Why We Must End Too Big to Fail

8/2/2019 Why We Must End Too Big to Fail

1/21

As a nation, we ace a distinct choice. We can perpetu-

ate too big to ail, with its inequities and dangers, or we

can end it. Eliminating TBTF wont be easy, but the vitality

o our capitalist system and the long-term prosperity it

produces hang in the balance.

2Federal reserve Bank oF dallas 2011 annual report


2/21

Choosing the Road to Prosperity

Why We Must End Too Big to FailNowby Harvey Rosenblum

Federal reserve Bank oF dallas 2011 annual report3

ore than three years ater a crippling nancial crisis, the American economy

still struggles. Growth sputters. Job creation lags. Unemployment remains high.

Housing prices languish. Stock markets gyrate. Headlines bring reports o a

shrinking middle class and news about governments stumbling toward bankruptcy, at

home and abroad.

Ordinary Americans have every right to eel anxious, uncertain and angry. Tey have

every right to wonder what happened to an economy that once delivered steady progress.

Tey have every right to question whether policymakers know the way back to normalcy.

American workers and taxpayers want a broad-based recovery that restores con-

dence. Equally important, they seek assurance that the causes o the nancial crisis have

been dealt with, so a similar breakdown wont impede the fow o economic activity.

Te road back to prosperity will require reorm o the nancial sector. In par-ticular, a new roadmap must nd ways around the potential hazards posed by the

nancial institutions that the government not all that long ago deemed too big to

ailor BF, or short.

In 2010, Congress enacted a sweeping, new regulatory ramework that attempts

to address BF. While commendable in some ways, the new law may not prevent the

biggest nancial institutions rom taking excessive risk or growing ever bigger.

BF institutions were at the center o the nancial crisis and the sluggish recov-

ery that ollowed. I allowed to remain unchecked, these entities will continue posing

a clear and present danger to the U.S. economy.

As a nation, we ace a distinct choice. We can perpetuate BF, with its inequities

and dangers, or we can end it. Eliminating BF wont be easy, but the vitality o our

capitalist system and the long-term prosperity it produces hang in the balance.

M


3/214Federal reserve Bank oF dallas 2011 annual report

When competition declines, incentives oten turn per-

verse, and sel-interest can turn malevolent. Thats what

happened in the years beore the fnancial crisis.

Flaws, Frailties and FoiblesTe nancial crisis arose rom ailures

o the banking, regulatory and political

systems. However, ocusing on acelessinstitutions glosses over the undamen-

tal act that human beings, with all their

faws, railties and oibles, were behind the

tumultuous events that ew saw coming

and that quickly spiraled out o control.

Complacency

Good times breed complacencynot

right away, o course, but over time as

memories o past setbacks ade. In 1983,the U.S. entered a 25-year span disrupted

by only two brie, shallow downturns, ac-

counting or just 5 percent o that period

(Exhibit 1). Te economy perormed

unusually well, with strong growth, low

unemployment and stable prices.

Tis period o unusual stability and

prosperity has been dubbed the Great

Moderation, a respite rom the usual tumult

o a vibrant capitalist economy. Beore the

Federal Reserves ounding in 1913, recession

held the economy in its grip 48 percent o

the time. In the nearly 100 years since the

Feds creation, the economy has been in

recession about 21 percent o the time.

When calamities dont occur, its hu-

man nature to stop worrying. Te world

seems less risky.

Moral hazard reinorces complacency.Moral hazard describes the danger that

protection against losses encourages riskier

behavior. Government rescues o troubled

nancial institutions encourage banks and

their creditors to take greater risks, know-

ing theyll reap the rewards i things turn

out well, but will be shielded rom losses i

things sour.

In the run-up to the crisis o 2008, the

public sector grew complacent and relaxed

the nancial systems constraints, explicitly

in law and implicitly in enorcement. Ad-

ditionally, government elt secure enough

in prosperity to pursue social engineering

goalsmost notably, expanding home

ownership among low-income amilies.

At the same time, the private sector

also became complacent, downplaying

the risks o borrowing and lending. For

example, the traditional guideline o 20

percent down payment or the purchase

o a home kept slipping toward zero, es-

pecially among lightly regulated mortgage

companies. More money went to those

with less ability to repay.1

Greed

You need not be a reader o Adam

Smith to know the power o sel-inter-

estthe human desire or material gain.Capitalism couldnt operate without it.

Most o the time, competition and the rule

o law provide market discipline that keeps

sel-interest in check and steers it toward

the social good o producing more o what

consumers want at lower prices.

When competition declines, incen-

tives oten turn perverse, and sel-interest

can turn malevolent. Tats what happened

in the years beore the nancial crisis. Newtechnologies and business practices reduced

lenders skin in the gameor example,

consider how lenders, instead o retaining

the mortgages they made, adopted the

new originate-to-distribute model, allowing

them to pocket huge ees or making loans,

packaging them into securities and selling

them to investors. Credit deault swaps ed

the mania or easy money by opening a

casino o sorts, where investors placed bets

onand a ew nancial institutions sold

protection oncompanies creditworthi-

ness.

Greed led innovative legal minds to

push the boundaries o nancial integrity


4/21

0

5

10

15

20

25

30

35

40

45

50

Time spent in recession (percent) Time spent in recession, pre-Fed vs. post (percent)

2008201119832007196119821939196019151938

0

20

40

60

1915201118571914

37

16 17

5

38

21

48

Exhibit 1

Reduced Time Spent in Recession

52011 annual report Federal reserve Bank oF dallas

with o-balance-sheet entities and other ac-

counting expedients. Practices that werent

necessarily illegal were certainly mislead-

ingat least thats the conclusion o manypostcrisis investigations.2

Complicity

We admire success. When everybodys

making money, were eager to go along or

the rideeven in the ace o a suspicion

that something may be amiss. Beore the

nancial crisis, or example, investors relied

heavily on the credit-rating companies that

gave a green light to new, highly complex

nancial products that hadnt been tested

under duress. Te agencies bestowed their

top rating to securities backed by high-risk

assetsmost notably mortgages with small

down payments and little documentation

o the borrowers income and employment.

Billions o dollars o these securities were

later downgraded to junk status.

Complicity extended to the public

sector. Te Fed kept interest rates too low

or too long, contributing to the specula-

tive binge in housing and pushing investors

toward higher yields in riskier markets. Con-

gress pushed Fannie Mae and Freddie Mac,

the de acto government-backed mortgage

sourCe: ni B f ecmic rch.


