WASHINGTON — If there's one piece of the Dodd-Frank Act that most banks like — and many academics applaud — it's the provisions that allow the government to seize and unwind a failing banking company.
Yet in their desire to undo the 2010 financial reform law, many in the industry fear those measures — found in Title II of the statute — will be a primary target under President-elect Donald Trump.
"Title II provides a last-resort firewall that imposes losses on the failed firm's stakeholders and by law, not on taxpayers," said James Wigand, the former director of the FDIC's Office of Complex Financial Institutions. "Having that firewall is a good thing."
Republicans have long objected to Title II, viewing it as formalizing "too big to fail," even though Democrats intend it to be the opposite. GOP lawmakers claim that the provisions effectively constitute a bailout by allowing the government to take over a company and put it back into the private market once its problems are fixed.
Trump's team, including Treasury Secretary-designate Steven Mnuchin, have said little about what specifically they will target in Dodd-Frank, but many interpreted criticisms that the law ensures "taxpayers remain on the hook for bailing out financial firms" as a veiled reference to Title II.
When it comes to "areas where populist views — the left and the right — essentially agree" topping the list is that Title II needs to go, said Karen Shaw Petrou, a managing partner at Federal Financial Analytics.
There have already been several efforts by lawmakers to roll back that part of the law. In April, the House passed a bill that would create a new bankruptcy code provision to accommodate large financial institutions — a solution that has been presented as an alternative to government intervention. In the same week, Rep. Lynn Westmoreland, R-Ga., introduced a bill to repeal Title II.
But this is one area on which the banking industry would prefer Dodd-Frank be left alone. They said it's unfair to conflate the Federal Deposit Insurance Corp.'s Orderly Liquidation Authority with "too big to fail."
Title II is unlikely to put taxpayers on the hook because the law stipulates that reimbursing the government is the first order of priority after immediate administrative costs. Because of this, proponents argue, it does not incentivize risky practices in banks.
"The kinds of actions that were taken in 2008 to rescue very large nonbanks and backstop very big bank holding companies could not occur under Title II," said Petrou. "And markets are pricing that."
In addition, advocates say, Orderly Liquidation Authority is placed in the right hands, because the FDIC regularly puts financial institutions under receivership to oversee their failure.
"Financial institutions are different, so that there is a separate resolution regime for banks, there is a separate resolution regime for insurers and there is a separate resolution regime for brokers," said one source with deep experience in the industry, speaking on condition of anonymity. "Only an agency with expertise in the area is really well suited to do this."
Without the FDIC's Orderly Liquidation Authority, it appears that there would be no other significant source of government-funded liquidity aid to financial institutions on the brink of collapse. The Federal Reserve's emergency lending authority was significantly restricted by Dodd-Frank and Wall Street hawks like Sen. Elizabeth Warren, D-Mass., are pushing to scale it back even further.
Moreover, after the last crisis and the wave of populism that brought Trump to power, the Fed would likely lack the political capital to intervene alone.
"The Fed is going to be gun-shy," said Kathryn Judge, a professor of law at Columbia Law School. "Even the Board of Governors are going to be more hesitant to intervene today."
If Title II were repealed, a failing large institution would have only one place to go: bankruptcy court.
Some believe that this is unviable — that the process of halting payments to creditors and counterparties during bankruptcy would create a ripple effect through the financial system, as it did when Lehman Brothers declared bankruptcy in 2008.
"Bankruptcy courts don't really act that fast," said Joseph Fellerman, a former special adviser at the FDIC. "Will they have the knowledge of the interrelations of these firms? I just don't know where the liquidity is going to come from to prevent catastrophic domino effects."
Getting rid of Title II would also spook authorities in Europe and elsewhere, who could respond by cutting off a troubled financial institution's access to funds held in its foreign subsidiaries.
"Foreign resolution authorities have stated time and time again that the bankruptcy process is too uncertain for their comfort," said Wigand. "And as a result they would have to take actions that would possibly only be in their interest and not in the interests of either the entity as a whole or the U.S. financial system."
Ultimately, observers said, if Title II gets repealed, something else needs to take its place to ensure that no large financial institution will go into free-fall, panic the markets and take the rest of the financial system along with it.
"We have a post-crisis view of big banks as evildoers," said Petrou. "Sometimes banks fail because of things that have nothing to do with banks."
