[Congressional Record (Bound Edition), Volume 156 (2010), Part 4]
[Senate]
[Pages 5216-5219]
[From the U.S. Government Publishing Office, www.gpo.gov]




                            TOO BIG TO FAIL

  Mr. KAUFMAN. Mr. President, I have spoken twice on the floor in the 
past few weeks on the problem of ``too big to fail.'' This is a 
critical issue for any financial reform legislation. Each Senator must 
ask whether this issue is effectively addressed in landmark legislation 
the Senate will soon consider. I will limit my remarks today to the 
central aspect of the challenge we face, ``too big to fail.'' In 
particular, does this bill take the necessary steps to reduce the size, 
complexity, and concentrated power of the behemoths that currently 
dominate our financial industry and our economy?
  If not, what is the justification for maintaining their status quo, 
what is the risk that one might fail, and--if that were to occur--what 
is the likelihood that the American taxpayer will once again have to 
bail them out?
  The answer is that there is little in the current legislation that 
would change the behavior or reduce the size of the Nation's six 
megabanks.
  Instead, this bill invests its hopes in two ideas: First, that 
chastened regulators--who, we must remember, failed miserably in 
preventing the crisis--will this time control these megabanks more 
effectively--today, tomorrow, and decades into the future. And, second, 
that a resolution authority designed to shield the taxpayers from yet 
another bailout will be able successfully to unwind incredibly complex 
megabanks that are engaged across the globe.
  In the midst of the Great Depression, Congress built laws that 
maintained financial stability for nearly 60 years.
  Through the Glass-Steagall Act, which included the establishment of 
the Federal Deposit Insurance Corporation, Congress separated 
investment banks, which were free to engage in risky behavior, and 
commercial banks, whose deposits were federally insured.
  As I described in a previous speech, during the last 30 years, that 
division was methodically disassembled by a deregulatory mindset, 
leading to the reckless Wall Street behavior that caused the greatest 
financial crisis and economic downturn since the 1930s.
  What walls will this bill erect? None.
  On what bedrock does this bill rest if the Nation is to hope for 
another 60 years of financial stability? Better and smarter regulators, 
plain and simple.
  No great statutory walls, no hard divisions or limits on regulatory 
discretion, only a reshuffled set of regulatory powers that already 
exist. Remember, it was the regulators who abdicated their 
responsibilities and helped cause this crisis.
  Thus far, on the central aspect of ``too big to fail,'' financial 
reform consists of giving regulators the authority to supervise 
institutions that are too big, and then the ability to resolve those 
banks when they are about to fail.
  Upon closer examination, however, the former is virtually the same 
authority regulators currently possess, while the latter--an orderly 
resolution of a failing megabank--I believe, is an illusion.
  Unless Congress breaks up the megabanks that are ``too big to fail,'' 
the American taxpayer will remain the ultimate guarantor in an almost 
certain-to-repeat-itself cycle of boom, bust, and bailout.
  The first question is how big must a financial institution be to be 
``too big to fail''?
  Let us examine how concentrated some of our giant financial 
institutions have become.
  Only 15 years ago, the six largest U.S. banks had assets equal to 17 
percent of overall gross domestic product.
  The six largest banks today in the United States now have total 
assets estimated to be in excess of 63 percent of our gross domestic 
product.
  Three of these megabanks have close to $2 trillion of assets on their 
balance sheets.
  Their gigantic size, and the perception in the marketplace that they 
are indeed too big for the government ever to permit them to fail, 
gives these megabanks a competitive advantage over smaller financial 
institutions. It also instills a dangerous willingness to engage in 
excessive risk taking.
  As Federal Reserve Chairman Ben Bernanke recently stated,

       [I]f 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.
       As a result, such firms face limited market discipline, 
     allowing them to obtain funding on better terms than the 
     quality or riskiness of their business would merit and giving 
     them incentives to take on excessive risks.

