The Failures Of 'Too Big To Fail'

Last week, two major events lay bare some of the major shortcomings of the Dodd-Frank Act, the expansive law passed in 2010 to regulate the financial industry and prevent another great recession. First, a federal judge ruled on Wednesday that the federal government lacked the authority to categorize the insurance giant MetLife as a systematically important financial institution (SIFI)—or, as the status is more-widely known, “too big to fail.”

This news was followed almost immediately by General Electric formally requesting the Federal Reserve remove its status as a SIFI. Rather than follow MetLife’s lead by challenging the classification in court, GE did so by drastically reshaping its corporate structure. According to The Wall Street Journal, the company claims to have “cut its total assets in the financing division by more than half, eliminated the majority of its U.S. operations, and cut the company’s ties to the rest of the financial system.”

Corporations don’t want to be "too big to fail"

There are clear differences in the approaches these companies took. MetLife fought the very authority of the government agency to label it as a SIFI; GE accepted the agency’s authority and accepted the premises of Dodd-Frank, but contorted itself to escape the new regulatory oversight. Nonetheless, the different tactics make clear that corporations don’t want to be too big to fail.

That may sound paradoxical—who wouldn’t want the government’s protection from failure? It’s true that membership in SIFI has its privileges. The government’s imprimatur implies security and stability, assuring consumers that a company is if not invincible, certainly less vulnerable to market forces than smaller competitors. That’s a selling point for many consumers, and a serious disadvantage for smaller regional enterprises that don’t meet the government’s "too big to fail" threshold.

Ultimately, however, the designation’s burdens outweigh the competitive advantages. It subjects corporations to stringent regulations and the eye of the Financial Stability Regulatory Council, a body chaired by the Secretary of the Treasury and charged with “constrain[ing] excessive risk in the financial system.”

The damage to community banks

Additionally, the imbalance helps explain why, by some measures, Dodd-Frank has done more damage to community banks than the financial crisis itself. A study released by Harvard last year found that smaller banks—who only lost 6% of their share of U.S. banking assets from 2006-2010—have hemorrhaged 12% of their share in the past 5 years.

Adding insult to injury, small banks must still pay compliance costs under Dodd-Frank, but have a much more difficult time absorbing the charges than their larger competitors. In 2012, William Grant—then the Chair of the Community Bankers Council of the American Bankers Association—testified before Congress that “the cost of regulatory compliance as a share of operating expenses is two-and-a-half times greater for small banks than for large banks.” The banks that are fortunate enough to be able to absorb this increased regulatory costs have no option but to pass those costs on to consumers.

Effects on consumers

When corporations peel-off the SIFI label, they create greater competition and, in the process, a stronger market for consumers. In the aftermath of the 2008 financial crisis, Ben Bernanke famously said “Too big to fail isn’t a policy; it’s a problem.” Dodd-Frank turned the problem into a policy. In doing so, the law has reduced consumer choice and imbued the taxpayer, a consumer in every regard, into the backstop for our institutions deemed too big to fail. Along the way it has increased consumer costs for financial services through the creation of regulatory burdens while stifling innovation among smaller companies who cannot afford the cost of compliance.

The removal of SIFI designations is the best possible outcome of the process created by the Dodd-Frank Act, and benefits financial institutions as well as the consumers they serve.