What will it actually take to let big banks fail?

Bloomberg News

WASHINGTON — Last week Martin Gruenberg, chair of the Federal Deposit Insurance Corp., gave a speech detailing how he and his fellow bank regulators have a plan for allowing banks — even big banks — to fail without resorting to bailouts or extraordinary measures to keep the macroeconomic humpty-dumpty together. 

"The ability of the FDIC and other U.S. regulatory authorities to manage the orderly resolution of large complex financial institutions remains foundational to U.S. financial stability," Gruenberg said. "Should the need arise, we are prepared to apply the resolution framework that the FDIC and other regulatory authorities in the U.S. and globally have worked so hard to develop."

Gruenberg's speech was supported by a detailed report laying out how exactly the FDIC would proceed with resolving a global systemically important bank using its Dodd-Frank Title II authorities. The substance of the report is not especially new: The emphasis appears to be on utilizing a Single Point of Entry model whereby the FDIC takes over and resolves the bank holding company while the bank and other subsidiaries continue to function — more or less the same strategy that regulators have preferred since the first GSIB living wills were submitted a decade ago.  

First and foremost, I think it's worth saying that preemptively thinking through how any bank — even the very biggest banks — could fail without holding the global economy hostage is important and vexing work that regulators don't get enough credit for doing. I'm also sympathetic to the challenge of trying to anticipate and counter a calamity that will almost by definition include an element of surprise. It's like NASA issuing a report on how they would repel an alien invasion — there are so many ways for a bank to fail, including ones that no one has thought of yet, that no one could possibly think of them all. Even so, a great deal of thought has gone into this problem over the years — it's like the Sword in the Stone for financial regulatory policymakers.

Law and regulation

FDIC's Gruenberg: We have a strategy to fail a 'too big to fail' bank

April 10, 2024 12:37 PM

My concern is that I don't think markets and the public believe anyone who says that "too big to fail" is over — no matter who says it or how forcefully they say it. The idea that, when push comes to shove, those in charge will make the bad thing go away is so deeply rooted in market expectations that unraveling it would require an act of tough love that no regulator, administration or Congress would be able to bring themselves to inflict.

That sentiment was likely reinforced by the failures of Silicon Valley Bank, Signature Bank and First Republic last year. To be sure, those banks weren't "bailed out" in the mode of 2008 — the government didn't fork over a bunch of money to keep those banks as a going concern, and investors and executives lost a bunch of money. But the systemic risk exception invoked to cover uninsured deposits sent the message — right or wrong — that regulators weren't comfortable with the collateral damage that failing to insure those uninsured deposits would inflict on a fragile economy in the interest of sending a message. I'm not sure I would have made a different call myself.

But there's always — always — collateral damage in a large bank failure, either in the form of material losses, consumer confidence or both. Innocent parties will get hurt, and I'm not sure there's a plan that could limit that pain unless the bank is sufficiently small to keep the pain localized or the right bank fails at exactly the right time for the right reason. And markets know how unlikely that is, and will assume the biggest banks are immortal until they have a reason to think otherwise.