  In other words, with a taxpayer safety net beneath them, these Wall 
Street firms will continue to have an irresistible incentive to keep 
walking across a financial high-wire of speculative investments in 
search of ever greater profits.
  Some might say that Canada and other countries also have large banks 
and didn't encounter serious problems. But this ignores the obvious 
facts that our economy is about 10 times the size of Canada's and our 
financial ecosystem is far more complex.
  It also ignores that Canada's largest banks rest on a bedrock of 
government-guaranteed mortgages and a social compact between those 
banks and their regulators.
  To adopt a Canadian-type model in the U.S., we would need to merge 
our

[[Page 5217]]

banks into even fewer banking giants, and then re-inflate Fannie Mae 
and Freddie Mac to guarantee some of the riskiest parts of the banks' 
portfolios.
  Moreover, for every example of a country--usually far smaller than 
ours--that has coped with megabanks, there are at least as many where 
this system has failed, and failed spectacularly.
  Take Ireland, for example, whose largest banks went on a credit binge 
that ended in disaster. Now Ireland's citizens are paying the price 
through draconian pay cuts and higher taxes, to say nothing of the 
country's lost economic growth.
  Ireland provides a cautionary tale. These megabanks, whether they are 
legally domiciled in our borders or beyond, are simply too big to 
manage and too complicated to regulate.
  There are also those who argue that we have had financial crises 
caused largely by small institutions. That is absolutely true. But 
those problems were managed without bringing our entire financial 
system to the brink of disaster, the signature and near-cataclysmic 
event of the last crisis.
  In the savings and loan crisis, more than 700 thrifts--both large and 
small--failed, many wrongdoers were sent to prison, and the Resolution 
Trust Corporation was created to liquidate the assets of failed 
institutions. In short, the crisis was managed and our financial system 
absorbed the blows.
  Compare that to the last crisis when our financial system barely 
recovered from a black hole that threatened to suck into oblivion our 
entire financial system after the failure of just one large investment 
bank.
  The legislation proposes that we must improve the regulation of 
institutions that are ``too big.'' The reform proposals would put in 
place a systemic risk council to monitor for such risks and to identify 
financial institutions that should be subject to enhanced supervision. 
Next, they would have the Federal Reserve act as the de facto regulator 
of these systemically significant financial institutions.
  The truth is, we have had a de facto systemic risk council for 
decades. It is called the President's Working Group on Financial 
Markets. Chaired by the Treasury Secretary, it includes the heads of 
the Federal Reserve, the Securities and Exchange Commission, and the 
Commodities Futures Trading Commission, and it was established by 
President Reagan following the 1987 stock market crash.
  Its track record in spotting incipient financial risks has been 
abysmal. Notably, Treasury Secretary Paulson used the President's 
Working Group as a form of a systemic risk council, but it achieved 
essentially nothing--nothing--to reduce those risks. While adding 
additional members and providing some additional powers, the new 
systemic risk council is the President's Working Group by another name.
  The reform proposals would also give the Federal Reserve the 
authority to supervise institutions that the council deems are 
systemically significant. Under the proposed legislation, the Federal 
Reserve would have specific powers to impose higher leverage, capital, 
liquidity, and other requirements upon these institutions.
  The Federal Reserve already has the power to impose such standards on 
most of these institutions. The proposed regulatory reforms are mainly 
a redundant statement of the Fed's existing powers.
  Just this week, a Moody's report stated:

        . . . the proposed regulatory framework doesn't appear to 
     be significantly different from what exists today.

  Moody's went on to explain that:

       The current regulatory regime is already authorized to 
     protect the soundness of banks and the financial system as a 
     whole. In addition, the current banking laws give bank 
     regulators the power to have banks cease and desist from 
     activities and to require banks to have higher capital 
     ratios.

