Too Big to Fail
To Block Bailouts, Living Wills and Capital Buffers
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 almost five-fold since 1997. That’s a lot of money in not too many hands. It might even mean that those banks are still too big to let fail, as governments decided during the panic of 2008. Anger soared over the disbursement of $700 billion to save banks while homeowners and businesses went under. Global regulators have been working ever since to make it possible for even the biggest financial institutions to close their doors without triggering an economic meltdown. There’s plenty of skepticism about whether they’ve succeeded.
Eight years of work by U.S. regulators to avoid bailouts by making banks safer and easier to shut were thrown into doubt by the election of Donald Trump as president. Trump has been an outspoken critic of Dodd-Frank, the financial regulation reform law passed in 2010. He has also, however, been a critic of big banks and spoken about bringing back the Depression-era separation of commercial and investment banking known as Glass-Steagall, an idea repeated by his economic team. That's opposed by many Congressional Republicans, who have proposed freeing banks from its rules if they voluntarily raise billions of dollars to be better able to withstand a downturn. Meanwhile, work continues under Dodd-Frank: Big Wall Street banks were told by the Federal Reserve in December that they need to raise about $70 billion more in long-term debt meant to convert to equity in case of failure so there’s no need for a government bailout. In October, reports of weakness at Deutsche Bank had sparked a lively debate over whether the German government should prop it up to protect other firms; the International Monetary Fund in June had ranked Deutsche Bank as the biggest global contributor to systemic risk.
The bank failures of the Great Depression led to the creation of deposit insurance and regulators like the U.S. Federal Deposit Insurance Corporation with powers to take over failing banks and liquidate them in an orderly way. That's also when the Glass-Steagall rules were put in place, to keep insured deposits separate from activities seen as riskier. 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 or shareholders started to doubt their solvency. When one, Lehman Brothers, was allowed to go under, regulators learned that the biggest firms were so interconnected that only massive bailouts kept dozens more around the world from failing. Responding to the crisis, regulators hastily extended the safety net till it eventually covered more than half of the financial sector. Dodd-Frank gave regulators powers to dismantle so-called systemically important financial institutions. The government pinned the SIFI label on General Electric and several large insurers: American International Group, Prudential and MetLife. GE decided to sell off its banking arm. MetLife went to court and a federal judge rejected the government’s designation in a ruling the government has appealed.
A 2014 study by the International Monetary Fund found that the belief among lenders that governments won’t let big banks go under produced annual savings of as much as $300 billion for large banks in the E.U., up to $70 billion in the U.S. and $110 billion in both the U.K. and Japan. Those figures suggested that this implicit subsidy could be at least as big as the big banks’ profits. Some argue that the governments should charge for this subsidy. In emerging markets like China, the subsidy is explicit: the government outright owns the biggest banks. That means it gets the upside in good times along with the burden when the banks have to be bailed out. Banks say that more recent data shows that any borrowing advantage has shrunk dramatically; a Government Accountability Office report in July 2014 backed this up. Democrats have vowed to defend Dodd-Frank, saying it is slowly but surely producing safer banks, and some have also called for the return of Glass-Steagall. Most Congressional Republicans, however, have joined Alan Greenspan, the former Fed chair, in saying it would be better to chuck the ever-thicker rulebook and make banks rely on hefty capital reserves.
The Reference Shelf
- 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 that concluded that big banks can borrow more cheaply, and one from the Clearing House, a banking industry trade association, that argues that the subsidy has faded with new regulations. And one from the U.S. General Accounting Office that 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.
- An analysis by Bloomberg Government in June 2013 of the too-big-to-fail subsidy and proposed capital surcharges.
- William Safire On Language column from 2008 on the origin of the term “too big to fail.”
First published April 14, 2014
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