William Dudley, the president of the New York Federal Reserve, said in a recent three-point speech that despite claims by Wall Street that Dodd-Frank corrected America’s “too big to fail” problem, too big to fail remains a major concern.
Dudley said that some firms deemed too big to fail receive insurance-like subsidies from the government, allowing the firms to borrow at lower rates and encouraging the business to grow even larger.
“The market’s belief that a [too big to fail] firm is more likely to be rescued in the event of distress than other firms weakens the degree of market discipline exerted by capital providers and counterparties,” Dudley said. “This reduces the firm’s cost of funds and incents the firm to take more risk than would be the case if there were no prospect of rescue and funding costs were higher.”
Dudley said that the first round of livings wills, in which banks are required to provide regulators with emergency plans for their liquidation, were unsatisfactory, saying that regulators are beginning to realize the complexities associated with an orderly bankruptcy.
“This initial exercise has confirmed that we are a long way from the desired situation in which large complex firms could be allowed to go bankrupt without major disruptions to the financial system and large costs to society,” Dudley said. “Significant changes in structure and organization will ultimately be required for this to be achieved. However, the ‘living will’ exercise is an iterative process, and we have only taken the first step in a long journey.”
Additionally, Dudley noted the difficulty of applying the “orderly liquidation authority” under Title II of Dodd-Frank to the largest global banks. No cross-border framework exists to handle the failure of large financial institutions, and different nations follow different guidelines.
“Certain Title II measures…may not apply through the force of law outside the United States, making orderly resolution difficult,” Dudley said.