  No doubt the bill does contain some expanded tools for the Fed. For 
the first time, the Fed will have direct supervisory authority for not 
just bank holding companies, but for their large nonbank subsidiaries 
as well. In addition, the Fed will also have authority over nonbank 
financial institutions that the council deems are systemically risky.
  But as Moody's has recognized, the powers resemble the current 
regulatory framework. Federal bank regulators, which had the 
responsibility to ensure financial stability before the crisis, will 
again bear the responsibility after the crisis.
  And bank regulators will continue to dance the tango with the big 
banks, interrupted briefly by new legislation which, in fact, includes 
few substantive changes in safety and soundness banking practices.
  It is true that under the current Senate bill, regulators could--
could--potentially invoke the Volcker Rule, which would prohibit 
commercial banks from owning or sponsoring ``hedge funds, private 
equity funds, and purely proprietary trading in securities, derivatives 
or commodity markets.''
  I applaud former Federal Reserve Chairman Paul Volcker for his 
critical leadership on these issues, which the administration has 
endorsed.
  Unfortunately, the legislation now being considered by the Senate 
requires the council first to study the Volcker rule before deciding 
whether to enforce it. In the end, it could issue a recommendation not 
to enforce the Volcker rule at all.
  Or the council might recommend simply that regulators mandate capital 
requirements that are adequate for any risky proprietary activities a 
particular bank might undertake--a power regulators already have. The 
reality is that regulators have long had the authority to prohibit 
speculative activities at banks, but never opted to do so.
  Under the Bank Holding Company Act, the Federal Reserve may require a 
bank holding company to terminate an activity or control of a nonbank 
subsidiary--such as a broker-dealer or an insurance company--if that 
activity or subsidiary poses serious risk to the safety, soundness or 
stability of the holding company.
  As we all know too well, in the past, these very same bank regulators 
failed utterly. Indeed, as the ``umbrella regulator'' for all bank 
holding companies, the Federal Reserve could have increased capital and 
other requirements for these institutions, but instead farmed out this 
function to credit rating agencies and the banks themselves.
  Meanwhile, as the consolidated supervisor of major investment banks, 
the SEC had similar powers to those of the Fed. And it goes without 
saying that its track record of regulatory enforcement was littered 
with colossal failures.
  Chastened regulators may try in the coming years to be harder on the 
megabanks, to increase their capital requirements, and to keep a close 
eye on their liquidity levels, liabilities, and leverage ratios.
  But even if they do, history has shown us that the tango will reach 
the end of the dance floor, and the big banks will execute the turn and 
lead again, leaving our regulators hopelessly aside in understanding 
the complex and opaque transactions that interconnect the giant banks.
  In sum, little in these reforms is really new, and nothing in these 
reforms will change the size ofour megabanks.
  That is why I believe we must impose these changes by statute--by 
statute. I would go beyond even statutorily requiring banks to live 
under the Volcker rule, by reinstating by statute the firewall between 
commercial and investment banking activities. Unless we break the 
megabanks apart, they will remain too large and interconnected for 
regulators to effectively control them. And once the next inevitable 
financial crisis occurs, and the contagion spreads too quickly for the 
government to believe that a failing firm won't take down others as 
well, the American taxpayer--the American taxpayer--the American 
taxpayer--will again be forced into the breach.
  The proposed plan calls for a resolution authority to deal with these 
institutions when they inevitably get into trouble. An early 
resolution, we are promised, guided by a systemic council looking into 
its crystal ball, will prevent the taxpayer from ever again needing to 
save the day.

[[Page 5218]]

  It is true that the existing mechanism, which tasks the FDIC with 
resolving failing depository institutions, has worked well--but only 
worked well up to a point. The problem is that our experience with 
resolving banks--highlighted by the 140 bank failures that occurred 
last year and their cost to the deposit insurance fund--has shown us 
that prompt corrective action is almost always too late.
  As many commentators have noted, no matter how well Congress crafts a 
resolution mechanism, there can never be an orderly winddown of a $2 
trillion financial institution that has hundreds of billions of dollars 
of off-balance-sheet assets, relies heavily on wholesale funding, and 
has more than a toehold in over 100 countries.
  A backstop of a $50 billion or even a $100 billion resolution fund 
would come nowhere close to being big enough to resolve a $2 trillion 
financial institution.
  As the Economist notes:

       [Resolution authority] may prove unworkable, of course. The 
     threat of being wiped out in bankruptcy could cause creditors 
     to flee both the troubled firm and any firms like it, 
     precisely the sort of panic the resolution regime is meant to 
     avoid.
       ``In a severe financial crisis it will be too terrifying 
     for politicians and bureaucrats to use'' the new process, 
     predicts Douglas Elliott of the Brookings Institution.
       Instead, he says, they will resort to ad hoc measures as 
     they did in 2008.

