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August 1, 2013

Sadly, Too Big to Fail Is Not Over

“Writing in Politico earlier this week, former Senator Chris Dodd and former Representative Barney Frank contend that the Dodd-Frank financial reform legislation of 2010 ends forever the ability of the United States government to provide support to failing financial companies. “The Dodd-Frank Act is clear: Not only is there no legal authority to use public money to keep a failing entity in business, the law forbids it,” they write.

Mr. Dodd and Mr. Frank worked long and hard on financial reform in 2009-10, and there is much in their bill that is helpful, which is why regulators need to pick up the pace on completing and putting in place genuinely strong rules. But on the bigger picture – whether too-big-to-fail financial institutions still benefit from implicit government subsidies and a high probability of explicit bailouts — I respectfully disagree with them. I’m not alone — in response to recent questioning from Senator Elizabeth Warren, Democrat of Massachusetts, the Federal Reserve chairman, Ben S. Bernanke, confirmed that credit markets still believed the government stands behind big banks.

There are three issues: the powers of the Federal Reserve, the mandate of the Federal Deposit Insurance Corporation and the vulnerability of taxpayers when one or more large complex financial institutions fail. We have at least five such companies in the United States, all of which are intensely cross-border in their operations (in order of size, JPMorgan Chase, Bank of America, Citigroup, Goldman Sachs and Morgan Stanley).

On the mechanics of what the Fed is allowed to do, Mr. Dodd and Mr. Frank are of course correct that their legislation changed the powers of the Federal Reserve. The precise legal authority that allowed a loan of $85 billion to American International Group in September 2008 no longer exists.

But as Marc Jarsulic and I explained in this space recently, the Federal Reserve still has plenty of other powers that can be invoked to provide support to failing financial companies. For example, the Taunus Corporation (a subsidiary of Deutsche Bank) and perhaps others were saved in 2008 by lending programs that were made available to a broader group of companies or that covered an entire class of assets. Such programs are still legal.


Read Simon Johnson’s full Economix Blog piece here

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