Too Big to Fail, Too Dangerous to Ignore

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Regulators recently rejected plans from five too-big-to-fail banks, saying they haven't found a way to go bankrupt without relying on taxpayers to bail them out. If they can't fix it, they're supposed to be broken up.

So why are we suddenly debating the very concept of "too big to fail" instead?

If that debate sometimes seem complicated -- well, maybe some people want it that way. But the problems these regulators identified are plain enough.

'Til Death Do Us Part

Five big banks -- JPMorgan Chase, Bank of America, Bank of New York Mellon, Wells Fargo, and State Street -- received failing grades from U.S. regulators in the design of their "living wills." Those are the banks' plans to dissolve themselves in an orderly fashion if they begin to collapse into bankruptcy.

Two regulators, the Federal Reserve and the Federal Deposit Insurance Corporation, issued their "living will" determinations jointly for the first time. One of the two agencies also gave a failing grade to Morgan Stanley. The other failed Goldman Sachs. Citigroup passed with "shortcomings."

The FDIC chair issued a celebratory statement about the findings. But vice chair Thomas Hoenig, who had a ringside seat at the 2008 crisis as a senior Fed official, said that the plans showed that none of the too-big-to-fail banks were "capable of being resolved in an orderly fashion through bankruptcy." He added:

"The goal to end 'too big to fail' and protect the American taxpayer by ending bailouts remains just that: only a goal."

Suddenly, A Controversy

Why aren't people talking about this? Instead there are those who would rather re-litigate the whole question of "too big to fail." Why?

Here's one reason: Sen. Bernie Sanders (disclosure: I work for Sanders' Democratic presidential campaign) has called for breaking up the big banks, and supporters of candidate Hillary Clinton are pushing back. There are undoubtedly others.

Paul Krugman argues that "shadow banks" like the insurer AIG and Lehman Brothers, along with other "non-Wall Street institutions," are the real problem, and that they are outside the scope of a "too big to fail" solution. (Clinton herself has taken the same position.)

Barney Frank attempts to turn the judicious remarks of too-big-to-fail critics into some sort of admission of failure, arguing that their willingness to evaluate each case rather than arbitrarily set a maximum bank size is somehow an admission that "the central question of how big is' 'too big' is too hard to answer."

Andrew Ross Sorkin of The New York Times even says that "generalists," including judges, are incapable of determining whether an institution is too big to fail or not.

Too Complicated to Understand?