-
More than a year after the Dodd-Frank Act was supposed to put the issue to rest, the question of whether "too big to fail" still exists is once again consuming the financial services industry.
September 21
WASHINGTON — Federal Reserve Board Chairman Ben Bernanke made it clear Wednesday that there is no room for any "too big to fail" institution to exist in the U.S. financial system.
"One of the main goals of the financial reform is to get rid of it because it's bad for the system, it's bad for the firms, it's unfair in many ways, and it would be a great accomplishment to get rid of 'too big to fail,'" said Bernanke, speaking to business students at George Washington University as part of a four-part lecture series.
Putting aside the fairness of having such institutions as part of the make-up of the financial system, it creates an automatic incentive for those firms to take bigger risks then they might otherwise take because of an implied understanding the government would never let such a firm fail, he said.
"Obviously they have an incentive to take big risks because they say, 'We'll take big risks. Heads we win, tails you lose. If they don't pay off the government will save us,'" said Bernanke. "That's a situation we cannot tolerate"
Bernanke explained in his third lecture the run-up of events that led to the crisis and the emergency steps the Fed took to provide liquidity to the system, not only to banks, but broker dealers like Bear Sterns, Merrill Lynch, and others, and the eventual failure of Lehman Brothers and the government's bailout of insurance giant American International Group Inc (AIG).
At the time, Bernanke said regulators didn't have the necessary tools to safely let institutions fail without creating a credible threat to the entire system. A wide swath of rules under Dodd-Frank now gives regulators the power to do that, while the law simultaneously clipped the Fed's emergency lending powers that allowed it to provide funding to non-banks.
"We wanted to be sure that this never happens again, and we want to be sure that the system is changed so that if a large systemically critical firm like AIG comes under this kind of pressure in the future that there will be a safe way to let it fail," said Bernanke.
Bernanke's next and last lecture will focus on the progress regulators have made in reforming the system, including instituting a requirement for institutions to draft 'living wills' to help supervisors safely unwind failing institutions.
"A system", Bernanke added, "that will, I hope, eventually at least end 'too big to fail.'"
During the height of the crisis, he said, regulators were forced to choose between the lesser of two evils.
"It was very difficult and in many ways distasteful intervention that we had to do on the grounds that we needed to do that to prevent the system from collapsing, but clearly, [there] is something fundamentally wrong with a system in which some companies are 'too big to fail,'" said Bernanke.
But failing to take steps to lessen the shock to the system seemed like the inappropriate choice despite cries by some to let AIG collapse.
"We never thought that that was really a good option," said Bernanke. "Particularly, if the whole system had collapsed, we would have had extraordinarily serious consequences."
Separately, Bernanke also appeared in a wide-ranging interview with ABC's Diane Sawyer, which was scheduled to be aired Tuesday evening on World News. During the interview, Bernanke said the actions the central bank took were necessary to stop the financial crisis and weren't a handout to banks as has often been suggested.
"We were facing a global financial meltdown which would have brought down the world economy," said Bernanke, according to a transcript of the interview released by ABC News. "And that was just something we couldn't allow to happen. And it wasn't a question of helping banks; it was a question of helping everybody, the whole economy."
Since then, he said, regulators have been pressing ahead with a lot of new rules on the banks to prevent a repeat of the last crisis.
"We continue to be tougher and we'll continue to add the rules necessary to make sure they're operating in a safe manner in a way that doesn't endanger our economic system," said Bernanke.
During the lecture, Bernanke noted that even with intervention by the Fed and the Treasury Department, there was a significant impact on the U.S. and world economy. In the U.S., gross domestic product declined more than 5%, 8.5 million people lost their jobs with the unemployment level reaching 10%, and threats of a second Great Depression were real, he said.
"The view is increasingly gaining acceptance that without the forceful policy response that stabilized the financial system in 2008 and early 2009, we could have had a much worse outcome in the economy," said Bernanke.
The chairman's final lecture is on Thursday. He is expected to discuss the aftermath of the crisis, the recession, why the recovery has been relatively sluggish, financial regulation drafted to ensure such episodes never happen again, and lessons learned.