5/21

Assets as a percentage of total industry assets

1970 2010

12,500 smallerbanks

46%

16%

37% 32%

17%

52%

Top 5 banks

95 large andmedium-sized

banks

5,700smaller banks Top 5 banks

Exhibit 2

U.S. Banking Concentration Increased Dramatically


Concentration amplifed the speed and breadth o the

subsequent damage to the banking sector and the

economy as a whole.

giants, to become the largest buyers o

these specious mortgage products.

Hindsight leaves us wondering what -

nancial gurus and policymakers could havebeen thinking. But complicity presupposes

a willul blindnesswe see what we want to

see or what lies experiences condition us to

see. Why spoil the party when the economy

is growing and more people are employed?

Imagine the political storms and public

ridicule that would sweep over anyone who

tried!

Exuberance

Easy money leads to a giddy sel-

delusionits human nature. A contagious

divorce rom reality lies behind many o his-

torys great speculative episodes, such as the

Dutch tulip mania o 1637 and the South

Sea bubble o 1720. Closer to home in time

and space, exuberance ueled the exas oil

boom o the early 1980s. In the rst decade

o this century, it ed the illusion that hous-

ing prices could rise orever.

In the run-up to the nancial crisis,

the certainty o rising housing prices

convinced some homebuyers that high-

risk mortgages, with little or no equity,

werent that risky. It induced consumers

note: a w cc ig h gy high h h f b mmig f h

b wih h m h g im f gizi- b .

sourCes: r f Cii Icm, F Fici Iii exmii Cci; ni IfmiC, F r sym.


6/2172011 annual report Federal reserve Bank oF dallas

to borrow on rising home prices to pay or

new cars, their childrens education or a

long-hoped-or vacation. Prudence would

have meant sitting out the dance; buyinginto the exuberance gave people what they

wantedat least or a while.

All booms end up busts. Ten comes

the sad rerain o regret: How could we

have been so oolish?

Concentration

In the nancial crisis, the human traits o

complacency, greed, complicity and exuber-

ance were intertwined with concentration,

the result o businesses natural desire to

grow into a bigger, more important and

dominant orce in their industries. Concen-

tration amplied the speed and breadth

o the subsequent damage to the banking

sector and the economy as a whole.

Te biggest U.S. banks have gotten a

lot bigger. Since the early 1970s, the share

o banking industry assets controlled by

the ve largest U.S. institutions has more

than tripled to 52 percent rom 17 percent

(Exhibit 2).

Mammoth institutions were built on a

oundation o leverage, sometimes mislead-

ing regulators and investors through the

use o o-balance-sheet nancing.3 Equitys

share o assets dwindled as banks borrowed

to the hilt to chase the easy prots in new,

complex and risky nancial instruments.Teir balance sheets deterioratedtoo little

capital, too much debt, too much risk.

Te troubles werent always apparent.

Financial institutions kept marking assets

on their books at acquisition cost and

sometimes higher values i their proprietary

models could support such valuations.

Tese accounting expedients allowed them

to claim they were healthyuntil they

werent. Write-downs were later revised by

several orders o magnitude to acknowledge

mounting problems.

With size came complexity. Many big

banks stretched their operations to include

proprietary trading and hedge und invest-

ments. Tey spread their reach into dozens

o countries as nancial markets globalized.

Complexity magnies the opportunities

or obuscation. op management may not

have known all o what was going onpar-

ticularly the exposure to risk. Regulators

didnt have the time, manpower and other

resources to oversee the biggest banks vast

operations and erret out the problems that

might be buried in nancial ootnotes or

legal boilerplate.

Tese large, complex nancial institu-

tions aggressively pursued prots in the

overheated markets or subprime mort-gages and related securities. Tey pushed

the limits o regulatory ambiguity and lax

enorcement. Tey carried greater risk and

overestimated their ability to manage it.

In some cases, top management groped

around in the dark because accounting and

monitoring systems didnt keep pace with

the expanding enterprises.

Blowing a GasketIn normal times, fows o money and

credit keep the economy humming. A

healthy nancial system acilitates payments

and transactions by businesses and consum-

ers. It allocates capital to competing invest-

ments. It values assets. It prices risk. For the

most part, we take the nancial systems

routine workings or granteduntil the ma-

chinery blows a gasket. Ten we scramble to

x it, so the economy can return to the ast

lane.

In 2007, the nations biggest in-

vestment and commercial banks were

among the rst to take huge write-os on

mortgage-backed securities (Exhibit 3).

(continued on page 11)


7/21

0

900

700

500

300

100

100

300

SepJunMarDecSepJunMarDecSepJunMarDecSepJunMar

2007 2008 2009 2010

8 9Federal reserve Bank oF dallas 2011 annual report 2011 annual report Federal reserve Bank oF dallas

Exhibit 3

Employment Plummets as Financial System Implodes

Selected Timeline, 20072010

Subprime mortgage

lenders show losses

and some go bankrupt:

New Century Financial

(4/07)

Losses spread to

investors in subprime

mortgage-backed se-

curities; Bear Stearns

fghts unsuccessully

to save two ailing

hedge unds (6/07)

Subprime

mortgage-related

and leveraged loan

losses mount amid

serial restatements o

write-downs; execs

at Citi and Merrill

Lynch step down

(07:Q4)

Nationalization o

systemically important

mortgage-lending

institutions: Northern

Rock (2/08); Fannie

Mae and Freddie Mac

(9/08)

Investment banks

acquired by largest

commercial banks

with government as-

sistance: Bear Stearns

(3/08); Merrill Lynch

(1/09)

Monoline insurers

downgraded (6/08)

Bank/thrit ailures:

IndyMac (7/08); Washington

Mutual (9/08)

Financial market

disarray Lehman

bankruptcy; AIG

backstopped

(9/08)

Banking behemoth consolidation Wells Fargo

acquires Wachovia; PNC acquires National City;

Goldman Sachs and Morgan Stanley become

bank holding companies (10/08)

Government interven-

tion Citi and Bank

o America receive

government guarantees;

troubled asset relie

program (TARP) unds

released, restrictions on

exec pay, stress tests

introduced; Fed pushes

policy rate near zero,

creates special liquidity

and credit acilities and

introduces large-

scale asset purchases

(08:Q409:Q1 )

TARP unds o largest

banks repaid at a

proft to taxpayers:

JPMorgan (6/09);

Bank o America,

Wells Fargo, Citi

(12/09)

NBER dates June

2009 as ofcial

recession end

(9/10)

Foreclosure procedure

questioned, halted an

ederally mandated t

be improved at sever

major banks/mortgag

servicers (10/10

Trouble starts with shadow banks Crisis spreads to larger shadow/investment banks Commercial banks are affected Smaller banks struggle amid a mixed recovery

Fallout through 2011

FDICs problem list reaches a peak asset total of $431 billion (3/10) and peak

number of 888 banks (3/11).

