TARP Inspector General: ‘Too Big to Fail’ Banks Are Still a Problem

Thursday, 25 Apr 2013 11:19 AM

By Michael Kling

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“Too big to fail” banks remain a threat to the financial system despite new regulations and efforts to prevent another crisis.

That’s the warning from the Special Inspector General for the Troubled Asset Relief Program (TARP).

It’s not just the size of huge financial firms that’s the problem. It’s their interconnectedness, argues Special Inspector General Christy Romero in a report to Congress.

Editor's Note: I Wish I Were Wrong — Economist Laments Being Right. See Interview.

In the 2008 financial crisis, regulators were surprised to learn that large financial firms were tied to each other as counterparties. “If one went down, it took the others down with it,” she says.

Companies did not understand how exposed they were to their counterparties or other large firms, as those risks were hidden in complicated derivatives and credit default swaps. Regulators were blindsided by the impact of those financial products, which were largely outside their purview.

“Our nation’s top financial regulators must take the necessary steps to end too big to fail by breaking off dangerous interconnections that led to the crisis and the TARP bailout, and could sow the seeds for a future crisis,” Romero urges.

If there’s another crisis, it’s doubtful if regulators would let a large bank go down, she notes. “To let one of the largest financial firms fail requires regulators to have confidence that they can close down the firm without damaging the economy, and as a nation we are not there yet.”

Romero also questions the usefulness of the Dodd-Frank’s provision for living wills, meant to smooth the way for orderly bankruptcies. “If there is a future crisis, there may be no time for bankruptcy.”

In a crisis, a firm may not have enough cash to last even a weekend. Plus, many operate in multiple countries under different bankruptcy laws.

To prevent another crisis and more bailouts, regulators must use living wills to break off dangerous interconnections now rather than waiting “until a company’s deathbed,” she explains.

Many lawmakers also believe too big to fail remains a problem.

Sens. Sherrod Brown, D-Ohio, and David Vitter, R-La., introduced a bill that would require big banks to increase their capital cushions, according to The Wall Street Journal.

“It’s pretty clear that the market is saying too big to fail is still a problem, that these huge Wall Street banks are too complex, too interconnected, too large,” Brown said at a roundtable discussion, The Journal reports.

Editor's Note: I Wish I Were Wrong — Economist Laments Being Right. See Interview.

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