The leader of the Federal Reserve said he didn’t mean to imply that the problem of too-big-to-fail no longer exists when he debated the issue with a high-profile U.S. senator during a recent hearing. Fed Chairman Ben Bernanke told the media during his March 20 Federal Open Market Committee press conference that too-big-to-fail is still a problem and that policymakers should consider additional steps to address the issue if current measures fail to achieve the desired results.
“I don’t think too-big-to-fail is solved now,” Bernanke told reporters. “We’re doing a number of things which I think will help.”
The simmering debate over whether certain institutions are too large to be permitted to fail due to the impact of such a failure on U.S. financial stability boiled over in recent weeks, driven in part by an exchange between Bernanke and Sen. Elizabeth Warren, D-Mass., during a Feb. 26 hearing before the Senate Banking Committee.
Warren noted that large firms still borrow at a discount relative to smaller firms, notwithstanding Dodd-Frank’s mandate to end too-big-to-fail. She asked Bernanke whether megabanks should be required to reimburse taxpayers for what she characterized as a subsidized insurance policy.
“The subsidy is coming because of market expectations that the government would bail out these firms if they failed. Those expectations are incorrect,” Bernanke told Warren. He said the markets will ultimately come to realize that the steps regulators have taken to end too-big-to-fail are effective. He also questioned recent estimates of the size of the too-big-to-fail subsidy.
Major financial trade groups including the Financial Services Forum, Financial Services Roundtable, The Clearing House, Securities Industry and Financial Markets Association and the American Bankers Association cited Bernanke’s remarks when they released a policy brief on too-big-to-fail on March 11. The groups argued that the funding advantage formerly enjoyed by the biggest banks largely evaporated as market participants acknowledge the impact of Dodd-Frank's enhanced prudential supervision and orderly liquidation provisions.
The groups also had a word of caution for policymakers who might consider additional steps to curb the alleged subsidy.
“It is important to acknowledge that there is substantial evidence that the market recognizes the impact Dodd-Frank has had on investor expectations,” the groups wrote. “Flawed arguments regarding subsidies to large banking companies are at best out of date, and their use to call for draconian structural limits on the financial industry is out of step with the diverse financial needs of the 21st century U.S. economy."
During his press conference, Bernanke explained that he agrees that too-big-to-fail remains a “major issue.”
“I never meant to imply that the problem was solved and gone. It is not solved and gone; it’s still here, but there’s a lot of work in train,” Bernanke said. “We’re putting in the Basel capital standards. We’re putting in the orderly liquidation authority from Dodd-Frank. We’re working with our international partners. And I hope that we’ll make progress against too-big-to-fail, because I agree with [Warren] 100 percent that it’s a real problem and needs to be addressed if at all possible.”
The Fed has not estimated the size of the too-big-to-fail subsidy, Bernanke said. However, to some extent, the markets seem to be taking into account that large financial firms can fail.
“Spreads in the credit default swaps indicate some probably of failure. You see some discrimination among different institutions according to the bond market, interest rates that they get charged and so on,” Bernanke said. “So there is some evidence of market discrimination.”
He noted that said some measures intended to address systemic risk, including proposed capital surcharges on the nation’s largest banks, have not yet been implemented. The Fed will continue to monitor the impact of these policies. Bernanke said, however, that if current initiatives don’t ultimately yield the desired results, policymaker should consider additional steps.
“Too-big-to-fail was a major part of the source of the crisis. And we will not have successfully responded to the crisis if we don't address that problem successfully,” Bernanke said.
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