Roughly 400 smaller banks still owe nearly $2 billion in TARP funds (10/11).

Only two of the 249 banks that failed in 2010 and 2011 held more than

$5 billion in assets (12/11).

Small banks face rising uncertainty about compliance

costs, unknown implementation of complicated new

regulations and anemic loan demand

Roughly 800,000 jobs lost per month


8/21

The term TBTF disguised the act that commercial banks hold-

ing roughly one-third o the assets in the banking system did

essentially fail, surviving only with extraordinary government

assistance.


or capitalist economies to thrive, weak companies mustgo out o business. The reasons or ailure vary rom

outdated products, excess industry capacity, misman-

agement and simple bad luck. The demise o existing rms

helps the economy by reeing up resources or new enterprises,

leaving healthier survivors in place. Joseph Schumpeter coined

the term creative destruction to describe this ailure and

renewal processa major driver o progress in a ree-enterprise

economy. Schumpeter and his disciples view this process as

benecial despite the accompanying loss o jobs, asset values

and equity.

The U.S. economy oers a range o options or this pro-

cess o ailure and rebirth:

BankruptciesEnterprises beyond saving wind up in Chapter 7 bank-

ruptcy, with operations ended and assets sold o. Firms with

a viable business but too much debt or other contractual

obligations usually le or Chapter 11 bankruptcy, continuing

to operate under court protection rom creditors. Both orms

o bankruptcy result in a hit to stakeholders: shareholders,

employees, top managers and creditors are wiped out or

allowed to survive at a signicant haircut. Bankruptcy means

liquidation or reduction; whether the bankrupt rm dies com-

pletely or scales down and survives with the same or similar

name, the end game is reallocation o resources.

Buyouts

A company acing potential bankruptcy may insteadbe sold. The acquisition usually produces similar stakeholder

reduction results as a Chapter 11 bankruptcy, but without the

obliteration o equity ownership and creditor allout.

Bailouts

The government steps in to prevent bankruptcy by providing

loans or new capital. The government becomes the most

senior secured creditor and begins downsizing losses, man-

agement, the corporate balance sheet and risk appetite. Asthe company restructures, the government, oten very slowly,

weans the company o lie support.

Banks are special

The FDIC handles most bank ailures through a resolution

similar to a private-sector buyout. The FDIC is unded primarily

by ees garnered rom the banking industry. The ailed institu-

tions shareholders, employees, management and unsecured

creditors still generally suer signicant losses, while insured

depositors are protected.

In the wake o the nancial crisis, DoddFrank added a

new option: the Orderly Liquidation Authority (OLA). In theory,

OLA will ollow the spirit o a Chapter 7 bankruptcyliquida-

tion o the ailed rms assetsbut in an orderly manner.Orderly may involve some FDIC/government nancing to

maximize rm value prior to the sale, thus blending some o

the degrees o ailure already discussed.

Buyouts, bankruptcies and FDIC resolutions have a long

history o providing a reasonably predictable process that

imposes no costs to taxpayers. Bankruptcies and buyouts sup-

port creative destruction using private sector unding. By con-

trast, bailouts and OLA are specically aimed at dealing with

too-big-to-ail institutions and are likely to involve some orm o

taxpayer assistance since this degree o ailure comes ater

private sector solutions are deemed unavailable. Bailouts

provide delayed support o the creative destruction process,

using sometimes politically infuenced taxpayer unds instead

o the ree-enterprise route o reduction, rebirth and realloca-tion.

In essence, dealing with TBTF nancial institutions neces-

sitates quasi-nationalization o a private company, a process

antithetical to a capitalist system.

But make no mistake about it: A bailout is a failure, just

with a different label.

Box 1

Degrees of Failure: Bankruptcies, Buyouts and Bailouts

F



As housing markets deteriorated, policy-

makers became alarmed, seeing the num-

ber o big, globally interconnected banks

among the wounded. Te loss o evenone o them, they eared, would create a

domino eect that would lead to a col-

lapse o the payment system and severely

damage an economy already battered by

the housing bust.

Capital markets did in act seize up

when Lehman Brothers, the ourth-largest

investment bank, declared bankruptcy in

September 2008. o prevent a complete

collapse o the nancial system and to

unreeze the fow o nance, the expedi-

ent x was hundreds o billions o dollars

in ederal government loans to keep these

institutions and the nancial system afoat.

In short, the situation in 2008

removed any doubt that several o the

largest U.S. banks were too big to ail.4 At

that time, no agency compiled, let alone

published, a list o BF institutions. Nor

did any bank advertise itsel to be BF.

In act, BF did not exist explicitly, in

law or policyand the term itsel dis-

guised the act that commercial banks

holding roughly one-third o the assets

in the banking system did essentially fail,

surviving only with extraordinary govern-

ment assistance (Exhibit 4).5 Most o the

largest nancial institutions did not ail in

the strictest sense. However, bankruptcies,buyouts and bailouts acilitated by the

government nonetheless constitute ailure

(Box 1). Te U.S. nancial institutions that

ailed outright between 2008 and 2011

numbered more than 400the most since

the 1980s.

Te housing bust and recessiondisabled the nancial system, stranding

many institutions on the roadway, creating

unprecedented trac jams. Struggling

Exhibit 4

Total Assets of Failed and Assisted Institutions Reached

Extraordinary Levels

sourCe: F di Ic C.

0

100

200

300

400

1006029894908682787470

Assisted institutions

1,306

1,917

0

1,000

2,000

0908

Total assets (billions of dollars)

0809$3.77 trillion

total failed/assisted

$3,223 assisted

Failed institutions

$542failed

372

170


10/21

Realincomegrows

Spendingincreases

Profitsincrease

Realeconomyexpands

Equipment,software

and other businessinvestments increase

Creditexpands

Vehicle, home anddurable goodsales increase

Employmentincreases

Pro

gres

singExpansionGo

odbegetsgood

Exhibit 5

Positive Feedback

Psychological side eects o TBTF cant be measured,

but theyre too important to ignore because they aect

economic behavior.


banks could not lend, slowing economic

activity. Massive layos ollowed, pinching

household and business spending, which

depressed stock prices and home values,urther reducing lending. Tese troubles

brought more layos, urther reduc-

ing spending. Overall economic activity

bogged down.

