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Reining in too-big-to-fail proves a challenge

The Dodd-Frank Act took effect in 2010 to protect the banking system from future collapse, but the legislation stopped short of ending too-big-to-fail banks altogether, Fed officials and policymakers warned Wednesday.

The debate over Dodd-Frank occurred in front of the House Financial Services Committee, with Federal Reserve Bank of Dallas CEO Richard Fisher reiterating the need to end excessively large banking institutions.

“I want to recognize the common goal that we all share—ending ‘too big to fail’ (TBTF) and taxpayer-funded bailouts,” Richard Fisher, president and CEO of the Federal Reserve Bank of Dallas, said.

Fisher says Dodd-Frank aims to protect the financial system from mega banks, but it falls short when considering all the market dynamics still favoring big banks.

The Dallas Fed Bank CEO says Dodd-Frank created an organized liquidation method for dealing with mega banks. However, when you read the fine print, an orderly liquidation for a mega bank begins to look somewhat like a U.S. government bailout — bringing the U.S. back into the same position, Fisher claims.

“In reality, rather than fulfill Dodd–Frank’s promise of ‘no more taxpayer-funded bailouts,’ the U.S. Treasury will likely provide debtor-in possession financing to the failed companies’ artificially-kept-alive operating subsidiaries for up to five years, but perhaps longer,” Fisher said of the liquidation proceedings.

“Some officials refer to this procedure as a ‘liquidity 10 provision’ rather than a bailout. Call it whatever you wish, but this is taxpayer funding at far-below-market rates,” he added.

Former Federal Deposit Insurance Corp. Chair Sheila Bair recognized some benefits from the Dodd-Frank Act. “I think there are very meaningful limits with the Dodd-Frank,” she explained. “It provides the tools to end too big to fail.”

However, Bair added that while the Federal Deposit Insurance Corporation has a solid plan and has been working diligently to prepare and address key challenges, important work still needs to be done with the orderly liquidation process.

Additionally, Jeffrey Lacker, president and CEO of the Federal Reserve Bank of Richmond, said, “Reducing the probability that a large financial firm becomes financially distressed ― through enhanced standards for capital and liquidity, for example ― is useful, but will never be enough.”

But the resolution planning process prescribed in Dodd-Frank provides the road map for this journey, Lacker explained.

“Resolution planning will require a great deal of hard work. But I see no other way to ensure that policymakers have confidence in unassisted bankruptcy and that investors are convinced unassisted bankruptcy is the norm,” he said.

Overall, every witness agreed Dodd-Frank needs more work.

“Today we have institutions that are every bit as vulnerable as they were before. If they do get into trouble, we still have a vulnerable financial system,” Thomas Hoenig, vice chairman of the FDIC, warned.

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