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Don't Declare Victory on 'Too Big to Fail' Yet
CAMBRIDGE, Mass. (12/10/13)--The U.S. government has a long way to go before it can declare victory over "Too Big to Fail," according to Massachusetts Institute of Technology business professor Simon Johnson.
Johnson claimed that the Federal Reserve still has the ability to bail out moribund Wall Street banks, and that banks' "living wills"--plans for bankruptcy with minimal disruption to the global financial system--lack significance. He also said that institutions with assets in multiple countries cannot be unilaterally wound down by the U.S. government.
The Sloan School of Management professor and Federal Deposit Insurance Corp. Systemic Resolution Advisory Committee member made the observations in a Bloomberg column after a speech made last week by Treasury Secretary Jack Lew ( Dec. 8). Lew said that "Too Big to Fail" has not ended yet, but is on its way to soon becoming a thing of the past.
Johnson said that the New York Fed, however, can bypass language in the Dodd-Frank Act--which prohibits the government from discriminatory bailouts like those that saved American International Group Inc. in September 2008.
"As long as support is available to a broad class of assets or to a set of companies, almost anything remains possible," he wrote, adding that reforms that sought to rein in the Federal Reserve's ability to bail out banks after 2008 are "formalities."
"The next bailout won't come from Congress," he said. "It will come from, or at least via, the Fed."
Johnson also contradicted Lew's assessment of big banks' "living wills," opining that the plans are not "credible" and that to "suggest regulators are really going to use this power is hardly plausible." Lew said regulators will force firms to revise plans if they lack credibility.
Johnson concluded with an argument that cross-border resolution would lead to "another destabilizing scramble for assets" in the absence of multilateral collaboration between regulators. He said that non-discriminatory policies that fully protect foreign creditors would leave taxpayers holding the bag "if a large financial institution fails."
The professor also said he doesn't have confidence that the impending finalization of the Volcker rule--mandating, in theory, the segregation of retail and investment banking--will stabilize the banking system.


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