Te chain reaction that started in De-

cember 2007 became the longest recession

in the post-World War II era, lasting a total

o 18 months to June 2009. Real output

rom peak to trough dropped 5.1 percent.

Job losses reached nearly 9 million. Unem-

ployment peaked at 10 percent in October

2009.

Te economy began seeing a slight

easing o congestion in mid-2009. With the

roadway beginning to clear o obstacles,

households and businesses sensed an op-

portunity to speed up. New jobs, higher

spending, rising asset prices and increased

lending all reinorce each other, building

up strength as the economy proceeds on a

growth path(Exhibit 5).

Monetary Policy Engine

In an internal combustion engine,

small explosions in the cylinders combus-



tion chambers propel a vehicle; likewise,

the monetary policy engine operates

through cylinders that transmit the impact

o Fed actions to decisions made by busi-nesses, lenders, borrowers and consumers

(Exhibit 6).6

When it wants to get the economy

moving aster, the Fed reduces its policy

interest ratethe ederal unds rate, what

banks charge one another or overnight

loans. Banks usually respond by mak-

ing more credit available at lower rates,

adding a spark to the bank loan cylinder

that drives borrowing by consumers and

companies. Subsequent buying and hiring

boost the economy.

Interest rates in money and capi-

tal markets generally all along with the

ederal unds rate. Te reduced cost o

nancing taking place in the securities

market cylinder enables many large busi-

nesses to nance expansion through sales

o stock, bonds and other instruments.

Increased activity occurs in the asset prices

and wealth cylinder stemming rom the

propensity o alling interest rates to push

up the value o assetsbonds, equities,

homes and other real estate. Rising asset

values bolster businesses balance sheets

and consumers wealth, leading to greater

capacity to borrow and spend.

Declining interest rates stimulate ac-

tivity in the exchange rate cylinder, makinginvesting in U.S. assets less attractive rela-

tive to other countries, putting downward

pressure on the dollar. Te exchange rate

adjustments make U.S. exports cheaper,

stimulating employment and economic

activity in export industries. However, what

other countries do is important; i they

also lower interest rates, then the eect on

exchange rates and exports will be muted.

From the rst moments o the

nancial crisis, the Fed has worked

diligentlyoten quite imaginativelyto

repair damage to the banking and nancial

sectors, ght the recession, clear away

impediments and jump-start the economy.

Te Fed has kept the ederal unds

rate close to zero since December 2008. o

deal with the zero lower bound on the ed-

eral unds rate, the Fed has injected billions

o dollars into the economy by purchasing

long-maturity assets on a massive scale,

creating an unprecedented bulge in its

balance sheet. Tat has helped push down

borrowing costs at all maturities to their

lowest levels in more than a hal century.

While reducing the interest burden or

borrowers, monetary policy in recent years

has had a punishing impact on savers,

particularly those dependent on shrinkinginterest payments.

In the United States, economic

growth resumed in mid-2009but it has

been tenuous and ragile through its rst

two-plus years. Annual growth has aver-

aged about 2.5 percent, one o the weakest

rebounds o any post-WWII recovery. Stock

prices quickly bounced back rom their

recessionary lows but seem suspended

in trendless volatility. Home prices have

languished.

At the same time, job gains have been

disappointing, averaging 120,000 a month

rom January 2010 to December 2011,

less than hal what they were in the mid-

to late 1990s when the labor orce was

considerably smaller. Trough 2011, only a

third o the jobs lost in the recession have

been regained.

Whats Different Now?

Te sluggish recovery has conounded

monetary policy. Much more modest Fed

actions have produced much stronger

results in the past. So, whats dierent now?


12/21

Exhibit 6The Four Cylinders of the Monetary Policy Engine

Bank loan

Securitiesmarket

Asset pricesand

wealth Exchangerate

Crankshaft

Bank capital lubricant

Connected toeconomy:

households,businesses

and governments

A vehicles engine with one cylinder misfring may get you

where you want to go; it just takes longer. The same goes or

the machinery o monetary policy, largely because o the

interdependence o all the moving parts.


Part o the answer lies in excesses that

havent been wrung out o the economy

alling housing prices have been a lingering

drag. Jump-starting the housing marketwould surely spur growth, but BF banks

remain at the epicenter o the oreclosure

mess and the backlog o toxic assets stand-

ing in the way o a housing revival. Mort-

gage credit standards remain relatively

tight.7

Loan demand lags because o uncer-

tainty about the economic outlook and

diminished aith in American capitalism.

Even though banks have begun easing

lending standards, potential borrowers be-

lieve the tight credit standards o 200810

remain in place.

Another part o the answer centers

on the monetary policy engine. It still isnt

hitting on all cylinders, impairing the Feds

ability to stimulate the real economys

growth o output and employment. As a

result, historically low ederal unds rates

havent delivered a large expansion o overall

credit. With bank lending weak, nancial

markets couldnt play their usual role in

recoveryrevving up lending by nonbanks

to the household and business sectors.

A vehicles engine with one cylinder



misring may get you where you want to

go; it just takes longer. Te same goes or

the machinery o monetary policy, largely

because o the interdependence o all themoving parts. When one is malunction-

ing, it degrades the rest. A scarcity o bank

credit, or example, inhibits rms capacity

to increase output or exports, undermining

the power within the exchange rate cylinder.

Similarly, the contributions to recovery

rom securities markets and asset prices

and wealth have been weaker than expect-

ed. A prime reason is that burned investors

demand higher-than-normal compensation

or investing in private-sector projects. Tey

remain uncertain about whether the -

nancial system has been xed and whether

an economic recovery is sustainable. Tey

worry about additional nancial shocks

such as the euro zone crisis.

Sludge on the CrankshaftA ne-tuned nancial system requires

well-capitalized banks, with the resources

to cover losses rom bad loans and invest-

ments. In essence, bank capital is a key

lubricant in the economic engine (see

Exhibit 6). Insucient capital creates a

grinding riction that weakens the entire

nancial system. Bank capital is an issue o

regulatory policy, not monetary policy. But

monetary policy cannot be eective when

a major portion o the banking system isundercapitalized.

Te machinery o monetary policy

hasnt worked well in the current recovery.

Te primary reason: BF nancial institu-

tions. Many o the biggest banks have sput-

tered, their balance sheets still clogged with

toxic assets accumulated in the boom years.

In contrast, the nations smaller banks

are in somewhat better shape by some mea-

sures. Beore the nancial crisis, most didnt

make big bets on mortgage-backed securi-

ties, derivatives and other highly risky assets

whose value imploded. Tose that did were

closed by the Federal Deposit Insurance

Corp. (FDIC), a government agency.

