Too Big to Fail
Too Big to Fail
(Bloomberg) -- There are some 6,000 banks in the U.S. The biggest six have $10 trillion in assets, almost twice as much as the next 30 combined. The six biggest banks in the U.S. and Europe have increased their assets more than five-fold since 1997. That’s a lot of money in a small number of hands. It might mean that failure is still not an option, as governments decided in the panic of 2008, introducing "too big to fail" to the daily lexicon. Anger soared over the disbursement of $700 billion globally to save banks, while many homeowners and businesses went under. Regulators have been working ever since to make it possible for even the biggest financial institutions to close without triggering a meltdown.
The Situation
Jerome Powell, President Donald Trump's pick to head the U.S. Federal Reserve, said in his confirmation hearing in late 2017 that new rules had ended too-big-to-fail, a view not universally accepted. Trump has been an outspoken critic of some of those rules, enabled by the 2010 Dodd-Frank financial reform law. One of his first executive orders directed the Treasury Department to see how financial regulation, which he blames for hampering economic growth, could be eased. The resulting proposals include lifting some of the regulatory burden on smaller banks, raising the asset threshold at which banks are subject to tougher scrutiny, and rewriting the Volcker Rule, which prevents banks from trading for their own accounts. The changes mostly focus on what regulators could do without legislation, as the narrow margin Republicans hold in Congress makes it difficult to pass laws unpopular with Democrats. Trump is also naming new bank overseers who are likely to push to deregulate the financial system.
The Background
The bank failures of the Great Depression led to the creation of deposit insurance and the U.S. Federal Deposit Insurance Corp., which has the power to take over and liquidate failing banks. Another law banned consumer and investment banking under the same roof, to keep insured deposits separate from riskier activities. The measures worked for decades. Then in 2007 and 2008, a series of deeply indebted investment banks not protected by the FDIC faced the equivalent of bank runs as creditors and shareholders started to doubt their solvency. When one, Lehman Brothers Inc., was allowed to go under, regulators learned that the biggest financial firms were so interconnected that only massive bailouts would keep dozens more around the world from failing. Regulators hastily extended the safety net until it covered more than half the financial sector. Dodd-Frank strengthened the hand of regulators in powerful ways, including letting the U.S. designate, regulate and dismantle in case of failure so-called systemically important financial institutions. The government subsequently said General Electric Co. and several large insurers were SIFIs, resulting in those companies ' selling units and shrinking assets to free themselves of the label.
The Argument
A 2014 study by the International Monetary Fund found that an implicit subsidy — the belief among lenders that governments won’t let big banks go under — produced as much as $480 billion in annual savings for large, global banks. While the subsidy has shrunk post-crisis, it hasn't disappeared, suggesting that neither has too-big-to-fail. Many bankers argue that their companies have much higher levels of capital (money from the sale of stock or from profits not distributed as dividends) and are more aware of their risks around the globe, bringing down the curtain on the too-big-to-fail era. Regulators, they add, are more informed of the risks through frequent stress tests. And most major economies now require some creditors to help shoulder the burden of failure through the issuance of special bonds that can be "bailed-in," or swapped for equity in case of failure. Skeptics, however, say bail-ins have a spotty record so far. Consumer groups and other critics say that capital might have tripled, but it's still too low considering the rapid growth in assets that banks can deem not risky, as they did with mortgages pre-crisis. Such critics also point out that large banks have trillions of dollars in derivatives that connect them to each other, so that one's fall could bring others down. What's more, Dodd-Frank's wind-down mechanism has never been tested — and may not work if multiple banks are under duress simultaneously, as often happens in crises.
The Reference Shelf
- QuickTake explainers on bail-ins, the Dodd-Frank financial reform law and the Volcker Rule.
- The Financial Stability Board’s annual list of Global Systemically Important Banks
- The IMF study and the financial industry’s response.
- A study from the Federal Reserve Bank of New York concluded big banks can borrow more cheaply. One from the Clearing House, a banking industry trade association, argues that the subsidy has faded with new regulations, and one from the U.S. General Accounting Office found support for both positions.
- A study commissioned by the Green Party in the European Parliament that put the value of the subsidy to EU banks at 234 billion euros ($321 billion) in 2012.
- A review by the FDIC of studies on the subject.
- William Safire On Language column from 2008 on the origin of the term “too big to fail.”
First published April
To contact the editor responsible for this QuickTake: Paula Dwyer at pdwyer11@bloomberg.net.
©2017 Bloomberg L.P.