Debate Over ‘Too Big to Fail’ Continues Into the New Year

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The question as to whether “too big to fail” no longer exists or is being codified by the government continued to be a hot button topic as 2015 wound down, and the debate isn’t slowing as 2016 begins.

The Dodd-Frank Wall Street Reform Act of 2010 contained a provision limited the Fed’s ability to engage in emergency lending and lending to programs with “broad based” eligibility, and was billed as the end of “too big to fail.”

While Dodd-Frank prohibits the Fed from lending to insolvent entities, however, the Fed issued a final rule in November 2015 that expanded the definition of insolvency to include borrowers who fail to pay undisputed debts as they become due 90 days before borrowing—or borrowers who are determined to be insolvent by the Fed or lending Reserve Bank.

Some in the industry were skeptical that the Fed’s final rule issued in November would be effective at ending emergency bailouts of large financial institutions. Among the skeptics was Ed Delgado, President and CEO of the Five Star Institute, who stated, “While the clarification of ‘broad-based lending’ is designed to limit the types of bailouts the industry realized in 2008, at the same time, the Fed expanded the definition of ‘insolvency’ ostensibly, given the circumstance, permitting lending to entities that may actually be insolvent, so I question how much of an impact this new rule will really have?”

Too big to fail has been heavily debated in the House Financial Services Committee, most recently in early December when the Committee held a hearing to discuss whether or not the Financial Stability Oversight Council (FSOC) is codifying too big to fail by designating certain financial institutions as “systemically important.”  The FSOC’s criteria for such a designation has also been greatly contested. The FSOC is an agency created by Dodd-Frank that consists mostly of the heads of government regulatory agencies.

House Financial Services Committee Chairman Jeb Hensarling stated in late November that “Designation (of an institution as systemically important) anoints institutions as too big to fail, meaning today’s SIFI designations are tomorrow’s taxpayer-funded bailouts.”

The topic of whether or not too big to fail still exists will be at the forefront once again on Friday, January 22, when the Hoover Institution and the Bipartisan Policy Center will host an event in Washington, D.C., titled “Ending Too Big to Fail: Reform and Implementation.” The event features remarks by Hoover Institution Senior Fellow John Taylor and the University of Rochester’s President Emeritus Thomas Jackson, and will include a panel of experts discussion the effectiveness of new capital requirements toward preventing short-term liquidity shortage, what changes are necessary to the Bankruptcy Code to limit financial distress, and whether or not proposals by the FDIC ensure that a resolution is certain.

The event is a follow-up to the Bipartisan Center’s white paper, Too Big to Fail: The Path to a Solution and coincides with the release of the Hoover Institute’s book, Making Failure Feasible: How Bankruptcy Reform Can End Too Big to Fail.

In September 2015, a study by Norbert J. Michel, Research Fellow in Financial Regulations, the Institute for Economic Freedom and Opportunity at the Heritage Foundation, concluded that Dodd-Frank still allows the Fed to engage in the type of emergency lending that the industry saw back in 2008 despite its claims that the controversial law had ended too big to fail.

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