Coming out o the crisis, the surviving

small banks had healthier balance sheets.

However, smaller banks comprise only one-

sixth o the banking systems capacity and

cant provide the nancial clout needed or

a strong economic rebound.

Te rationale or providing public

unds to BF banks was preserving the

nancial system and staving o an even

worse recession. Te episode had its

downside because most Americans came

away rom the nancial crisis believing that

economic policy avors the big and well-

connected. Tey saw a topsy-turvy worldthat rewarded many o the largest nancial

institutions, banks and nonbanks alike, that

lost risky bets and drove the economy into

a ditch.8

Tese events let a residue o distrust

or the government, the banking system,

the Fed and capitalism itsel(Box 2). Tese

psychological side eects o BF cant be

measured, but theyre too important to

ignore because they aect economic be-

havior. People disillusioned with capitalism

arent as eager to engage in productive ac-

tivities. Teyre likely to approach economic

decisions with suspicion and cynicism,

shying away rom the risk taking that drives

entrepreneurial capitalism. Te ebbing o

aith has added riction to an economy try-

ing to regain cruising speed.

Shifting into GearLooking back at the nancial crisis, re-

cession and the tepid recovery that ollowed

points to two challenges acing the U.S.

economy in 2012 and beyond. Te short

term demands a ocus on repairing the


14/21

Box 2

TBTF: A Perversion of Capitalism

n unortunate side eect o the governments massive aid to TBTF

banks has been an erosion o aith in American capitalism. Ordinary

workers and consumers who might usually thank capitalism or their

higher living standards have seen a perverse side o the system, where

they see that normal rules o markets dont apply to the rich, powerul and

well-connected.

Here are some ways TBTF has violated basic tenets o a capitalist sys-

tem:

Capitalism requires the freedom to succeed and the freedom to fail.

Hard work and good decisions should be rewarded. Perhaps more impor-

tant, bad decisions should lead to ailureopenly and publicly. Econo-

mist Allan Meltzer put it this way: Capitalism without ailure is like religion

without sin.

Capitalism requires government to enforce the rule of law. This requires

maintaining a level playing eld. The privatization o prots and socializa-

tion o losses is completely unacceptable. TBTF undermines equal treat-

ment, reinorcing the perception o a system tilted in avor o the rich and

powerul.

Capitalism requires businesses and individuals be held accountable

for the consequences of their actions. Accountability is a key ingredient

or maintaining public aith in the economic system. The perceptionand

the realityis that virtually nobody has been punished or held account-

able or their roles in the nancial crisis.

The idea that some institutions are TBTF inexorably erodes the founda-tions of our market-based system of capitalism.

The verdict on DoddFrank will depend on what the fnal rules

look like. So ar, the new law hasnt helped revive the economy

and may have inadvertently undermined growth.


A



nancial systems machinery, so the impacts

o monetary policy can be transmitted to

the economy quickly and with greater orce.

o secure the long term, the country mustnd a way to ensure that taxpayers wont be

on the hook or another massive bailout.

Both challenges require dealing with

the threat posed by BF nancial institu-

tions; otherwise, it will be dicult to restore

condence in the nancial system and the

capitalist economy that depends on it.

Te governments principal response to

the nancial crisis has been the DoddFrank

Wall Street Reorm and Consumer Protec-

tion Act (DoddFrank), signed into law on

July 21, 2010. Its a sprawling, complex piece

o legislation, addressing issues as diverse as

banks debit card ees and systemic risk to

the nancial system. Since DoddFrank be-

came law, at least a dozen agencies, includ-

ing the Fed, have been working to translate

its provisions into regulations to govern the

nancial system. Teyre unlikely to nish

until 2013 at the earliest.

Te verdict on DoddFrank will

depend on what the nal rules look like.

So ar, the new law hasnt helped revive the

economy and may have inadvertently un-

dermined growth by adding to uncertainty

about the uture.

A prolonged legislative process preced-

ed the protracted implementation period,

with bureaucratic procedure trumpingdecisiveness. Neither banks nor nancial

markets know what the new rules will be,

and the lack o clarity is delaying repair o

the bank-lending and nancial market parts

o the monetary policy engine.

Te laws sheer length, breadth and

complexity create an obstacle to transpar-

ency, which may deepen Main Streets

distrust o Washington and Wall Street,

especially as big institutions use their law-

yers and lobbyists to protect their tur. At

the same time, small banks worry about a

massive increase in compliance burdens.

Policymakers can make their most im-

mediate impact by requiring banks to hold

additional capital, providing added protec-

tion against bad loans and investments. In

the years leading up to the nancial crisis,

BF banks squeezed equity to a minimum.

Tey ran into trouble because they used

piles o debt to expand risky investments

in the end nding that excessive leverage is

lethal.

Te new regulations should establish

basic capital levels or all nancial institu-

tions, tacking on additional requirements

or the big banks that pose systemic risk,

hold the riskiest assets and venture into the

more exotic realms o the nancial land-scape.9 Mandating larger capital cushions

tied to size, complexity and business lines

will give BF institutions more skin in

the game and restore some badly needed

market discipline. Overall, the revised regu-

latory scheme should provide incentives to

cut risk. Some banks may even rethink their

mania or growing bigger.

Higher capital requirements across

the board could burden smaller banks and

probably urther crimp lending. Tese insti-

tutions didnt ignite the nancial crisis. Tey

didnt get much o a helping hand rom

Uncle Sam. Tey tend to stick to traditional

banking practices. Tey shouldnt ace the

same regulatory burdens as the big banks

that ollow risky business models.

BF banks sheer size and their

presumed guarantee o government help

in time o crisis have provided a signicant

edgeperhaps a percentage point or

morein the cost o raising unds.10 Mak-

ing these institutions hold added capital

will level the playing eld or all banks,

large and small.


16/21

Higher capital requirements across the board could bur-

den smaller banks and probably urther crimp lending.

These institutions shouldnt ace the same regulatory bur-

dens as the big banks that ollow risky business models.


Facing higher capital requirements,

the biggest banks will need to raise addi-

tional equity through stock oerings or in-

creased retained earnings through reduceddividends. Attracting new investment will

be comparatively less burdensome or the

healthiest institutions, dicult or many

and daunting or the weaker banks.

DoddFrank leaves the details or

rebuilding capital to several supervisory

agencies. Te specics are still being worked

out; it appears banks will have until 2016 or

2017 to meet the higher thresholds.

