Written by Patrick Sims
The following commentary was left as a comment on What Is Missing In the TBTF Discussion? (by Dwight Haskins, 116 April 2013).
I would argue that markets and regulators alike agree that Dodd-Frank regulations will address several outstanding TBTF concerns. Specifically, FDIC resolution authority will provide regulators the authority to wind-down a firm and sell its assets at no cost to the taxpayer. Sheila Bair wrote about this authority a few days ago in Fortune.
The previous few months of data favors an optimistic outlook on Dodd-Frank.
To start, read William Dudley, President and CEO of the Federal Reserve Bank of New York, remarks (November 2012) before the Clearing House, where Dudley outlined several ways Dodd-Frank is working to address the TBTF problem.
Dudley explains how Dodd-Frank regulations reduce incentives for excessive risk-taking through regulations that increase capital through Basel III and SIFI surcharges; provide for annual stress tests; require additional liquidity; mandate increased internal governance; create additional restrictions in proprietary trading; and impose additional caps on size through mergers and acquisitions.
And while regulators are far from finished implementing the totality of the regulations imposed by the Dodd-Frank law and Basel III requirements, the good news is that banks are taking significant steps towards these goals and the markets are taking notice. As Fed Governor Rosengren highlighted in February, banks have already significantly improved their capital levels:
"… the Tier 1 common capital ratio aggregated across 15 large U.S. banking organizations fell to close to 5 percent in late 2008. However, during the economic recovery these institutions have significantly improved their Tier 1 common capital ratio, to above 10 percent. The broader definitions of capital show similar strong improvement relative to pre-crisis norms."
Rosengren's full statement to the Bank of Korea is available via the Boston Fed.
Last week Moody's Analytics released a report explaining how credit default ratings at several major U.S. banks indicate that any market expectations of a future bank bailout are diminishing. Building on Moody's work, Bloomberg reported that,
"The FDIC has made 'considerable progress' by identifying obstacles to implement its so-called orderly liquidation authority, which gives the agency power to wind down, split up or sell off companies considered a potential systemic risk to U.S. financial stability, Moody’s said in the report."