The Honorable Chairman Dodd
Committee on Banking, Housing, and Urban Affairs
United States Senate
Washington, DC 20510
April 9, 2010

Dear Chairman Dodd,

The over 250 consumer, employee, investor, community and civil rights groups who are members of Americans for Financial Reform (AFR) are writing to voice our strong support for the pre-funded Orderly Liquidation Fund, which we view as an important “gambler pays” taxpayer protection mechanism, despite the opposition’s rhetoric.  In addition, we strongly support Senator Menendez’s amendment to raise the Orderly Liquidation Fund from $50 billion to $150 billion, increasing the protection to American taxpayers and ensuring that high-risk firms pay the costs of their failure. We recognize that lobbyists for the financial sector are opposed to the idea of risky firms paying more into a larger fund.  But the financial crisis taught us that the excessive speculation that caused the crisis is immensely profitable to Wall Street executives in the short term; assessing firms fees based on their size and riskiness provides a powerful counter-incentive – and is only fair.

Pre-funding the Orderly Liquidation Fund would force systemically risky firms to bear the cost that their gambling places on the financial system, and would do so in a way that is not pro-cyclical and would not create perverse incentives.  By increasing the size of the fund from $50 billion to $150 billion, the Menendez amendment also reduces the possibility that taxpayer funds would be put at risk if multiple firms were to fail simultaneously.  Furthermore, the bill currently provides that the $50 billion in financing for the fund is to be raised over a period of five years, which may prove inadequate to the task of dealing with another banking meltdown affecting multiple firms. By increasing the size of the Orderly Liquidation Fund from $50 billion to $150 billion the Menendez amendment makes the fund a more viable tool and drastically decreases the likelihood that regulators would be forced to make the unpalatable choice, if the fund is exhausted, between a line of credit from Treasury or an assessment on financial firms during a crisis.

We also urge you to oppose attempts to weaken or eliminate the “gambler-pays” pre-funding system. Opponents of pre-funding contend that it would create moral hazard.  This argument, while understandably appealing to industry, which would prefer to have taxpayer funds on the line than their own, is flawed.  The existence of the Orderly Liquidation Fund does not induce firms to take risks with no thought of the impact of their actions.  The proposed liquidation process is not a bailout and it is not insurance.  It does not soften or eliminate the consequences of irresponsible behavior.  Liquidation is a winding down and liquidation of a failed company. Management is fired, equity is wiped-out, and creditors suffer losses.  Resolution does not relieve firms from suffering the consequences of irresponsible actions; it’s the death penalty.

A pre-funded systemic liquidation fund avoids the perverse incentives and outcomes created by post-funding.  First, in a post-funded system the cost of resolving a failed firm is borne by its competitors, not the failed institution. If the repercussion of excessive risk taking is that your competitors bear the burden of your mistakes, what incentive is there to take risks responsibly?

Senator Menendez’s amendment to increase the size of the Orderly Liquidation Fund from $50 billion to $150 billion would create a sound pre-funded systemic resolution fund with risk–based assessments.  The amendment would force systemically risky firms to internalize the cost of the risk they pose to the financial system, prevent the use of taxpayer funds, avoid extracting crucial liquidity from the financial system during a crisis, and would do so without introducing moral hazard into the financial system.  We urge you to support it and to oppose efforts to weaken or eliminate the risk-based Orderly Liquidation Fund.

If you have questions, please do not hesitate to contact Dana Chasin of Americans for Financial Reform at dana.chasin@gmail.com.

Sincerely,

Americans for Financial Reform