Bernanke: ‘Too Big To Fail’ is Unconscionable, Insidious

Fed Chairman Ben BernankeFinancial institutions such as those that brought the world economy to the brink two years ago present an unconscionable threat and the most “insidious barriers” to competition in financial services, Federal Reserve Chairman Ben Bernanke said today.
Speaking at the Independent Community Bankers of America convention in Orlando, Florida, Bernanke unleashed a wave of criticism against “too big to fail” financial firms and offered a three-part outline to prevent such institutions from posing systemic risk.
Bernanke’s prepared remarks come as Senate Banking Committee Chairman Christopher Dodd in coming days will work with colleagues to tweak his proposed financial oversight reform bill. The reform calls for the Fed to serve as chief overseer of the largest institutions and work with a new council to help with an orderly dismantling of firms deemed to threaten the economy.
The Fed chairman also referenced the concept of “moral hazard,” when large institutions are inclined to take risks knowing the government will interject with assistance, such as bailout facilities.
“Perhaps most important, if a firm is publicly perceived as too big, or interconnected, or systemically critical for the authorities to permit its failure, its creditors and counterparties have less incentive to evaluate the quality of the firm’s business model, its management, and its risk-taking behavior,” Bernanke said.
Bernanke’s first component of his three-part solution is tougher oversight of larger firms, including pusher for higher reserves.
“The Federal Reserve have been working with international colleagues to require that the most systemically critical firms increase their holdings of capital and liquidity and improve their risk management,” he said.
The second component centers on increasing the resilience of the financial system itself by “leading collaborative efforts to improve the clearing and settlement of credit default swaps and other derivatives, and to enhance the stability of markets for repurchase agreements.”
The third part has to do eliminating “moral hazard” and creating a legal framework for the “winding down” of the largest firms that pose a threat to the system.
Financial market participants need to be convinced that “if one of these firms is unable to meet its obligations, its shareholders, creditors, and counterparties will not be protected from losses by government action.”
To make such a threat credible, Bernanke added, “We need a new legal framework that will allow the government to wind down a failing, systemically critical firm without doing serious damage to the broader financial system.”

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