  Not surprisingly, there are many barriers to resolving large and 
complex financial institutions. Most notably, there are international 
dimensions to the problem, depending on resolution authority.
  Following the collapse of Lehman Brothers, there was an intense and 
disruptive dispute between regulators in the U.S. and U.K. over how to 
handle customer claims and liabilities. While U.S. bankruptcy 
protection allowed Lehman Brothers' U.S. operations to continue for 
days as a going concern, Lehman's operations in the U.K. were halted in 
accordance with British bankruptcy law.
  Given that there apparently were more than 600,000 open derivatives 
contracts in the U.K. on the day that Lehman failed, many 
counterparties and clients were stranded, consequently hampering 
bankruptcy efforts in the U.S. as well.
  To those who promote resolution authority as a solution, I ask: 
Exactly what would have happened differently if Lehman had been in 
receivership during those harrowing days in September?
  Moreover, the reluctance last spring to nationalize these banks, to 
place them in a form of resolution receivership, was because it would 
have been too costly to the taxpayer to take over or put into 
bankruptcy the megabanks.
  Why would it not be costly with a U.S.-only resolution authority? The 
truth is: It would be. The taxpayer will remain the ultimate guarantor.
  The international difficulty of acting quickly before contagion 
spreads is almost impossible to overcome without a cross-border 
resolution agreement. Unfortunately, there is nothing in the resolution 
authority that the Senate will consider that would help address this 
problem. We all know that it is a problem that will only get worse 
given the inevitability of further financial globalization.
  In coming years, the U.S. megabanks will extend their reach into 
global markets, relying on their funding advantages as too-big-to-fail 
U.S. banks to profit from increasingly sophisticated transactions in 
countries around the world.
  The problems with resolution authority for the megabanks aren't just 
international in nature. These institutions use short-term 
collateralized loans called repurchase agreements, or repos, to finance 
a significant portion of their balance sheet and have massive 
counterparty exposures that arise out of their roles as derivatives 
dealers.
  Both repos and derivatives are qualified financial contracts, meaning 
that exposures that arise from them are effectively super senior to the 
claims of all other creditors. By giving these trading exposures such a 
privileged position under the bankruptcy code, we have allowed a major 
part of our financial system--called the shadow banking system--to grow 
completely unchecked without any market or regulatory discipline 
whatsoever.
  As Peter Fisher, former Under Secretary of the Treasury and former 
head of the markets desk at the Federal Reserve Bank of New York, has 
stated:

       [these changes to the bankruptcy code] transformed the 
     `too-big-to-fail' problem of our largest deposit takers into 
     the `too-interconnected-to-fail' problem of our major 
     financial institutions.

  The proof of that statement is borne out by the data.
  One report by researchers at the Bank of International Settlements 
estimated that the size of the overall repo market in the U.S., Euro 
region and the U.K. totaled approximately $11 trillion at the end of 
2007.
  Meanwhile, the total notional value of OTC derivatives contracts is 
equal to $605 trillion, as of June, 2009.
  Large financial institutions that rely chiefly upon wholesale 
financing and have massive counterparty exposures from their 
derivatives positions are combustible. The case studies of Lehman and 
the other investment banks show how quickly and violently these 
institutions can implode. When they do, their interconnected nature 
inevitably causes a contagion, leading to a collapse in confidence and 
the classic patterns of a bank run.
  As the Moody's report summarizes the question, We must:

     try to assess whether or not the law could be effective in 
     its stated objective: allowing a troubled, systemically 
     important financial institution to default on selected 
     obligations, while avoiding the larger effects that such a 
     default might have on the financial system and on the broader 
     economy.
       That is a challenging objective to accomplish in reality, 
     given contagion risk and the high degree of connectedness 
     among such institutions, both domestically and cross border 
     (where any such resolution authority would have no 
     authority).

