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Unfinished Business: Lehman Anniversary Kindles TBTF Debate

By: Bill Poquette

In September five years ago, Lehman Brothers declared bankruptcy and Fannie Mae and Freddie Mac were taken over by the federal government. AIG was “stabilized” and at month-end the Dow dropped almost 800 points. In the next few months, more dominoes fell, with General Motors and Chrysler effectively becoming wards of the government. The Great Recession was full-blown and threatened to take out some of the nation’s largest banks — ones that were too big and too important to fail — without massive government intervention.

Nearly two years later, in July 2010, the Dodd-Frank Act was passed with the aim of averting another financial crisis of this magnitude or worse. Included were tools for regulators to resolve too-big-to-fail institutions without taxpayer-funded bailouts. Or so we were told. There have been doubters all along, but more have been speaking out around this fifth anniversary.

A troubling picture is emerging, not helped by the fact that while General Motors and Chrysler have recovered and prospered, Fannie and Freddie are still owned by the government and now, three years later, the too-big-to-fail banks are much too bigger to fail and many of the rules and regulations mandated by the Dodd-Frank Act are still in limbo. This includes the Volcker rule, which would curb the big banks’ riskiest derivatives trading, which played such a large part in the financial meltdown of 2008.

No surprise, two of the most vocal and credible advocates of more effective regulatory measures for banks still considered by many to be too big to fail spoke out on the subject again in September — FDIC Vice Chairman Thomas Hoenig in a speech to a Texas group of the National Association of Corporate Directors and Dallas Fed President Richard Fisher on The Dallas Morning News’ website.

“We need to rationalize, not consolidate the structure of the financial industry and narrow the federal safety net to its intended purpose of protecting only the payments and intermediation systems that commercial banks operate,” said Hoenig. “At a minimum, simplifying the structure would enhance the FDIC’s ability to implement its new authorities to resolve institutions should they fail.”

In The Dallas Morning News op-ed, Fisher and his co-author, Harvey Rosenblum, executive vice president and senior policy adviser at the Dallas Fed, noted that Dodd-Frank claims to end too big to fail. “Instead, it entrenches the TBTF pathology,” they argued. “Since its enactment, the giants have gotten bigger and the profitability of community and regional banks that might have posed more meaningful competition has been undermined by its complexity.”

There is a tenable alternative, they suggested. “Government policy should require that giant banking institutions restructure and streamline their disparate operations into separately owned companies, less complex and opaque and more manageable and focused.”

It is hard to believe, even after Dodd-Frank, that a bank with $3 trillion or $4 trillion in assets will be closed on a Friday afternoon in a relatively seamless if painful transaction like those used to resolve more than 400 failed community banks since 2009. The stockholders and bondholders of these smaller banks lose their investments and officers and directors often face FDIC lawsuits, but taxpayers are off the hook. Isn’t this is the way a failed-bank resolution should work every time?

Bill Poquette is editor-in-chief of BankNews.

Copyright (c) October 2013 by BankNews Media