Too Big to Fail: Motives, Countermeasures, and the Dodd-Frank Response

Levy Economics Institute of Bard College Working Paper No. 709

12 Pages Posted: 29 Feb 2012

See all articles by Bernard Shull

Bernard Shull

City University of New York, CUNY Hunter College - Department of Economics

Date Written: February 28, 2012

Abstract

Government forbearance, support, and bailouts of banks and other financial institutions deemed “too big to fail” (TBTF) are widely recognized as encouraging large companies to take excessive risk, placing smaller ones at a competitive disadvantage and influencing banks in general to grow inefficiently to a “protected” size and complexity. During periods of financial stress, with bailouts under way, government officials have promised “never again.” During periods of financial stability and economic growth, they have sanctioned large-bank growth by merger and ignored the ongoing competitive imbalance. Repeated efforts to do away with TBTF practices over the last several decades have been unsuccessful. Congress has typically found the underlying problem to be inadequate regulation and/or supervision that has permitted important financial companies to undertake excessive risk. It has responded by strengthening regulation and supervision. Others have located the underlying problem in inadequate regulators, suggesting the need for modifying the incentives that motivate their behavior. A third explanation is that TBTF practices reflect the government’s perception that large financial firms serve a public interest — they constitute a “national resource” to be preserved. In this case, a structural solution would be necessary. Breakups of the largest financial firms would distribute the “public interest” among a larger group than the handful that currently hold a disproportionate concentration of financial resources. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 constitutes the most recent effort to eliminate TBTF practices. Its principal focus is on the extension and augmentation of regulation and supervision, which it envisions as preventing excessive risk taking by large financial companies; Congress has again found the cause for TBTF practices in the inadequacy of regulation and supervision. There is no indication that Congress has given any credence to the contention that regulatory motivations have been at fault. Finally, Dodd-Frank eschews a structural solution, leaving the largest financial companies intact and bank regulatory agencies still with extensive discretion in passing on large bank mergers. As a result, the elimination of TBTF will remain problematic for years to come.

Keywords: Too Big to Fail, Banking Policy, Antitrust, Government Policy, Regulation

JEL Classification: G21, G28

Suggested Citation

Shull, Bernard, Too Big to Fail: Motives, Countermeasures, and the Dodd-Frank Response (February 28, 2012). Levy Economics Institute of Bard College Working Paper No. 709, Available at SSRN: https://ssrn.com/abstract=2012612 or http://dx.doi.org/10.2139/ssrn.2012612

Bernard Shull (Contact Author)

City University of New York, CUNY Hunter College - Department of Economics ( email )

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New York, NY 10021
United States
609-896-9194 (Phone)

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