When President Barack Obama signed the Dodd–Frank Act in 2010, he claimed that it would “put a stop to taxpayer bailouts once and for all” and would “make clear that no firm is somehow protected because it is ‘too big to fail.’” Vice President Joe Biden said that Dodd-Frank ended the ability of banks to “take massive risks with the knowledge that [a] taxpayer bailout is around the corner when they fail.”

Yet the Dodd-Frank Act retained a loophole that allowed the government to support failing banks. With the bailout of depositors at the Silicon Valley Bank and Signature Bank, and with the use of taxpayer funds to facilitate their sale to other banks, we now know that selective bailouts will continue. Congress must go back to the drawing board and, once and for all, end the ability of regulators to rescue their most influential charges.

Congress has tried many times to limit bailouts, but it always provided loopholes that made them inevitable. In its 1949 annual report, the Federal Deposit Insurance Corporation (FDIC) noted that for the previous five years it had used its funds to keep all depositors whole, despite the formal limitation of deposit insurance to $5,000. The next year, Congress tried to limit such bailouts but said that the FDIC could support a bank if it was “essential to provide adequate banking service to the community.”

The FDIC used the “essentiality” exception to bail out the large First Pennsylvania Bank in 1980. Then-FDIC chairman Irvine Sprague said that it was an isolated incident and that he didn’t expect “additional significant problems.” Four years later, Sprague and the FDIC bailed out Continental Illinois, giving birth to the phrase “too big to fail.”

In 1991, Congress passed an act to limit bailout authority once again, stating that the FDIC should resolve bank failures in whatever way created the “least cost” to taxpayers. Yet Congress again included a loophole, which said that the FDIC could use taxpayer funds if a failed bank presented a “systemic risk” to the financial system.

One might ask what sort of bank presents a systemic risk, and the answer becomes obvious: large ones. The failure of small banks threatens only the community they serve. But the failure of banks with tens or hundreds of billions of dollars in assets threatens other large banks and thus what the law calls “financial stability.”

In 2008 and 2009, the FDIC used the systemic-risk exception to offer support to Wachovia, Citigroup, and Bank of America, outside of Congress’s and the Federal Reserve’s more general bailout programs. It also used the exception to guarantee all banks’ transactions deposits, no matter the amount. Ironically, this guarantee for the wealthiest depositors occurred less than two weeks after Congress had set the legal deposit insurance limit at $250,000. As so often in banking history, the bailout exception swallowed the rule seeking to limit it.

Though Dodd-Frank tried to limit bailouts by the Federal Reserve, the act kept and clarified the separate systemic-risk exception for banks taken over by the FDIC, and thus the government’s ability to rescue their creditors. The act also stated that the guarantee of all bank deposits would continue until 2012 before coming to an end.

FDIC chairman Martin Gruenberg confirmed to the Senate last week that he used the Dodd–Frank Act’s systemic-risk exception to bailout depositors at SVB and Signature and to facilitate a sale of those two banks, at a cost to taxpayers of about $22.5 billion, or almost $70 for every man, woman, and child in the country. He also noted that after these bailouts, depositors were moving their money into “systemically important banks.” Those depositors understand that the systemic-risk exception and the rule barring general deposit guarantees move the U.S. banking system closer to a too-big-to-fail standard than ever before.

Some argue that the recent guarantees were not taxpayer bailouts, since SVB and Signature shareholders will lose their investment and their senior managers have lost their jobs. They point out that any funds to support depositors will come from assessments made on other banks. But as one FDIC study observed, the 1980s bailouts also led to “shareholders losing their investments and managements being removed.” It argued that by these measures, even Continental Illinois “failed.” Those older bailouts were also funded by FDIC assessments on other banks, which did not make them any less likely to encourage risky behavior.

Unfortunately, the claim that Dodd–Frank would end bailouts and too-big-to-fail banks has been exposed as a fallacy. The irony is that under the act, the more systemically risky a bank becomes, the more likely it is to get bailed out, and thus the safer it becomes for people depositing or investing with it. Only when Congress closes these loopholes for good will there be any hope of stopping the perverse incentives that weaken our banking system and justifiably outrage the public.

Photo by Justin Sullivan/Getty Images


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