Dallas Federal Reserve on Too Big to Fail

by Ammon Simon

Richard Fisher, president of the Federal Reserve Bank of Dallas, on too-big-to-fail:

[Too Big To Fail is defined as] financial firms whose owners, managers and customers believe themselves to be exempt from the processes of bankruptcy and creative destruction. Such firms capture the financial upside of their actions but largely avoid payment—bankruptcy and closure—for actions gone wrong, in violation of one of the basic tenets of market capitalism… Such firms enjoy subsidies relative to their non-TBTF competitors. They are thus more likely to take greater risks in search of profits, protected by the presumption that bankruptcy is a highly unlikely outcome.

The phenomenon of TBTF is the result of an implicit but widely taken-for-granted government-sanctioned policy of coming to the aid of the owners, managers and creditors of a financial institution deemed to be so large, interconnected and/or complex that its failure could substantially damage the financial system. By reducing a TBTF firm’s exposure to losses from excessive risk taking, such policies undermine the discipline that market forces normally assert on management decisionmaking. . . .

Dodd–Frank does not do enough to constrain the behemoth banks’ advantages. Indeed, given its complexity, it unwittingly exacerbates them.

You should read Fisher’s whole speech, which rejects Dodd-Frank and its complete faith in a complex and convoluted regulatory structure. In its place, Fisher proposes a simpler, serious alternative that addresses the causes of the financial crisis without undermining steady economic growth. His speech represents the kind of innovative thinking in which conservatives must engage if we are to make any progress on financial reform in the near future.

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