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WILMARTH 4/1/2011 1:11 PM 986 OREGON LAW REVIEW [Vol. 89, 951 begin with.” 138 Similarly, Simon Johnson and James Kwak contend that “the problem at the heart of the financial system [is] the enormous growth of top-tier financial institutions and the corresponding increase in their economic and political power.” 139 V THE DODD-FRANK ACT DOES NOT SOLVE THE TBTF PROBLEM In 2002, I warned that “the TBTF policy is the great unresolved problem of bank supervision” because it “undermines the effectiveness of both supervisory and market discipline, and it creates moral hazard incentives for managers, depositors, and other uninsured creditors of [LCFIs].” 140 During the current financial crisis, as noted above, the U.S. and European nations followed a TBTF policy that provided more than $10 trillion of support to the entire financial sector. 141 Three studies concluded that the TARP capital infusions and FDIC debt guarantees announced in October 2008 represented very large transfers of wealth from taxpayers to the shareholders and creditors of the largest U.S. LCFIs. 142 138 Alison Fitzgerald & Christine Harper, Lehman Monday Morning Lesson Lost with Obama Regulator-in-Chief, BLOOMBERG (Sept. 11, 2009), http://www.bloomberg.com /apps/news?pid=newsarchive&sid=aUTh4YMmI6QE (quoting Nomi Prins). 139 JOHNSON &KWAK, supra note 137, at 191. 140 Wilmarth, supra note 120, at 475. 141 See supra notes 11–12 and accompanying text. 142 Elijah Brewer, III & Anne Marie Klingenhagen, Be Careful What You Wish for: The Stock Market Reactions to Bailing Out Large Financial Institutions, 18 J. FIN. REG. & COMPLIANCE 56, 57–59, 64–66 (2010) (finding significant increases in stock market valuations for the twenty-five largest U.S. banks as a result of Treasury Secretary Paulson’s announcement, on Oct. 14, 2008, of $250 billion of TARP capital infusions into the banking system, including $125 billion for the nine largest banks); Pietro Veronesi & Luigi Zingales, Paulson’s Gift 2–3, 11–31 (Chicago Booth Research Paper No. 09-42, 2009), available at http://ssrn.com/abstract=1498548 (concluding that the TARP capital infusions and FDIC debt guarantees produced $130 billion of gains for holders of equity and debt securities of the nine largest U.S. banks at an estimated cost to taxpayers of $21 to $44 billion); see also CONG. OVERSIGHT PANEL, FEBRUARY OVERSIGHT REPORT: VALUING TREASURY’S ACQUISITIONS 4–8, 26–29, 36–38 (2009), available at http://cop.senate.gov/documents/cop-020609-report.pdf (presenting a valuation study concluding (1) that capital infusions into eight major banks (Bank of America, Citigroup, Chase, Goldman, Morgan Stanley, US Bancorp, and Wells Fargo) that were made under TARP’s Capital Purchase Program provided an average subsidy to those banks equal to 22% of the Treasury’s investment and (2) that additional capital infusions into AIG and Citigroup under TARP provided an average subsidy to those institutions equal to 59% of the Treasury’s investment).
WILMARTH 4/1/2011 1:11 PM 2011] The Dodd-Frank Act 987 The enormous competitive advantages enjoyed by TBTF institutions must be eliminated (or at least significantly reduced) in order to restore a more level playing field for smaller financial institutions and to encourage the voluntary breakup of inefficient and risky financial conglomerates. 143 The financial crisis has proven, beyond any reasonable doubt, that large universal banks operate based on a dangerous business model that is riddled with conflicts of interest and prone to speculative risk taking. 144 Accordingly, U.S. and European governments must rapidly adopt reforms that will (1) greatly reduce the scope of governmental safety nets and thereby significantly diminish the subsidies currently provided to LCFIs and (2) facilitate the orderly failure and liquidation of LCFIs under governmental supervision, with consequential losses to managers, shareholders, and creditors of LCFIs. A few months before Dodd-Frank was enacted, I wrote an article proposing five key reforms to accomplish these objectives. My proposed reforms would have (1) strengthened existing statutory restrictions on the growth of LCFIs, (2) created a special resolution process to manage the orderly liquidation or restructuring of systemically important financial institutions (SIFIs), (3) established a consolidated supervisory regime and enhanced capital requirements for SIFIs, (4) created a special insurance fund to cover the costs of resolving failed SIFIs, and (5) rigorously insulated FDIC-insured banks that are owned by LCFIs from the activities and risks of their nonbank affiliates. 145 The following sections of Part V of this Article discusses my proposed reforms and compare those proposals to relevant provisions of Dodd-Frank. As shown below, Dodd-Frank includes a portion of my first proposal as well as the major components of my second and third proposals. However, Dodd-Frank omits most of my last two proposals. In my opinion, Dodd-Frank’s omissions are highly significant and raise serious doubts about the statute’s ability to prevent TBTF bailouts in the future. As explained below, a careful reading of Dodd-Frank indicates that Congress has left the door open 143 Wilmarth, supra note 6, at 740–44. As I argued in a previous article, large financial conglomerates have never proven their ability to achieve superior performance without the extensive TBTF subsidies they currently receive. Id. at 748–49. 144 Saunders et al., supra note 45, at 143–47; Wilmarth, supra note 4, at 970–72, 994– 1002, 1024–50; JOHNSON &KWAK, supra note 137, at 74–87, 120–41, 193, 202–05; John Kay, Narrow Banking: The Reform of Banking Regulation 12–16, 41–44, 86–88 (unpublished manuscript), available at http://www.johnkay.com/wp-content/uploads/2009 /12/JK-Narrow-Banking.pdf. 145 Wilmarth, supra note 6, at 747–79.
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