Did Dodd-Frank end too-big-to-fail?

The New York finance attorney who blogs at Economics of Contempt argues that critics who claim the Dodd-Frank Act didn’t end the era of too-big-to-fail financial institutions are premature in their assessment. The Act establishes a resolution authority, to unwind large troubled financial institutions, and it’s too early to tell if the process will work, EoC argues in a Feb. 25 post.

EoC notes the following steps taken by the Dodd-Frank Act which will make it difficult for regulators to bail out financial institutions in the future as they did in 2008:
-Dodd-Frank stripped the Fed of its “Section 13(3) authority” to bail out individual institutions.
-The FDIC’s ‘open bank assistance; is prohibited under the new resolution authority.

The only option would be for Congress to pass emergency legislation bailing out a faltering institution, which seems unlikely, especially for the next several years, says EoC.

The financial crisis of 2007 and 2008 was primarily the result of giant financial institutions taking on too much debt in the shadow banking system, mainly on the repurchase market. Experts worldwide are sparring over whether the next financial crisis can best be averted by forcing the giants to downsize, or by doing a better job of regulating the shadow system, or both. The Dodd-Frank Act chose the latter approach but made few changes in repo operations.

Shadow banking includes money market funds, securities broker-dealers, investment and commercial banks and their holding companies, finance companies and mortgage brokers, issuers of asset backed securities (ABS) and asset backed commercial paper (ABCPaper), derivative product companies, hedge funds, off-the-books businesses variously known as trusts, special purpose entities, special purpose vehicles, variable interest entities, conduits and structured investment vehicles, and any other kind of financial company that borrows short and lends long outside the federal financial safety net of FDIC insurance and Federal Reserve discount window loans. Most of the borrowing by these shadow bankers is done on the repurchase market.


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