Given the urgent need or restoring

the vitality o the banking industry, this may

seem a long wait. However, capital rebuild-

ing will likely take place aster as the stronger

banks recognize the advantages o being

rst movers. Recently, many o the largest

banks have made eorts to raise capital and

have met or surpassed supervisory expecta-

tions or capital adequacy under stress

tests.11

Banks that quickly clean up their

balance sheets will have a better chance

o raising new undsso they can then be

in shape to attract even more new capital.

Past evidence shows that nancial markets

avor institutions that oer the best pros-

pects or returns with acceptable risk.12

Laggards will be worse o, nding it

even more dicult to attract new inves-

tors. Ultimately, these institutions willurther weaken and may need to be broken

up, their viable parts sold o to competi-

tors. With the industry already too concen-

trated, its important to redistribute these

banking assets in a way that enhances

overall competition.

Ensuring that banks have adequate

capital is essential to eective monetary

policy. It comes back to the bank capital

linkage, which recognizes that banks must

have healthy capital ratios to expand

lending and absorb losses that normally

occur. Repairing the damaged mechanism

through which monetary policy impacts

the economy will be the key to accelerating

positive eedbacks.

o some extent, the Feds zero interest

rate policy, adopted in December 2008 at

the height o the nancial crisis, assisted

the banking industrys capital rebuilding

process. It reduced banks costs o unds

and enhanced protability. But short-term

interest rates cannot cross the zero lower

bound, limiting any additional impact rom

this capital-building mechanism. It could



be argued that zero interest rates are taxing

savers to pay or the recapitalization o the

BF banks whose dire problems brought

about the calamity that created the origi-nal need or the zero interest rate policy.

Unortunately, the sluggish recovery is

a cost o the long delay in establishing the

new standards or bank capital. Given the

urgent need to restore economic growth

and a healthy job market, the guiding prin-

ciples or bank capital regulation should

be: codiy and clariy, quickly. Tere is no

statutory mandate to write hundreds o

pages o regulations and hundreds more

pages o commentary and interpretation.

Millions o jobs hang in the balance.

A Potential RoadblockDoddFrank says explicitly that

American taxpayers wont again ride to the

rescue o troubled nancial institutions. It

proposes to minimize the possibility o an

Armageddon by revamping the regulatory

architecture.

As part o its strategy to end BF,

DoddFrank expanded the powers o the

Fed, FDIC and most other existing regula-

tors. New watchdogs will be put on alert.

A 10-member Financial Stability Oversight

Council (FSOC), aided by a new Oce

o Financial Research, has been charged

with monitoring systemic risk. It will try to

identiy and resolve problems at big banksand other nancial institutions beore they

threaten the nancial system. In an eort

to increase transparency, much o the new

inormation will be made public. Opaque

business practices thwart market discipline.

Can DoddFrank do what was

unthinkable back in 2008identiy and

liquidate systemically important nancial

institutions in an orderly manner that

minimizes risk to the nancial system and

economy?

Te current remedy or insolvent

institutions works well or smaller banks,

protecting customers money while

the FDIC arranges sales or mergers that

transer assets and deposits to healthy

competitors. During the nancial crisis,

however, the FDIC didnt have the sta,

nancial resources and time to wind down

the activities o even one truly mammoth

bank. Tus, many BF institutions stayed

in business through government support.13

DoddFrank envisions new proce-

dures or troubled big banks and nancial

institutions, directed by the FSOC watch-

dog and unded by ees charged to the

biggest nancial institutions.

Te goal is an alternative to the BF

rescues o the past three decades. In prac-tice, these rescues have penalized equity

holders while protecting bond holders and,

to a lesser extent, bank managers. Disciplin-

ing the management o big banks, just as

happens at smaller banks, would reassure a

public angry with those whose reckless de-

cisions necessitated government assistance.

Will the new resolution procedures

be adequate in a major nancial crisis?

Big banks oten ollow parallel business

strategies and hold similar assets. In hard

times, odds are that several big nancial

institutions will get into trouble at the

same time.14 Liquid assets are a lot less

liquid i these institutions try to sell them

at the same time. A nightmare scenario o

several big banks requiring attention might

still overwhelm even the most ar-reaching

regulatory scheme. In all likelihood, BF

could again become MFtoo many to

ail, as happened in 2008.

A second important issue is credibil-

ity. Going into the nancial crisis, markets

assumed there was government backing

or Fannie Mae and Freddie Mac bonds


18/21

A fnancial system composed o more banksnumerous

enough to ensure competition but none o them big enough

to put the overall economy in jeopardywill give the United

States a better chance o navigating through uture fnancial

potholes, restoring our nations aith in market capitalism.


despite a lack o explicit guarantees. When

push came to shove, Washington rode to

the rescue. Similarly, no specic mandate

existed or the extraordinary governmentalassistance provided to Bear Stearns, AIG,

Citigroup and Bank o America in the midst

o the nancial crisis.15 Lehman Brothers

didnt get government help, but many o

the big institutions exposed to Lehman

did.16

Words on paper only go so ar. What

matters more is whether bankers and their

creditors actually believe DoddFrank puts

the government out o the nancial bailout

business. I so, both groups will practice

more prudent behavior.

DoddFrank has begun imposing

some market discipline and eroding the big

banks cost-o-unds advantage. Credit-

rating agencies have lowered the scores

or some larger banks, recognizing that the

law reduces government bailout protec-

tions that existed just a ew years ago and

that Washingtons scal problems limit its

ability to help beleaguered nancial institu-

tions in a nancial emergency.

While decrying BF, DoddFrank

lays out conditions or sidestepping the

laws proscriptions on aiding nancial insti-

tutions. In the uture, the ultimate decision

wont rest with the Fed but with the rea-

sury secretary and, thereore, the president.

Te shit puts an increasingly politicalcast on whether to rescue a systemically

important nancial institution. (It may be

hard or many Americans to imagine politi-

cal leaders sticking to their anti-BF guns,

especially i they ace a too-many-to-ail

situation again.)

I the new law lacks credibility, the

risky behaviors o the past will likely recur,

and the problems o excessive risk and

debt could lead to another nancial crisis.

Government authorities would then ace

the same edge-o-the-precipice choice they

did in 2008aid the troubled banking

behemoths to buoy the nancial system or

risk grave consequences or the economy.

Te pretense o toughness on BF

sounds the right note or the atermath o

the nancial crisis. But it doesnt give the

watchdog FSOC and the reasury secretary

the oresight and the backbone to end

BF by closing and liquidating a large

nancial institution in a manner consistent

with Chapter 7 o the U.S. Bankruptcy Code

(see Box 1). Te credibility o DoddFranks

disavowal o BF will remain in question



until a big nancial institution actually ails

and the wreckage is quickly removed so the

economy doesnt slow to a halt. Nothing

would do more to change the risky behav-ior o the industry and its creditors.

