In the words of Sheila Bair, the departing chairman of the Federal Deposit Insurance Corp., the era of too-big-to-fail banks isn’t just ending -- it’s already over. Consider her statement two weeks ago, in a news release heralding the creation of a committee to advise the agency on how to deal with large, dying financial firms:
“Congress has given the FDIC a tremendous amount of responsibility to ensure that financial organizations formerly deemed too big to fail will no longer receive taxpayer funded bailouts.”
Formerly deemed, huh?
Maybe Bair didn’t express herself clearly or was giving voice to her inner hopes. Either way, it’s hard to believe she convinced anyone that the government wouldn’t rescue Bank of America Corp., Citigroup Inc., Goldman Sachs Group Inc., JPMorgan Chase & Co. and Morgan Stanley -- to name just a few -- amid a crisis that threatened to take down the global financial system.
The capital markets sure don’t seem to buy it. Otherwise, the bonds of these banks would be trading for a lot less, as would their stocks. Bank of America and Citigroup, whose shares fetch much less than the net assets on their balance sheets, might be dead already.
The basis for Bair’s assertion rests in the FDIC’s new powers under the Dodd-Frank Act passed by Congress last year. The act, it’s worth noting, didn’t even pretend to end too big to fail at Fannie Mae or Freddie Mac, both of which are in government conservatorship almost three years after they were seized, or American International Group Inc., which is still majority-owned by the Treasury Department.
At least the FDIC’s general counsel, Michael Krimminger, qualified his answer when he testified before Congress this week about whether Dodd-Frank will work as advertised. He said the act provides “the tools to end too big to fail, if properly implemented.”
Yes, Dodd-Frank prohibits bailouts of the sort we saw under the $700 billion Troubled Asset Relief Program. Financial companies deemed “systemically important” must submit so-called living wills to regulators, mapping out how they would dismantle themselves in a crisis. Those that don’t turn in credible plans could face sanctions, including higher capital minimums. If and when such companies become insolvent, the government would have the option of placing them into a special resolution program aimed at providing an orderly liquidation, as an alternative to a traditional bankruptcy filing.
All this remains untested. There’s little reason to expect the bureaucrats at the FDIC would know a good living will if they saw one. It’s even harder to envision that executives who don’t know what’s going on inside their own too-big-to-manage banks would be any better at designing a resolution roadmap.
And we all remember what happened the last time regulators decided they didn’t have the right tools to deal with a financial crisis that was spiraling out of control. They scared Congress into changing the law, and in 2008 we got TARP. Congress always could change the law again in the face of a potentially cataclysmic meltdown.
Dodd-Frank doesn’t end taxpayer-supported bailouts. The liquidation scheme outlined in the act would let the FDIC borrow money from the Treasury Department to finance a company’s operations, as a way to promote calm and head off bank runs. That protects bondholders and counterparties from the sorts of large, immediate losses they otherwise might incur through a traditional bankruptcy proceeding.
The law says any company that enters the special resolution process must be liquidated within five years, which isn’t exactly quick. It also says there shall be “no losses to taxpayers,” and that the financial-services industry would have to foot the bill for a company’s liquidation through special fees if necessary. By then, taxpayers’ money would be out the door, and good luck getting it back. The FDIC already has a hard time charging banks enough premiums to keep its deposit-insurance fund solvent.
Congress could have broken up the nation’s banking cartel had it wanted to. It didn’t. Alternatively, regulators could saddle the largest banks with capital requirements of, say, 20 percent of assets or more, giving them an adequate cushion to absorb the inevitable losses from risky, reckless trading. That might even compel some banks to break themselves up and shed their financial casino operations. That’s not happening either.
This leaves the government with one way to demonstrate that too big to fail is dead. That’s to let a huge, systemically important company die, which means accepting the risk that others will blow up with it and take down the economy. The markets have decided they’ll believe that when they see it, and understandably so. The pain from Lehman Brothers Holdings Inc.’s death in 2008 proved too much for policy makers to bear.
The new regulations called for by Dodd-Frank remain largely unfinished. The living wills don’t exist yet, not that they would be much help during a global credit freeze. There’s no reason to believe regulators will be more competent at enforcing their new rules than the old ones. The main thing that’s changed since 2008 is some of the biggest banks have gotten bigger.
We’re no safer today than we were then.
(Jonathan Weil is a Bloomberg View columnist. The opinions expressed are his own.)
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