• Bernanke Reiterates Threat of "Too Big Too Fail"
  • March 30, 2010 | Author: Darren M. Cooper
  • Law Firm: Alston & Bird LLP - Washington Office
  • On Saturday, during the Independent Community Bankers of America National Convention, in Orlando, Florida, Federal Reserve Board Chairman Ben Bernanke reiterated that "one of the greatest threats to the diversity and efficiency of our financial system is the pernicious problem of financial institutions that are deemed 'too big to fail.'"  Chairman Bernanke described the "three-part approach" favored by the Federal Reserve, briefly described below:

    • First, the Federal Reserve and other supervisory agencies must "continue to develop and implement significantly tougher rules and oversight that serve to reduce the risks that large, complex firms present to the financial system."
    • Second, the resilience of the financial system must be increased to "reduce the potential damage from a systemic event like the failure of a major firm."  Limiting the fallout of a major firm "helps to reduce too-big-to-fail problem, because the government has much less reason to intervene."
    • Third, "increasing market discipline is an essential piece of any strategy for combating too-big-to-fail." To create real market discipline for the largest firms, "market participants must be convinced that if one of these firms is unable to meet its obligations, its shareholders, creditors, and counterparties will not be protected from losses by government action." Therefore, it is crucial to develop "a new legal framework that will allow the government to wind down a failing, systemically critical firm," as "an alternative for resolving failing firms that is neither a disorderly bankruptcy nor a bailout."

    Similar themes were articulated by Federal Reserve Governor Daniel K. Tarullo, in a speech on Thursday at the Symposium on Building the Financial System of the 21st Century.  Governor Tarullo's remarks focused on the importance of a new resolution regime for large financial institutions, noting that "any new regime should be used only in those rare circumstances where a firm's failure would have serious adverse effects on financial stability" and that "to promote market discipline," the new regime should include "a clear expectation that the shareholders and creditors of the failing firm will bear losses to the fullest extent consistent with preserving financial stability."  He also discussed the importance of international coordination, observing that it "seems reasonably clear that effective management of these problems will, at least for the foreseeable future, require regulatory coordination and supervisory cooperation before a large firm's failure becomes a real possibility."

    Separately, FDIC Chairman Sheila Bair, in her speech before the Independent Community Bankers of America National Convention, noted that for the "long-term viability" of the banking system "job number one must be to level the playing field once and for all and to put an end to the doctrine of too big to fail."  

    The topic of "too big to fail" has been heavily debated by regulators and industry leaders since the beginning of the economic crisis.  Both Senate Banking Committee Chairman Christopher Dodd's (D-CT) financial regulatory reform draft legislation unveiled this past Monday, and the recently House-passed Wall Street Reform and Consumer Protection Act of 2009 propose significant reforms to address the problem of "too big to fail, including among other things, a resolution authority that specifically applies to these large, complex institutions.