Financial reform bill: What does it do about firms deemed 'too big to fail'?
Financial reform legislation hammered out Friday between the House and Senate is the biggest set of new bank regulations since the Depression. But experts disagree on whether it can eliminate 'too big to fail' banks and prevent future bailouts.
Financial reform legislation hammered out early Friday morning by House and Senate lawmakers is supposed to protect the US against another credit crisis, but experts are split on whether the bill would end the "too big to fail" mystique surrounding some financial institutions.Skip to next paragraph
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Obama administration officials say that it would. Regulators would have new powers to seize and dispose of failing financial firms, they point out, which would deter those firms from becoming too large and reckless.
Other experts aren’t so sure. There is nothing specific in the legislation that would allow the federal government to limit the size of banks or other institutions, they say. Without such a cap, banks and other financial entities will continue to grow to the point where their failures might threaten to badly damage the entire US economy.
Many analysts say the economy is distorted by the widely held perception that some financial firms are so large the US government can’t afford to let them fail. Such an implicit federal guarantee allows these behemoths to borrow at cheaper rates, because the markets see them as safer investments. The firms themselves may take risks they might otherwise have shunned, figuring that even if they mess up, Uncle Sam will be there to bail them out in the end.
To see “too big to fail” in action, just look at the events of September 2008, say economists. The giant insurance firm AIG suffered a liquidity crisis, and the Bush administration effectively nationalized the firm, fearing that it was so intertwined with other financial giants that if it took a swan dive it would bring half of Wall Street down with it. At the same time, the Bush team allowed Lehman Brothers to go under. That move proved to be an exception that proved the rule, as the Lehman bankruptcy froze credit markets and indeed may have accelerated the world financial meltdown.
The financial reform bill attempts to address this problem by creating a halfway station between bailout with taxpayer dollars and bankruptcy. Banks and other large financial firms would have to create “funeral plans” indicating how they could be broken up and shut down with as little damage to other firms as possible.