WASHINGTON -- A rift has emerged over “too-big-to-fail” between the Treasury Department and the regulators who oversee financial groups, a top Democratic lawmaker has alleged, potentially creating an uncomfortable situation for an administration keen to show it has cracked down on the nation’s biggest banks.

The Federal Reserve, Office of the Comptroller of the Currency and Federal Deposit Insurance Corp. said in a joint statement this week that financial markets continue to perceive some leading financial institutions as too big to fail, perverting the financial system and giving large banks unfair advantages over smaller peers in the form of lower funding costs.

Sen. Sherrod Brown (D-Ohio), a senior lawmaker on the Senate Banking Committee, on Thursday seized on an April speech delivered by Mary Miller, Treasury undersecretary for domestic finance, in which Miller disputed the notion that big banks enjoy a funding advantage due to perceptions they are too big to fail. At the time, lobbies representing big banks cheered her remarks.

Quoting the bank regulators, Brown asked her simply: “Why are they wrong and you’re right?”

Miller stuck to her previous remarks -- the evidence that big banks unfairly benefit from a funding advantage remains mixed -- but the potentially divisive question showed what some Democrats privately acknowledged as a source of frustration with the Obama administration over financial regulation.

While many lawmakers have praised the administration for its efforts to reform Wall Street, some have said they’ve been disappointed the Treasury Department has not been more aggressive in fixing the industry blamed for triggering the 2007-09 financial crisis and the most punishing economic downturn since the Great Depression.

In the fall of 2008, virtually every large financial group was rescued by the federal government, committing taxpayer dollars to propping up teetering banks whose failure risked sending the economy into a worse tailspin.

With some Republican support, a group of Democrats have proposed forcible restructurings of big banks, breaking them up along lines of business, capping their size, forcing them to significantly reduce their borrowing, and tougher prohibitions on certain trading activities.

For example, this week, a bipartisan group of four lawmakers led by Sens. Elizabeth Warren (D-Mass.) and John McCain (R-Ariz.) proposed a law that would force large banks to cleave off their securities units in a revival of the Depression-era law known as Glass-Steagall.

Though the Treasury Department has largely opposed these moves, Treasury Secretary Jack Lew appeared to endorse additional efforts that regulators deemed necessary to forever end the perception that some banks remain too big to fail.

“It is certainly the objective to be able to say at the end that we have ended ‘too-big-to-fail’ and that we have eliminated any subsidy that might exist,” Lew told Brown during a May hearing before the Senate Banking Committee. “The fact that the market implies a subsidy when we've said as a matter of policy that ‘too-big-to-fail’ is not our policy is a bit of a challenge.

“And we are saying it as often as we can, but we're going to have to demonstrate it with the rules that we've put in place that make it quite costly to be a large bank in terms of the requirements that are put in place,” Lew added.

To Lew’s point, some regulators at the banking agencies have supported tougher measures.

On Tuesday, the desire among some regulators to do more led the Fed, FDIC and OCC to propose a measure that would force the eight biggest banks, including JPMorgan Chase and Citigroup, to significantly reduce their reliance on borrowed funds in favor of building up their capital.

As part of the rule, the regulators said they remained concerned over too-big-to-fail. The acknowledgement marked one of the few times the banking agencies had teamed up to express alarm about the continued existence of too-big-to-fail in the wake of Dodd-Frank, the post-crisis 2010 overhaul of U.S. financial regulation designed specifically to forever end the perception that some banks are considered so big or important that policymakers would never allow them to fail. The law explicitly bans taxpayer-funded bailouts.

“A perception continues to persist in the markets that some companies remain ‘too big to
fail,’ posing an ongoing threat to the financial system,” the regulators said. “First, the existence of the ‘too-big-to fail’ problem reduces the incentives of shareholders, creditors and counterparties of these companies to discipline excessive risk-taking by the companies.

“Second, it produces competitive distortions because companies perceived as 'too big to fail' can often fund themselves at a lower cost than other companies. This distortion is unfair to smaller companies, damaging to fair competition, and tends to artificially encourage further consolidation and concentration in the financial system.”

The statement signified a rare agreement among regulators that big banks continue to benefit from a cost advantage due to the perception that they are too big to fail. The argument over whether this subsidy exists gripped Washington earlier this year as banking groups rushed to dispute the charge after lawmakers used the subsidy claim to justify moves to break up America’s biggest banks.

The regulators added that the enhanced capital measure they proposed this week addresses “the concern that some institutions benefit from a real or perceived implicit federal safety net subsidy or may be viewed as ‘too big to fail.’”

By contrast, Miller said in April that the evidence regarding a cost advantage for big banks was “mixed and complicated, making it hard to attribute the existence or absence of a funding cost advantage to any single factor, including a market perception of a too-big-to-fail subsidy.”

Rather, Miller said, the funding advantage may be due to a variety of factors. For example, larger companies in all sectors tend to enjoy lower borrowing costs because the market for their debt is bigger, allowing it to trade more often and with more buyers. Big banks also may enjoy advantages because they are involved in more businesses, she said, providing a buffer if one line of business suffers.

Miller also argued that perhaps big banks are paying more to borrow than their smaller peers, citing recent research.

She urged caution to those seeking to draw conclusions, though she expressed hope that regulators’ efforts “should help wring it the rest of the way out of the market.”

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