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Central View: Too Big To Fail Is Too Big To Ignore


Joel James
Thursday, January 1, 2009

In the wake of the global financial crisis, Congress and the administration are reviewing a number of proposals to reform the structure and regulation of the financial industry. In addition, financial regulators are taking action to rein in certain activities to ensure these practices do not undermine the safety and soundness of the banking system.

To be sure, the Federal Reserve’s actions and many legislative initiatives seeking to curb suspect banking practices aim to restore the strong and stable foundation on which our nation’s financial system was built. Yet one issue that does not seem to have gained the same level of attention within the legislative debate is the question of how to deal with extremely large, financially related and interconnected organizations, whose instability can significantly disrupt operations of the global financial system. Dealing with the “too big to fail” issue, or TBTF, is crucial to meaningful reform of our nation’s financial system.

Without question, the inability to deal effectively with TBTF organizations is the problem that jeopardized the functioning of our global financial system—it is that critical. As of this writing, it is simply too early to tell what substantive legislative proposals will take hold and win passage, but it appears that regulatory oversight and reforming consumer protection are getting the most attention. This focus is understandable, as many financial institution customers have in some way been adversely affected by the recent financial turmoil.

However, this crisis uncovered the susceptibility of world economies to the condition of financial institutions that were not only too big, but too big to fail quickly. The lack of clear resolution strategy to manage the rapid deterioration and eventual resolution of TBTF organizations left governments and regulators worldwide scrambling to piece together plans for rescue operations for these firms, financial markets and national economies.

Reform efforts must deal with this issue and in a substantive manner. If we learned nothing else from this crisis, it is that if these kinds of institutions fail suddenly, panic ensues, in much the same way the panic during the Great Depression shuttered some 7,000 banks. We need to focus on several channels: enhanced regulatory oversight that is implemented responsibly, development of a resolution regime that insulates taxpayers and the macro economy from damage, and global cooperation in managing the oversight and resolution of TBTF firms with international operations. It is a large task, but one that is too big to ignore and one we can’t afford to get wrong.