The Big Fail

Despite the reach of Dodd-Frank, the "too-big-to-fail" dilemma lives on.

In 2009, Federal Reserve chairman Ben Bernanke told members of the Federal Crisis Inquiry Commission that regulatory reform would be a failure if it did not contemplate a system by which Goldman Sachs could go bankrupt and its creditors lose money.

While few would call banking regulatory reform a failure — thus far, at least — it has fallen well short of what Bernanke wanted. The “too-big-to-fail” problem, defined as the government using taxpayer dollars to rescue “systemically important” banks, remains unsolved. And the solutions being debated may elevate overall industry risk instead of subduing it.

Taxpayer-funded bank rescues are political dynamite, of course, but in addition, the expectation of bailouts provides banks no incentive to guard against excessive risk. The recent history of ad-hoc crisis resolution — think Citigroup, Lehman Brothers, and General Motors — contributes to a climate of uncertainty. Major bank rescues can spark global economic upheaval, so it would help if everyone knew the game plan at the Treasury Department and the Federal Reserve before any future failures of large banks.

“Systemically important” banks are not going away. Banking regulators want their banks safe, sound, and big, says Ernie Patrikis, a partner in the bank and insurance regulatory practice of White & Case LLP. Many CFOs of multinational firms also see the money-center banks as indispensable for management, investment banking, and capital-raising. “They’re some of the best-run banks in the country,” says JoAnn Lilek, finance chief at consulting firm Accretive Solutions and former CFO of Midwest Bank Holdings. “They’re very well managed, they’re perceived to be very solid, and the breadth of services is incredible.”

Many CFOs think irresponsible management should suffer the consequences, but worry that, absent a government safety net, middle-market companies would be more vulnerable. While large corporations can just increase their stable of lenders, smaller companies have to concentrate their credit relationships with one or two banks to get access to debt, explains Lilek. In addition, many finance chiefs at midsize companies would not have the expertise or bandwidth to do the necessary credit monitoring that the removal of an implicit government backstop would require.

Since the end of 2007, the largest U.S. banks have been piling on the assets.

“If government bailouts were absolutely prohibited, I would be very concerned that [the problems of three years ago] would play out again and again,” says Ron Box, finance chief at Joe Money Machinery, a construction-equipment dealer. “It is a fact of life that we have a global financial system with very complex interrelated parts. Unfortunately, I do not believe that the clock can be turned back to a more isolationist time.”

Can U.S. banking regulators really solve — partially or in whole — the too-big-to-fail problem without exposing financial institutions to higher capital costs, subjecting nonfinancial companies (banks’ customers) to another credit crunch, or being granted an incredible amount of political independence?

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