  Resolution authority is therefore a slender reed upon which to lean 
when it comes to institutions as large, complex and interconnected as 
these.
  The truth is that we need to split up and break down the largest and 
most complex financial institutions.
  As President of the Federal Reserve Bank of Dallas Richard Fisher 
stated on March 3rd:

       I think the disagreeable but sound thing to do regarding 
     institutions that are [`too big to fail'] is to dismantle 
     them over time into institutions that can be prudently 
     managed and regulated across borders. And this should be done 
     before the next financial crisis, because it surely cannot be 
     done in the middle of a crisis.

  The first step is to separate federally insured banks from risky 
investment banks. As Senators Maria Cantwell, John McCain and others 
have urged, we should break up the largest banks and resign to history 
``too big to fail'' banks. This worked for nearly 60 years, and would 
once again ensure the soundness of commercial banks while placing risky 
investment bank activities far beyond any government safety net.
  Second, we also need statutory size and leverage limits on banks and 
nonbanks. We should set a hard cap on the liabilities of banks and 
other financial institutions as a percentage of GDP.
  The size limit should constrain the amount of non-deposit liabilities 
at large mega-banks, which rely heavily on short-term financing like 
repos and commercial paper.
  In addition, we should institute a simple statutory leverage 
requirement to limit how much firms can borrow relative to how much 
their shareholders have on the line.
  Finally, we must put in place reforms for derivatives and other 
qualified financial contracts.
  Get this: The five largest banks control 95 percent of the OTC 
derivatives market.
  We must require derivatives to be centrally cleared, which will 
reduce the complex web of counterparty credit risks throughout our 
system.
  CFTC Chairman Gary Gensler underscores that point by stating:

       Central clearing would greatly reduce both the size of 
     dealers as well as the interconnectedness between Wall Street 
     banks, their customers and the economy.

  In addition, we should reconsider the legal treatment of qualified 
financial contract exposures under the bankruptcy code, and therefore 
under a resolution regime, as well.

[[Page 5219]]

  Given the sheer size of cross exposures arising from derivatives and 
repos that financial firms have with each other, it makes sense to 
allow derivative and repo exposures to be netted out prior to any 
automatic stay.
  It is not apparent why that net credit exposure should come ahead of 
the claims of other secured creditors. This is special treatment, not 
market discipline.
  All of these changes taken together would reduce risk in the system, 
impose discipline in the market, and break the cycle of obligatory 
booms, busts and bailouts. In short, they eliminate the problem of 
having institutions that are both too big and interconnected to fail.
  If instead our solution is to depend on regulators, and to wait with 
an impractical plan to resolve failing institutions, the financial 
system will continue on its inexorable path, growing bigger, more 
complex and more concentrated. And we will only be laying the 
groundwork for an even greater crisis the next time.
  In the midst of the Great Depression, we built strong walls that 
lasted for generations. The devastation of our most recent crisis 
challenges us to do so again.
  These megabanks are too big to manage, too big to regulate, too big 
to fail, and too interconnected to resolve when the next crisis hits. 
We must break up these banks and separate again those commercial 
banking activities that are guaranteed by the government from those 
investment banking activities that are speculative and reflect greater 
risk.
  We must limit the size, liabilities, and leverage of any systemically 
significant financial institution.
  Given the ever-increasing rate of financial innovation, the need for 
Congress--not the regulators--to impose these time-honored principles 
has never been greater. The stakes have never been higher.
  It is time to follow in the footsteps of those great Senators who 
made the tough decision in the 1930s to pass the Glass-Steagall Act and 
other landmark reform bills, which paved the way for almost 60 years 
without a major financial meltdown. Once again, we must ensure that 
government guarantees of commercial bank deposits do not enable 
financial institutions to engage in the risky activities of investment 
banks.
  Finally we must guarantee that there are no banks that are too big to 
manage too big to regulate, and too big to fail. The American people 
deserve no less.
  Mr. President, I yield the floor.
  Mr. President, I suggest the absence of a quorum.
  The PRESIDING OFFICER. The clerk will call the roll.
  The bill clerk proceeded to call the roll.
  The PRESIDING OFFICER (Mr. Kaufman). The Senator from Connecticut.
  Mr. DODD. Mr. President, I ask unanimous consent that the order for 
the quorum call be rescinded.
  The PRESIDING OFFICER. Without objection, it is so ordered.

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