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September 30, 2022

Regulators Still Aren’t Serious About Ending Too Big to Fail

This Op-Ed was published on the Barron’s website.

The catastrophic 2008 financial crisis was caused by Wall Street banks that were big, complex, leveraged, interconnected, and systemically important. They were so big that elected officials, policymakers, and regulators faced a difficult choice: bail them out with taxpayer money or let them fail and risk precipitating a second Great Depression. That’s why those gigantic banks are called “too big to fail.” Their failure would collapse the financial system and economy and, thereby, ruin the lives and livelihoods of tens of millions of Americans.

The 2010 Dodd-Frank Financial Reform and Consumer Protection law was supposed to ensure that no more banks would pose the danger of systemic failure. It was meant to end the phenomenon of too-big-to-fail banks entirely. But for that to happen, regulators would need to fully use the power and authorities they were given. That hasn’t happened, mostly because of the fierce opposition of the financial institutions that prefer to remain too big to fail, so that they get bailed out rather than failing.

A spree of bank mergers is happening right now. It would create the most too-big-to-fail banks since the 2008 crash. Regulators must get serious about applying the law and ending too big to fail or history is going to repeat itself.

Four of the ten largest banks in the U.S. by assets will have been created in just a little more than three years if two pending merger applications before the Federal Reserve and the Office of the Comptroller of the Currency are approved as expected. One pending application is TD Bank ’s request to acquire First Horizon , which when completed would make the combined bank the eighth-largest in the U.S. Similarly, U.S. Bancorp ’s pending acquisition of MUFG Union Bank would make it the seventh-largest bank. The supersizing of these banks comes on top of several other huge mergers in the past few years.

Unfortunately, the Fed and OCC merger-review process fails to fully assess the threat these banks pose given their scale and often vast, complex operations. In fact, the regulators have been approving these mergers with only a subjective assessment of financial stability risks that is not supported with meaningful metrics and provide none of the contagion mitigation that is provided by robust resolution plans (so-called living wills). This minimalist review is threatening the stability of the financial system, future taxpayer bailouts, and the jobs, homes, and savings of Main Street families, as was painfully proved in the aftermath of the 2008 collapse of numerous too-big-to-fail banks.

The banking agencies must change that by requiring the submission of robust, workable resolution plans for the combined banks before any merger or acquisition is considered, much less approved. While the banks currently submit resolution plans for the smaller, premerger banks, this change would ensure that the postmerger banks, no matter how big, complex, leveraged, and interconnected, can fail and go through the bankruptcy process without threatening the financial system and economy.

“We have to get rid of anything that looks like too-big-to-fail,” JPMorgan Chase CEO Jamie Dimon said in 2012 when he testified before the Senate Banking Committee. “We have to allow our big institutions to fail. It is part of the health of the system, and we should not prop them up.” He said he supported Old Testament justice: banks that need bailouts should be dismantled “and the name buried in disgrace.”

He is correct, but that can’t happen without regulators requiring resolution plansbefore and after bank mergers. Combined with capital, liquidity, and other resiliency measures, this would end the ongoing threat. Importantly, such a rule—call it the “Dimon Rule”—wouldn’t interfere with banks merging if there were good business reasons to do so and the combinations weren’t anticompetitive. It would address the risks and dangers that the merged banks pose to the financial system and economy.

Such a rule, however, will only work if the resolution-planning process itself is materially strengthened and prioritized. It is simply unacceptable that the Federal Reserve and FDIC have indefinitely extended their one-year deadline to review the existing TBTF banks’ resolution plans that were submitted in July 2021.

Moreover, among other things, the Federal Reserve must make its “expectations” for resolution plans—particularly those for certain capital and liquidity needs—part of legally binding rules. Such “expectations” do little to ensure banks and their subsidiaries are in fact properly positioned to handle periods of extreme stress.

The Federal Reserve and OCC have the authority to make these changes. After the trauma and devastation of the 2008 crash and bailouts, the American people need regulators who will act to ensure that the latest wave of bank mergers is not a precursor to history repeating itself.

Photo credit: Barron’s.



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