Failures in an Orderly Fashion

Discussion in Washington around the concept of large financial firms being “too big to fail” (TBTF) has reached new heights. Recent editorials, studies, and commentators have debated whether financial services firms are too large to serve the greater good of the economy, and if their magnitude will have adverse effects on consumers should another financial crisis occur.

Congressman Barney Frank, one-part of the namesake “Dodd-Frank Act” recently responded to the House Financial Services Committee analysis on the status of large financial institutions as “too big to fail”. In short, he summarized, “The Wall Street Reform and Consumer Protection Act clearly establishes a framework that allows large financial firms to fail while preventing catastrophic harm to the broader economy.”

While we don’t always agree with Congressman Frank, on this issue, there is consensus.

Financial services firms are safer and stronger today to serve the economy and American consumers, and there are a multitude of reasons why.

Consider these facts:

  • Large financial services firms today have more capital—the largest have the most Tier 1 capital than at any other point in history. They have over 12% Tier 1 capital ratios, on average.
  • Financial services companies have ended the riskier practices. There is stronger underwriting for new mortgages, and executive compensation plans has been aligned with long-term performance.
  • There is more liquidity in the financial system.

Systemic oversight is in place for the first time in history.  The Financial Stability Oversight Council was created to monitor risks across the financial services system.  For the first time ever, all banking regulators are sitting around the same table with the sole purpose of improving about the safety of the financial system at large. Additionally, there is more information available about the industry from the newly established Office of Financial Research.

Furthermore, regulatory improvements have resulted in:

  • Living Wills: a map of how to effectively wind-down a failing company that does not hurt the greater economy, or financial system. These extensive plans are submitted annually to the FDIC and Federal Reserve.
    • Orderly Liquidation Authority: the power for regulators to enact the above plan if a financial firm fails.
    • Enhanced Prudential Standards: Banks now submit to regular stress tests and other enhanced prudential standards such as increased capital and liquidity via Section 165/166 of DFA.
    • No Taxpayer Dollars:  assessments will be used to pay for failures, not taxpayer dollars, re: Section 214 of the Dodd-Frank Act. It reads, “Taxpayers shall bear no losses from the exercise of any authority under this title.” “No taxpayer funds shall be used to prevent the liquidation of any financial company under this title.”

In fact, Federal Reserve Board Chairman, Ben Bernanke, was recently quoted as saying “Risk indicators present a picture of the banking system that has become healthier and more resilient.”

No one can guarantee that another economic contraction will not occur. Indeed, it is almost certain that it will.  Luckily, legislative, regulatory and market changes, as a result of the 2008 crisis, have strengthened the financial sector.

Too big to fail is over. Moving forward the industry, not taxpayers, will be on the hook.

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