Wilmarth, Arthur E. --- "Finding a Solution to the ‘Too-Big-To-Fail’ Problem" [2011] ELECD 498; in LaBrosse, Raymond John; Olivares-Caminal, Rodrigo; Singh, Dalvinder (eds), "Managing Risk in the Financial System" (Edward Elgar Publishing, 2011)

Book Title: Managing Risk in the Financial System

Editor(s): LaBrosse, Raymond John; Olivares-Caminal, Rodrigo; Singh, Dalvinder

Publisher: Edward Elgar Publishing

ISBN (hard cover): 9780857933812

Section: Chapter 13

Section Title: Finding a Solution to the ‘Too-Big-To-Fail’ Problem

Author(s): Wilmarth, Arthur E.

Number of pages: 25

Extract:

13. Finding a solution to the `too-big-
to-fail' problem
Arthur E. Wilmarth, Jr.

13.1. INTRODUCTION

The financial crisis ­ widely viewed as the worst since the Great Depression1
­ has inflicted tremendous damage on financial markets and economies
around the world.2 It has revealed fundamental weaknesses in the finan-
cial regulatory systems of the US, the UK, and other European nations,
making regulatory reforms an urgent priority. Publicly-funded bailouts of
`too-big-to-fail' (TBTF) financial institutions have provided indisputable
proof that (i) TBTF institutions benefit from large explicit and implicit
public subsidies, and (ii) those subsidies undermine market discipline
and distort economic incentives for large, complex financial institutions
(LCFIs).3 Accordingly, a primary objective of regulatory reforms must be
to eliminate (or at least greatly reduce) TBTF subsidies, thereby forcing
LCFIs to internalize the risks and costs of their activities.
This chapter proposes five reforms designed to prevent excessive risk-
taking by LCFIs and to shrink TBTF subsidies in the US financial system.4
The proposed reforms would (1) strengthen current statutory restrictions
on the growth of LCFIs, (2) create a special resolution process to manage
the orderly liquidation or restructuring of systemically important financial
institutions (SIFIs), (3) establish a consolidated supervisory regime and
enhanced capital requirements for SIFIs, (4) create a special insurance
fund for SIFIs in order to cover the costs of resolving failed SIFIs, and (5)
rigorously insulate banks that are owned by LCFIs from the activities and
risks of their nonbank affiliates.


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