‘Too big to fail’ bank law seen as too weak to work

S&P skeptical of bailout ban

A year after the enactment of a sweeping Wall Street reform law, evidence is growing that it failed in its main mission of ending taxpayer bailouts of global banks considered “too big to fail.”

Despite an outright ban on bailouts written into the legislation, Wall Street investors and credit agencies remain skeptical that the government will not step in again to prevent any downfall of major banks such as Bank of America, Citigroup or JP Morgan. Those financial goliaths have only grown in size and power, making it more certain that they would bring down much of the financial system with them.

The most concrete sign that the banks still enjoy an implicit guarantee from the government is that none of the top banks has been downgraded since the legislation was enacted, even though their high credit ratings for years have been based on the expectation that the government would prevent any catastrophic failure of the bank that would harm the bank’s creditors.

Standard & Poor’s Corp. last week pointedly disputed the often-stated claim on Capitol Hill that the legislation had put an end to “too big to fail” and the era of federal bailouts.

S&P thinks “the government in a handful of situations may be forced to provide some sort of support to an institution,” especially if the failure of the bank threatens the economy and well-being of ordinary Americans, as occurred in the fall of 2008, said S&P managing director Rodrigo Quantanilla. S&P cited the long history of bank bailouts in times of economic stress as well as what it sees as ambiguities in the Wall Street reform law.

The S&P may change its mind, depending on how regulations implementing the law turn out. Yet the agency is so skeptical of Congress’ resolve that it expects an amendment to the Wall Street reform law to remove any ambiguity and make it easier to bail out big banks.

“For us to change our views about whether the U.S. government remains supportive or not,” Congress would have to, among other things, require that bank creditors are forced to take losses if a bank makes mistakes that leads to its failure, Mr. Quantanilla said. Attempts to amend the law to include such language failed last year.

Moody’s Investors Service also has defied the law’s authors by not downgrading any of the biggest banks, whose ratings depend on government support. It says, however, that it is reviewing whether regulations implementing the law would require a downgrade.

Rep. Barney Frank, Massachusetts Democrat, former chairman of the House Financial Services Committee and co-author of the law, blasted S&P for “clearly misreading” the law and said the agency’s assertion that the law is likely to be changed to permit bailouts shows that, in fact, the law accomplished what it set out to do.

“Any fair reading of the mood of the American public and the appetite of Congress suggests that there is absolutely no support for more bank bailouts,” he said in a letter to S&P last week, adding that the credit agency should stop trying to predict what Congress will do and stick to its “core business” of assessing creditworthiness.

Republicans have long contended that the law failed to end bailouts. “For all the Democrats’ claims about the virtues of the Dodd-Frank bill, this law remains one of the single biggest incubators of the ‘too big to fail’ status quo and bailout culture in Washington,” said Rep. Tom Price, Georgia Republican and chairman of the House Republican Policy Committee.

Joshua Rosner, managing director of Graham Fisher & Co. and author of a book on the financial debacle, said the notion clearly persists on Wall Street that the government will rescue banks and other financial institutions with assets of more than $50 billion.

“In fact, the Dodd-Frank law reinforces the market perception that a small and elite group of large firms are different from the rest” by designating those banks as “systemically important,” he said.

While the law places greater burdens and constraints on banks designated as important, including requirements that they set aside more capital to cover losses and submit “living wills” to the government outlining how to break up and dispose of the bank should it fail, Mr. Rosner said, none of that has altered the market’s conviction that the government stands behind the Wall Street’s biggest names.

He also noted that the banks have only become bigger and more powerful since the 2008 crisis. In 1995, the six biggest banks - JP Morgan, Bank of America, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley - controlled assets equal to 17 percent of the U.S. economy. Today, their assets equal 64 percent of economic output, and they control nearly half of all bank deposits in the U.S., he said.

The banks grew exponentially in size in recent years, mainly as a result of mergers with failing rivals such as Bear Stearns, Washington Mutual and Countrywide Mortgage during the crisis - mergers that ironically were arranged by regulators seeking to avoid taxpayer bailouts.

Mr. Rosner asked whether regulators would make the tough decisions needed to ensure the banks are allowed to fail.

“To falsely declare an end to ‘too big to fail’ without actually accomplishing that end is more damaging to the credibility of U.S. markets than a failure to act at all,” he said.

Mr. Rosner said the only way to ensure taxpayers aren’t on the hook to rescue big banks is to break up the big banks so they’re no longer “too big to fail.” Since Congress repeatedly rejected amendments to break up the banks last year, perhaps it could consider a less far-reaching measure that would make banks much more careful about the risks they take by requiring their executives to pay dearly in the event of failure, he said.

Regulators are annoyed about the skepticism of their willingness to be tough on Wall Street.

“Read the law,” former Federal Deposit Insurance Corp. Chairman Sheila C. Bair, whose agency is charged with dismantling insolvent big banks under the law, said in remarks to the Financial Times.

She said she hopes that the ratings agencies will change their opinions. “I think it’s a disservice to investors. They raise expectations on investors that they’re going to get bailed out when they’re not,” she said. “They shouldn’t be speculating on whether the government’s going to come in or not. That’s not their job. I don’t think it’s appropriate.”

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