Still too big to fail

In a joint review by the Governors of the Federal Reserve System and the Board of Directors of the Federal Deposit Insurance Corporation (FDIC), the two financial regulatory bodies say that resolution plans (so-called "living wills") submitted by eleven large banks—which included Wall Street titans Bank of America, Bank of New York Mellon, Barclays, Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan Chase, Morgan Stanley, State Street Corp., and UBS—shared common flaws that make the institutions a continued threat to the overall economy.

 When Glass-Steagall was repealed, the CEO's of banks were turned loose to invest heavily in the unregulated derivatives market (stupid, but perfectly legal). Dodd-Frank was supposed to regulate Wall Street and prevent what happened. None of the major banks would have survive even a day without major government support, including quantitative easing.

The Dodd-Frank Wall Street Reform and Consumer Protection Act, signed into law in 2010, included provisions meant to avoid a repeat of what happened in 2008, when a collapse of the mortgage market sent a shockwave through the financial services industry. Portions of Dodd-Frank compelled these large institutions to create 'resolution plans' so that in the event of a similar crisis, the banks would be dismantled in a more orderly fashion and large-scale government intervention would not be necessary—nor in theory, allowed.

The problem, according to the Fed and the FDIC, is that the plans put together by the big banks simply won't work.

"Each plan being put forth is deficient and fails to convincingly demonstrate how, in failure, any one of these firms could overcome obstacles to entering bankruptcy without precipitating a financial crisis," said FDIC vice chairman Thomas Hoenig in a statement. "Despite the thousands of pages of material these firms submitted, the plans provide no credible or clear path through bankruptcy that doesn't require unrealistic assumptions and direct or indirect public support."

The phenomenon known as too big to fail is based on the notion that government officials will always rescue a failing financial company when it believes the failure would cause financial chaos. Since investors in the company believe they'd be bailed out, they accept a lower return for funding the company's operations. That in turn enables the too big to fail company to enjoy a taxpayer-provided subsidy unavailable to its smaller rivals.

 A report by Government Accountability Office came to similar conclusions as the FDIC and Fed governors after it was asked to look into the impact that Dodd-Frank has had on the 'too big to fail' institutions.

“...some institutions remain too complex and interconnected to be unwound quickly and efficiently if they get into trouble. It is also clear that this status confers financial benefits on those institutions. Stated simply, there is an enormous value in a bank’s ability to tap the taxpayer for a bailout rather than being forced to go through bankruptcy.”

Since 2008, the largest banks in the U.S. have gotten larger, not smaller. FDIC's Hoenig conceded on Tuesday, "These firms are generally larger, more complicated, and more interconnected than they were prior to the crisis of 2008. They have only marginally strengthened their balance sheet to facilitate their resolvability, should it be necessary. They remain excessively leveraged."

From here