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May 23, 2013

How a Big-Bank Failure Could Unfold

Defenders of big banks are adamant that we have fixed the problem of too big to fail. Organizations such as the Bipartisan Policy Center and the law firm Davis Polk & Wardwell assert that the critical breakthrough was the introduction of new orderly liquidation powers under the 2010 Dodd-Frank financial reform legislation, enabling the Federal Deposit Insurance Corporation to handle the resolution or managed failure of very large financial companies.

This is the core of their argument that no financial reforms or higher capital requirements are needed. This discussion can get a little abstract, so to understand the details – and why the bank advocates’ position is wrong – consider what could happen if there were a hypothetical problem at a major international financial conglomerate such as Deutsche Bank or Citigroup.

Deutsche Bank is not currently in obvious trouble, but during the financial stress and instability at the end of 2008, the Taunus Corporation, the American subsidiary of Deutsche Bank, looked very vulnerable to the financial storm building around it. Although the bank had more than $396 billion in assets, making it one the top 10 bank-holding companies in the United States, it had equity of negative $1.4 billion on an accounting basis (i.e., its assets were worth less than its liabilities).”

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Read Marc Jarsulic and Simon Johnson’s full post in the New York Times here

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