For all its bluster, DoddFrank leaves

BF entrenched. Te overall strategy

or dealing with problems in the nancial

industry involves counting on regulators to

reduce and manage the risk. But huge insti-

tutions still dominate the industryjust as

they did in 2008. In act, the nancial crisis

increased concentration because some

BF institutions acquired the assets o

other troubled BF institutions.

Te BF survivors o the nancial

crisis look a lot like they did in 2008. Tey

maintain corporate cultures based on the

short-term incentives o ees and bonuses

derived rom increased oligopoly power.

Tey remain dicult to control because

they have the lawyers and the money to re-

sist the pressures o ederal regulation. Just

as important, their signicant presence in

dozens o states coners enormous political

clout in their quest to reocus banking stat-

utes and regulatory enorcement to their

advantage.

Te Dallas Fed has advocated the ulti-

mate solution or BFbreaking up the

nations biggest banks into smaller units.17

It wont be easy or several reasons. First,

the prospect raises a range o thorny issuesabout how to go about slimming down the

big banks. Second, the level o concentra-

tion considered sae will be dicult to

determine. Is it rolling things back to 1990?

Or 1970? Tird, the political economy o

BF suggests that the big nancial institu-

tions will dig in to contest any breakups.

aking apart the big banks isnt cost-

less. But it is the least costly alternative, and

it trumps the status quo.18

A nancial system composed o

more banks, numerous enough to ensure

competition in unding businesses and

households but none o them big enough

to put the overall economy in jeopardy,

will give the United States a better chance

o navigating through uture nancial

potholes and precipices. As this more

level playing eld emerges, it will begin to

restore our nations aith in the system o

market capitalism.

Taking the Right RoutePeriodic stresses that roil the nancial

system cant be wished away or legislated

out o existence. Tey arise rom human

weaknessesthe complacency that comes

rom sustained good times, the greed and

irresponsibility that run riot without mar-ket discipline, the exuberance that over-

rules common sense, the complicity that

results rom going along with the crowd.

We should be vigilant or these ailings, but

were unlikely to change them. Teyre a

natural part o our human DNA.

By contrast, concentration in the

nancial sector is anything but natural.

Banks have grown larger in recent years be-

cause o articial advantages, particularly

the widespread belie that government will

rescue the creditors o the biggest nancial

institutions. Human weakness will cause

occasional market disruptions. Big banks

backed by government turn these manage-

able episodes into catastrophes.

Greater stability in the nancial sector

begins when BF ends and the assump-

tion o government rescue is driven rom

the marketplace. DoddFrank hopes to

accomplish this by oreswearing BF,

tightening supervision and compiling more

inormation on institutions whose ailure

could upend the economy.

Tese well-intentioned initiatives may


20/21

The road to prosperity requires recapitalizing the fnancial sys-

tem as quickly as possible. Achieving an economy relatively

ree rom fnancial crises requires us to have the ortitude to

break up the giant banks.


be laudable, but the new law leaves the

big banks largely intact. BF institutions

remain a potential danger to the nancial

system. We cant be sure that some uturegovernment wont choose the expediency

o bailouts over the risk o severe recession

or worse. Te only viable solution to BF

lies in reducing concentration in the bank-

ing system, thus increasing competition

and transparency.

Te road to prosperity requires re-

capitalizing the nancial system as quickly

as possible. Te saer the individual banks,

the saer the nancial system. Te ultimate

destinationan economy relatively ree

rom nancial criseswont be reached

until we have the ortitude to break up the

giant banks.

Harvey Rosenblum is the Dallas Feds

executive vice president and director of

research. Special mention and thanks go

to Richard Alm for his journalistic assis-

tance, to David Luttrell for research and

documentation, and to Samantha Coplen

and Darcy Melton for their artistry in the

exhibits.

Notes1 Taming the Credit Cycle by Limiting High-Risk

Lending, by Jeery W. Gunther, Federal Reserve

Bank o Dallas Economic Letter, vol. 4, no. 4, 2009.

2 See speech by U.S. Attorney General Eric

Holder, Columbia University Law School, New

York City, Feb. 23, 2012, in which he noted that

much o the conduct that led to the nancial

crisis was unethical and irresponsible but this

behaviorwhile morally reprehensiblemay

not necessarily have been criminal. www.

justice.gov/iso/opa/ag/speeches/2012/ag-

speech-120223.html

3 A structured investment vehicle (SIV) is an o-

balance-sheet legal entity that issues securities

collateralized by loans or other receivables rom

a separate but related entity while investing in

assets o longer maturity. Several o the largest

banks used SIVs to issue commercial paper tound investments in high-yielding securitized

assets. When these risky assets began to deault,

the banks reluctantly took them back onto their

balance sheets and suered large write-downs.

4 In conjunction with the 1984 rescue o Con-

tinental Bank, the Comptroller o the Currency,

the supervisor o nationally chartered banks,

acknowledged the TBTF status o the largest

banks. See U.S. Wont Let 11 Biggest Banks in Na-

tion Fail, by Tim Carrington,Wall Street Journal,

Sept. 20, 1984.

5 In 2008 and 2009, the Federal Deposit Insur-

ance Corp. (FDIC) acilitated the ailure o 165institutions with $542 billion in assets. The largest

bank ailure in history occurred when Washing-

ton Mutual shuttered its doors in late September

2008, its $307 billion in assets accounting or

the lions share o the $372 billion total o ailed

institutions assets that year. Although staggering,

the amount o capital drained rom the banking

system due to ailures during the crisis pales in

comparison with the $3.2 trillion in assets as-

sociated with institutions receiving extraordinary

assistance rom the FDIC during this period, most

o it involving just two entities, Citigroup and

Bank o America.

6 Regulatory and Monetary Policies Meet Too

Big to Fail, by Harvey Rosenblum, Jessica K.

Renier and Richard Alm, Federal Reserve Bank o

Dallas Economic Letter, vol. 5, no. 3, 2010.

7 According to the July 2011 Federal Reserve

Senior Loan Ocer Opinion Survey, a majority

o large banks have eased standards or con-

sumer loans and or commercial and industrial

loans. However, credit standards on residential

and commercial real estate lending remain

tight over the period since 2005.

8 Taxpayers money wasnt given to the banks.

It was loaned, and most loans have been

repaid with interest. Nevertheless, the percep-

tion remains that bailout dollars were gits. And

perception drives public sentiment.

