems to be a lack of cooperation between Congress, FDIC, and Treasury Secretary on this entire set of Title II/ "bail-in" issues and scenarios.


One of our important sources of information for the above research paper was this ABA post:


Title II Overview: Orderly Liquidation Authority, which is cited as a reference.


Editor's Note:  This paragraph is quite significant as it highlights the uncertainties that may result after a big bank failure:


“While this approach will provide significant new tools for Federal regulators to deal with threats to U.S. financial stability, it will create significant uncertainties for companies, that because of their size or interconnections with other major financial services firms, could potentially become the subject of a Federal receivership action.  These companies and their equity holders, creditors, borrowers, customers, vendors and counter-parties will have no assurance in advance as to whether financial distress at the company will be dealt with in a Chapter 11 reorganization or a Chapter 7 liquidation under the Bankruptcy Code, or a Federal receivership under Title II.”


Here's a very troubling section of the ABA's Title II Summary: 


2.17. Study on Secured Creditor Haircuts.

The Oversight Council is required to conduct a study that evaluates the importance of maximizing taxpayer protections and promoting market discipline in regard to the treatment of fully secured creditors in connection with the utilization of orderly resolution authority. Among other matters, the Oversight Council is to examine how a haircut on secured creditors could improve market discipline and protect taxpayers. The Oversight Council is also to examine the behavior of creditors who are unsecured or under-collateralized and who seek collateral when a firm is failing, and the impact such behavior has on financial stability and an orderly resolution that protects taxpayers if the firm fails. The Oversight Council must provide a report to Congress on its findings and recommendations no later than 1 year after the enactment of the Act. [§215]


Separately, the FDIC website makes no mention of “bail-in” or any similar procedure to avoid taxpayer bailouts of big banks that fail.  Please refer to When a Bank Fails - Facts for Depositors, Creditors, and Borrowers 


It's crucial to remember that if a single big bank fails, contagion is rapid (due to inter-relationships banks have) which would likely result in a series of cascading bank failures.  That would quickly exhaust FDIC bail-out funds making it all the more likely that some type of “bail-in” scheme would be used.  It's over one year from Fed Vice Chair Stanley Fischer's Stockholm speech describing such a scenario, but we can't find any corresponding laws promulgated yet.  Are we missing something?


Today, Victor contacted one huge money center bank that he's done business with for over two decades.  He asked what would happen to his funds on deposit if the bank failed.  After being put on hold, he was transferred to the FDIC, which evaded answering his questions.


Why has the mainstream media/press avoided publishing anything on this topic?  The public's savings and checking accounts are at risk if a big bank fails!  With so many personal finance columns published, how can this hugely important issue be ignored?


Victor's Closing Comments:


The ACA (Obamacare) and Dodd-Frank are the two major laws passed by Congress in the last 6.5 years.  They are both excessively long, open-ended, incoherent, and can be changed at whim.  They seem to be intentionally NOT specific.  As opaque as it is, the Dodd-Frank law hasn't yet been completed.  Why not? And why does it take more than one year (and counting) for Fed Vice Chair Stanley Fischer's “bail-in” proposal to become law?


The fact that a major bank I asked today does a tag-team with the FDIC (who will not answer questions directly) is truly concerning.  Such evasiveness seems like obfuscation (or a cover up?) of the risk millions of U.S. depositors and savers might face if their “too big to fail” bank did exactly that – failed.


According to Zero Hedge, the FDIC had $25 billion in assets as of March 2013.  However, over the counter derivatives represent the vast majority of "off the books" assets of U.S. banks.   The total derivative notional outstanding of the top 25 holding companies is $297,514 billion.  That means there are 32 times more notional derivatives than there are total deposits.  The NY Times reported in 2014 that JP Morgan had ~ $2 trillion in assets, but $70 trillion in notional off-balance sheet derivatives for a 35:1 derivatives to assets ratio.  Worse yet, the ratio of gross derivatives to FDIC deposit insurance is a staggering 11,900-to-1.


Neither the U.S. government nor the press has disclosed this vital information.  Sadly, it's one reason why America, as a country, is in a major bear market. The law should be clear.  As James Madison said:  “It will be of little avail to the people that the laws are made by men of their own choice if the laws be so voluminous that they cannot be read, or so incoherent that they cannot be understood.”


The Curmudgeon


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Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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