A decade of reform efforts has given financial regulators an array of tools to stave off the next crisis—living wills, orderly liquidation authority, and so on. These new tools, in turn, have produced a large and lively literature in legal and economic scholarship. Yet a fundamental question—exactly when regulators should deploy the new regulatory apparatus—has received little attention. In his latest offering, Professor John Crawford puts regulatory “triggers” in the spotlight.
Consider the example of regulators’ new orderly liquidation authority (“OLA”), which provides a streamlined procedure for recapitalizing bank holding companies without disrupting the operations of their banking and other subsidiaries. Many commentators view OLA as a useful regulatory innovation, but regulators have relatively wide discretion in deciding when to use it. This discretion may be problematic. If regulators wait too long, crisis dynamics might be too far along for the procedures to work. If regulators jump the gun, an unnecessary intervention will impose its own costs. A variety of factors, such as informational limitations, regulatory capture, and political dynamics, complicate these crucial timing decisions.
Professor Crawford highlights two candidates for triggering regulatory action: balance-sheet insolvency (“capital” in financial-regulation terminology) and illiquidity. Both candidates have deficiencies. Illiquidity, Professor Crawford argues, is especially problematic because hinging regulatory intervention on that trigger might instigate liquidity hoarding, which amplifies crisis dynamics. Insolvency, Professor Crawford argues, is more conceptually sound. But regulatory measures of insolvency may not be timely indicators of financial distress. As Professor Crawford points out, these measures of capital did not effectively distinguish viable from failing institutions in 2008.
Professor Crawford is not all gloom and doom. He offers a roadmap for regulatory innovation. For example, he discusses Dodd-Frank regulations that were drafted but never adopted. These regulations would have provided for escalating levels of attention or intervention based on a wide range of measures, including some market-based measures. In Professor Crawford’s view, reviving these floundering regulations would at least produce a useful scaffolding.
In any event, Professor Crawford makes a compelling case that OLA timing is a foundational issue that should be receiving more attention.