Too Big to Fail? Solution Proposed

Oct. 27, 2009 — -- In an effort to avoid future taxpayer bailouts, the Treasury Department and a key House panel today unveiled new draft legislation that would give the federal government the power to wind down large, collapsing companies that in the recent financial crisis were viewed as "too big to fail."

The new draft bill, released by the House Financial Services committee and the Treasury Department, would give the government resolution authority, enabling it to wind down major failing financial institutions (banks not included), rather than decide between bailing them out or risking a failure that could damage the economy. The wind down process would be similar to the one that the Federal Deposit Insurance Corporation currently uses for smaller banks.

The committee, chaired by Rep. Barney Frank, said in a statement that both the panel and Treasury are "committed to ensuring that the taxpayers are never again called upon to take responsibility for Wall Street's business decisions."

Under the proposal, the costs of the firm's collapse would be covered by the industry and shareholders. When a major firm fails, shareholders and unsecured creditors would be wiped out first. Then any remaining shortfall would be covered by charges to other financial institutions with assets of $10 billion or more.

Frank's draft proposal would also create an oversight council to serve as a systemic risk regulator on the lookout for risky firms and activities that pose a threat to the overall system.

Backlash After Bailout

Last year's controversial $700 billion bailout of the financial system has led to numerous calls for reform to ensure that in the future, the government does not have to step in with taxpayer money to save systemically important firms from collapse. The goal, officials have said, is to avoid another situation such as the AIG meltdown, when the insurance giant received $120 billion in taxpayer aid to avert a failure that could have widespread ramifications.

Just last week, Federal Reserve governor Dan Tarullo said at a speech at the Exchequer Club in Washington that "the reform process cannot be judged a success unless it substantially reduces systemic risk generally and, in particular, the too big to fail problem."

'Too Big to Fail'

However, numerous watchdog groups have warned that the "too big to fail" problem has only worsened since last fall's bailouts.

At a hearing of the Congressional Oversight Panel last Thursday, the panel's chief, Elizabeth Warren, said, "I worry…that the factors that led us to this crisis have not yet changed. The financial sector that we talked about a year ago as too consolidated and too big to fail is more consolidated than it was back then."

Earlier last week, Neil Barofsky, the special inspector general for the Troubled Asset Relief Program (TARP), cautioned in a report, "The firms that were 'too big to fail' last October are in many cases bigger still, many as a result of government-supported and sponsored mergers and acquisitions."

On Thursday morning, Treasury Secretary Timothy Geithner will testify before the House panel on the proposed resolution authority. At Geithner's last hearing before the panel, September 23, Frank said, "There will be death panels enacted by this Congress, but they will be for non-bank financial institutions that will not be considered too big to die."