Can the FDIC prevent financial disaster?

Crumbling bank facade

Former FDIC Chairman Sheila Bair tells us regulators now have the tools under the Dodd-Frank law to end "too big to fail."

This confidence is reflected in a recent FDIC report showing how the Lehman Brothers failure might have been handled had the new law been in effect in 2008.

Lehman, of course, was the firm whose rapid and disorderly demise is cited by Wall Street analysts and pundits as the triggering event in the panic that nearly caused the collapse of our financial system.

The system-wide disaster might have been avoided -- or at least greatly mitigated -- Wall Street asserts, if Lehman had been considered "too big to fail" and had simply been bailed out.

The report basically argues that, could we but rewind the Lehman tape and apply the "orderly liquidation authority" mechanism of Dodd-Frank to the evolving situation, an efficient and effective dissolution of that firm could have been achieved.

Simply put, had Dodd-Frank been in place, the FDIC would have had the necessary authority to evaluate Lehman’s assets and liabilities, restructure its operations and ultimately arrange an orderly sale of its various assets and businesses.

Losses by creditors would have been minimized and market disruptions largely avoided.

The unstated implication, of course, is that no bailouts would have been necessary. (Dodd-Frank expressly prohibits bailouts.)

I have no doubt the analysis is valid -- if you assume that, during the period Lehman was busy failing, nothing else of much consequence was going on.

Unfortunately, that wasn’t the case.

As one subcommittee witness noted, if we would have been operating under Dodd-Frank, the FDIC "would have had to address Wachovia, Merrill, Lehman, AIG, Citibank, Washington Mutual and perhaps others almost simultaneously."

Would it have had the necessary resources -- staffing, funding and expertise -- to contain all the fires burning at once?

And, if Lehman’s businesses were put up for sale, per the procedure, who would the bidders have been -- other big firms undergoing their own Dodd-Frank "resolutions"?

In other words, with all the background noise, could the this agency really have succeeded where others failed in 2008 and successfully unwound Lehman?

Pardon my skepticism about regulatory "tools."

The truth is that "too big to fail" still survives -- not necessarily because Dodd-Frank doesn’t work, but, as discussed in the next post, the financial markets have willed it.

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