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The fact that some banks are now too big to fail (TBTF) came up in the first presidential debate, when Romney observed that this was one of the most serious failures of the Dodd-Frank Act. But in the debate tomorrow, Romney should point out that the Dodd-Frank Act actually extends TBTF beyond banking into other financial industries where it has never existed before.
No one likes TBTF, and for good reason. When a financial institution is TBTF it is able to attract funding at favorable rates. This is because its creditors believe that the government will make special efforts to assure that the institution remains stable. And if it fails, there is a good chance that the government will step in to protect its creditors, as occurred for example with Bear Stearns, AIG, and Fannie Mae and Freddie Mac. Both these elements create serious dangers for a competitive financial system. The advantages that TBTF provides to large institutions threatens the survival of smaller ones, as Romney noted in the case of banks.
Given the consensus that nothing good can come from TBTF institutions, it is remarkable that there has been no significant commentary about news reports last week that the Financial Stability Oversight Council—a group of federal financial regulators constituted as an uber regulator by the Dodd-Frank Act—is getting ready to designate certain large nonbank financial institutions as “systemically important” and to subject them to special regulation by the Federal Reserve.
These designations, when they occur, will be based on a judgment by the Council that the failure of one or more of these institutions—large insurance companies, and at least one finance company—could cause instability in the US financial system if they fail. In other words, it will be a statement by the government that they are TBTF. This action will extend the TBTF problem beyond banking for the first time, and provide these firms with the same advantage over their smaller competitors that the TBTF banks have over smaller banks.
What is remarkable is that Romney has not cited this fact in his indictment of the Dodd-Frank Act. He is certainly correct that the act did nothing to prevent the development of TBTF banks, but in this case Dodd-Frank is actually extending TBTF to other sectors of the financial system.
If the subject of financial regulation comes up in the town-hall debate on Tuesday, Romney would be well advised to point out that the Dodd-Frank legislation that Obama pushed through Congress will make the TBTF problem materially worse by spreading it beyond banking to other sectors of the financial system.
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