9 At this time (March 2012), it appears that bank

capital regulations under DoddFrank will ollow

the Basel III ramework, with capital surcharges

o at least 1 percentage point imposed on

global systemically important nancial institu-

tions (G-SIFIs). In addition, a more realistic

denition o capital is likely to be put in place to

avoid a repeat o the situation in 200809, when

two o the largest banks were never rated lessthan adequately capitalized at the height o

the crisis, while at the same time they together

received hundreds o billions in capital inusions

and loan guarantees and never made it onto

the FDICs Problem Bank List.


21/21

10 See How Much Did Banks Pay to Become

Too-Big-to-Fail and to Become Systemically

Important?, by Elijah Brewer III and Julapa

Jagtiani, Federal Reserve Bank o Philadelphia,

Working Paper no. 11-37, 2011, and the literature

cited therein.

11 The Federal Reserves Comprehensive Capital

Analysis and Review (CCAR) evaluates the capi-

tal planning processes and capital adequacy

o the largest bank holding companies. This exer-

cise includes a supervisory stress test to evaluate

whether rms would have sucient capital in

times o severe economic and nancial stress.

In the CCAR results released on March 13, 2012,

15 o the 19 bank holding companies were

estimated to maintain capital ratios above

regulatory minimum levels under the hypotheti-

cal stress scenario, even ater considering the

proposed capital actions, such as dividend

increases or share buybacks. For more inorma-tion, see www.ederalreserve.gov/newsevents/

press/bcreg/20120313a.htm.

12 In the early 1990s, nancial markets rewarded

banks or increasing their capital-to-asset ratios.

Banks that held more capital had higher returns

on equity (ROE) primarily because o reduced

interest rates paid or uninsured liabilities.

See Banking in the 21st Century, by Alan

Greenspan, remarks at the 27th Annual Coner-

ence on Bank Structure and Competition, Federal

Reserve Bank o Chicago, May 2, 1991, especially

pp. 910. In addition, banks were rewarded with

higherequity prices or dividend retention and

issuance o new stock, two methods o raisingcapital that bankers generally claim will reduce

stock prices. See Bank Capital Ratios, Asset

Growth and the Stock Market, by Richard Can-

tor and Ronald Johnson, Federal Reserve Bank

o New York FRBNY Quarterly Review, Autumn

1992, pp. 1024 (emphasis added).

13 For other large nonbank nancial rms (or

example, Lehman Brothers, AIG and Bear

Stearns) and or bank holding companies, there

was no resolution authority at all. The choice

came down to buyouts, bankruptcies or bailouts

(see Box 1). With no private-sector buyers willingto step up, and with bankruptcy generally a

long and uncertain process, government inter-

vention in the orm o bailouts became the least

disruptive alternative, at least in the short run.

14 The FDIC estimates that it could have

perormed an orderly liquidation o Lehman, i

it had DoddFrank powers six months beore

Lehman declared Chapter 11 bankruptcy in

September 2008, and would have paid creditors

97 percent o what they were owed. But this as-

sumes that other giant nancial institutions did

not require simultaneous and similar attention.

15 On March 24, 2008, the Federal Reserve Banko New York announced that it would provide

term nancing to acilitate JPMorgans buyout

o Bear Stearns at $10/share, or $1.4 billion. On

Sept. 15, 2008, the worlds largest underwriter o

mortgage bonds, Lehman Brothers, led or the

worlds largest bankruptcy with listed liabilities o

$613 billion. The ollowing day, one o the worlds

largest insurance organizations and counter-

parties or credit deault swaps, AIG, received

Federal Reserve support: an $85 billion secured

credit acility amid credit rating downgrades

and nancial market panic. On Nov. 23, 2008,

the Treasury, Federal Reserve and the FDIC

entered into an agreement with Citigroup to

provide a package o guarantees, liquidity ac-cess and nonrecourse capital to protect against

losses on an asset pool o approximately $306

billion o loans and securities. On Jan. 16, 2009,

a similar government loan-loss agreement was

oered to Bank o America, backstopping an as-

set pool o $118 billion, a large majority o which

was assumed as a result o BoAs acquisition o

broker-dealer Merrill Lynch.

16 More than three years have passed since

the Lehman bankruptcy. A vigorous debate

persists regarding (1) whether the Fed could

have ound a way to bail out Lehman and

(2) whether this might have avoided a global

nancial and economic collapse. Using datarom late 2008 and early 2009 shown in Exhibit

3, the inescapable answer to both questions is:

It would not have mattered. Two days later, AIG

was essentially nationalized, and within a matter

o a ew months, the already imbedded but un-

recognized and undisclosed losses at Citigroup

and Bank o America necessitated a combined

Fed and FDIC assistance package that quasi-

nationalized these institutions. The extent o

these losses was disavowed by managements

up until assistance packages were announced.

17 Taming the Too-Big-to-Fails: Will DoddFrank

Be the Ticket or Is Lap-Band Surgery Required?,

speech by Richard Fisher, president and chieexecutive ocer o the Federal Reserve Bank o

Dallas, Columbia Universitys Politics and Busi-

ness Club, New York City, Nov. 15, 2011; Financial

Reorm or Financial Dementia?, by Richard

Fisher, Southwest Graduate School o Banking

53rd Annual Keynote Address, Dallas, June 3,

2010; Paradise Lost: Addressing Too Big to Fail,

speech by Richard Fisher, Cato Institutes 27th

Annual Monetary Conerence, Washington, D.C.,

Nov. 19, 2009.

18 Evidence o economies o scale (that is, re-

duced average costs associated with increased

size) in banking suggests that there are, at best,

limited cost reductions beyond the $100 billionasset size threshold. Cost reductions beyond this

size cuto may be more attributable to TBTF sub-

sidies enjoyed by the largest banks, especially

ater the government interventions and bailouts

o 2008 and 2009. See Scale Economies Are a

Distraction, by Robert DeYoung, Federal Reserve

Bank o Minneapolis The Region, September

2010, pp. 1416, as well as Brewer and Jagtiani,

note 10. However, DoddFrank seeks to reduce

these TBTF subsidies.
http://www.federalreserve.gov/newsevents/press/bcreg/20120313a.htmhttp://www.federalreserve.gov/newsevents/press/bcreg/20120313a.htmhttp://www.federalreserve.gov/newsevents/press/bcreg/20120313a.htmhttp://www.federalreserve.gov/newsevents/press/bcreg/20120313a.htm

Documents

Why We Must End Too Big to Fail