Fact and Fiction Behind Too Big to Fail

BREAK ‘EM UP Reason #2: Dodd-Frank’s Resolution Authority is Too Little Too Late

After passing Dodd-Frank, Congressional leaders claimed both “no more bailouts” and that Dodd-Frank’s “resolution authority” was a primary tool in solving “too big to fail”. These two claims are polar opposites. The former states there will be no further government bailouts of big banks, and the latter involves strengthening the government’s ability to do just that — after the collapse. In a panic, nothing is orderly.

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If Congress intends to prevent further government bailouts, wouldn’t the best tactics be focused on minimizing the creation of systemic risk?

Resolution authority deals with resolving failed banks after they have failed. TBTF bank CEOs can continue to take excessive risks and earn their high compensation, knowing that while they may be removed after their institutions have collapsed, the government will be able to bail out and take over those institutions with stronger legal authorities. What the CEOs also know is that when panic sets in during a systemic crisis, logic is replaced by pure pragmatism, as happened in the fall of 2008. Leadership may not be touched, and those in the industry will continue to run it.

In a November 13, 2009, Op-Ed in the Washington Post JPMorgan Chase CEO Jamie Dimon warned against tampering with the size or structure of the largest banks. He began his piece quoting Treasury Secretary Timothy Geithner’s statement that the term “too big to fail” must be removed from our national vocabulary. He proceeds to promote the resolution authority and its improving the means to take over failing institutions.

This wasn’t just a U.S. CEO phenomenon. The U.K. was considering its own resolution authorities, called “living wills”. Barclay’s CEO Bob Diamond in a March 7, 2011, interview related in The Telegraph stated, “You shouldn’t be trying to create a system where no bank fails but you should be creating one that catches a bank and allows it to fail without impacting the financial markets.”

Former House Financial Services Committee Chairman Spencer Bachus (Republican) described what he saw in Dodd-Frank after its passage. “Lots of bailouts.” Quoting chapter and verse of the law, he described how it actually made bailing easier. “For Bank of America, that’s $2 trillion in bailout authority alone, to be paid for by the taxpayer.”

If Republicans really want to decrease bailout risk, will they have the courage to remove the taxpayer’s guarantee from investment bank trading? It’s easy just to criticize and look good in statements in Washington. Will they do the hard work, given their own benefits of largesse from the sector?

There is a huge difference between strengthening after-the-fact powers and measures that minimize the build-up of systemic risk. Isolating the Federal deposit guarantee from investment bank’s trading risks is a measure that addresses the creation of systemic risk up front. When resolution authority is invoked, taxpayers still are left holding the bag. Not too little, but certainly too late.

 

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Fairy Tale Capitalism: Fact and Fiction Behind Too Big to Fail

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Was the mortgage debacle the sole cause of the financial bubble's collapse? Do you believe those who say the elimination of Glass-Steagall barriers didn't contribute to its building? Fairy Tale Capitalism: Fact and Fiction Behind Too Big To Fail places the mortgage mess into a broader perspective. It explains how the Federal deposit guarantee was married to investment banking's trading intensity, why the Fed had no choice but to bail out the biggest banks and how derivatives played a poorly-understood, but equally important role in the crisis. In simple terms Emily Eisenlohr walks with those who live on Main Street down Wall Street's darker alleys.

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