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New FDIC powers are unable to prevent too big to fail, financial expert says

New powers given to the Federal Deposit Insurance Corp. by the Dodd-Frank Act to cut shareholders and impose losses on creditors during a collapse of a larger U.S. bank will not work, according to a financial expert.

Simon Johnson, a senior fellow at the Peterson Institute for International Economics, said that there are three reasons why giving the FDIC the authority to manage the orderly liquidation of big banks and non-bank financial companies will not work or affect the country’s current financial instability, Bloomberg.com reports.

The first reason is based on the fact that the authority is domestic only. The new powers do not allow U.S. legislation to determine how assets and liabilities in other countries will be handled.

The second reason, according to Johnson, is that it is unclear that any federal agency would use such resolution powers preemptively and is willing to put them into play before the losses are too great.

The third reason is the unanswered question of who would lose money in a potential liquidation?

“The fundamental premise of the resolution authority is that some creditors could face losses, but they would be imposed in an orderly and predictable manner to avoid undermining confidence and destabilizing the financial system,” Johnson wrote, according to Bloomberg.com. “Any such thinking today seems far-fetched.”

According to Johnson, the only way to make the FDIC’s new powers credible would be to make large banks small and simple enough to fail.

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