Special Studies
Too big to fail
by Ron J. Feldman
The Problem
The government's response to the 2007-08 financial turmoil, although justified, expanded the safety net normally reserved for large banks and exacerbated the existing too big to fail (TBTF) problem. A larger TBTF problem is costly, having the capability to sow the seeds of future financial crises, which means policymakers should begin now to develop a new approach to manage TBTF.
Minneapolis Fed Proposal
While safety net expansion has increased TBTF concerns, the essence of the problem and underlying cause of TBTF remain clear: Policymakers support large-bank creditors to contain or eliminate spillover effects, but the support creates an incentive for too much risk-taking in the future. Our approach is straightforward. If spillovers lead to government support, then policymakers who want to reduce creditors' expectations of such support should enact reforms that make spillovers less threatening. Reforms that fail to address this fundamental issue will not change policymaker behavior and will not convince creditors that they face real risk of loss.
So what should policymakers do to address concerns over spillovers? The Federal Reserve Bank of Minneapolis recommends an approach labeled systemic focused supervision (SFS), which focuses supervision and regulation efforts on spillover reduction, and which consists of three pillars:
- early identification,
- enhanced prompt corrective action (PCA) and
- stability-related communication.
In particular, SFS uses the information-gathering and analytical skills of supervisors to better understand how one firm's impairment might spread to other firms or markets; it relies on the enforcement capabilities of regulation (combined with market information) to close firms before they incur losses that could bring down their peers; and it extends central bank communication techniques to financial-stability-related efforts.
The following links include recent essays and speeches on this subject produced at the Bank for more than 10 years, including the Bank's 2007 Annual Report. In addition, readers may be interested in reading the book Too Big to Fail: The Hazards of Bank Bailouts, by Gary Stern (President) and Ron Feldman (Senior Vice President), published by Brookings Press in 2004. Read an excerpt from the book.
Evolution of Minneapolis Fed Thought
- Macrostability Ratings: A Preliminary Proposal, Gary Stern and Ron Feldman, September 2009.
- Addressing the Too Big to Fail Problem,
Gary Stern Testimony before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, Washington D.C.,
May 6, 2009 [PDF] - Addressing TBTF by Shrinking Financial Institutions: An Initial Assessment
Gary Stern and Ron Feldman, April 17, 2009,
revised May 20, 2009 - Better Late Than Never: Addressing Too-Big-To-Fail,
Gary Stern Speech, Washington D.C., March 31, 2009 - Banking Policies and Too Big To Fail,
Gary Stern Speech, Minneapolis, Minnesota, March 26, 2009 - Prospects for Macro- and Financial Policy,
Gary Stern Speech, St. Paul, Minnesota, February 5, 2009 - Prospects for Macro- and Financial Policy,
Gary Stern Speech, Cedar Rapids, Iowa, January 14, 2009 - Too Big to Fail: The Way Forward
Gary Stern Speech, November 13, 2008 - Policy and the Economy in the Wake of the Shock,
Gary Stern Speech, October 21, 2008 - Limiting Spillovers Through Focused Supervision, The Region, September 2008
- Message from the President
Introducing the 2007 Annual Report Essay
- Managing the Expanded Safety Net, 2007 Annual Report Essay
- Repercussions from the Financial Shock, Gary Stern speech,
August 14, 2008 - Too Big To Fail: The
Hazards of Bank Bailouts, Excerpt from book by Gary H.
Stern and Ron Feldman, The Region, December 2003
- More Speeches and Publications on Too Big To Fail
Information on Too Big To Fail: The Hazards of Bank Bailouts is available from Brookings Institution Press.