Too Big to Fail is a Failure

Five years after President Obama signed it into law to address America’s financial crisis, the Dodd-Frank Act and the federal regulations that followed from it are relatively unknown by at least one-third of normal Americans.

At the Heritage Foundation last Wednesday, University of Virginia Law School dean Paul Mahoney pointed out how Dodd-Frank allows a class of creditors to have access to their funds when a bank is going bankrupt. Short-term creditors, who often “run for the exits” when a crisis emerges, can now can “get access to all their funds” under Dodd-Frank. Usually, all creditors would have to wait in line to gain access to their funds. But, Dodd-Frank “hasn’t ended the bailouts at all because short-term creditors know” they will have access. “Too Big To Fail” policies actually “implicitly guaranteed” access, which “market-oriented” economists opposed because it does not end bailouts. Mahoney averred, “What a great deal for the Fed…we’re going to impose tens of billions of dollars on the economy for a turf war” with expanded regulatory powers.

U.S. Senator Richard Shelby, (R-AL), also spoke at the Heritage Foundation on the effects of Dodd-Frank. As chairman of the Senate Committee on Banking, Housing, and Urban Affairs, he was quick to say, “I do not believe that any financial institution…is too big to fail.” Dodd-Frank, which employed the “Too Big to Fail” strategy to save big banks and corporations, is “an anti-competitive and anti-market” law, Shelby said. He continued, “It is inefficient, creat[ed] serious negative consequences for the economy and ultimately, the taxpayers.” “Failure is a part of capitalism,” noted Shelby, adding that “businesses that choose to take excessive risk should fail.”

He briefly outlined the problems with the Too Big to Fail strategy, and explained that these types of bailouts “are the root of moral hazard in the financial system” of America. Moral hazard, in this case, is when the federal government bail out banks when they participate in risky behavior and hover near bankruptcy. “Dodd-Frank has actually encouraged the biggest banks to become larger and more complicated,” adding that it “effectively deciding which companies will be rescued and which will be allowed to fail.”

He gave several examples, one of which was the American International Group, or AIG. “AIG received three separate bailouts,” which meant that the federal government eventually owned over half of the company during the bailout.

“It’s fallen short, I believe, of reducing risk in the system,” he argued. Shelby also pointed out how Dodd-Frank “imposed arbitrary” regulations and standards for regulators in the financial industry, which did not actually resolve the root cause of the economic crisis. Shelby spoke about risk in finances, explaining that “Less systemic risk is a good thing, but that does not mean we should have a system devoid of risk.” He added, “Our system should encourage less risk” and unfortunately, “Too Big to Fail is far from dead.” The goal of scaling back Dodd-Frank, Shelby said, is to “reduce the probability of taxpayer bailout in the future.”

In a short question-and-answer session after his remarks, Shelby reiterated the importance of equal and fair treatment under the law, “I don’t think people should be above the law…because it undermines the justice system.” He asked financial regulators, such as those employed by the Federal Deposit Insurance Corporation (FDIC), to do their job “fairly,” yet admitted, “a lot of people don’t do their jobs.” Shelby also pointed out that the costs of Dodd-Frank should be “subject to the appropriations process” and that he was not a fan of repealing previous financial regulations such as the Glass-Steagall. “I voted against the repeal of [it].” To try to bring back those pre-Too Big To Fail regulations “would be difficult to do,” Shelby concluded.

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