POLITICS
07/17/2013 08:53 pm ET Updated Jul 18, 2013

Jack Lew: Too-Big-To-Fail Dead By Year's End ... Or Else

The threat posed by too-big-to-fail banks should be eradicated by year's end, and if not, more restrictive measures targeting large financial groups may be necessary, U.S. Treasury Secretary Jack Lew said Wednesday.

Lew's remarks during a panel discussion in New York create perhaps the first marker by which to judge the Obama administration's efforts to forever end the perception that policymakers would never allow a select group of financial institutions to fail because of the risk to the economy. It also represents a slight break from the Treasury Department's previous positions, in which agency officials have sought to trump the end of too-big-to-fail and have disputed claims that it still exists.

"It's unacceptable to be in a place where too-big-to-fail has not been ended," Lew said. "If we get to the end of this year and we cannot, with an honest, straight face, say that we have ended too-big-to-fail, we are going to have to look at other options."

The Treasury Department has come under fire for an apparent split with the federal government's three banking agencies over too-big-to-fail. While the Federal Reserve, Office of the Comptroller of the Currency and Federal Deposit Insurance Corp. are united in thinking 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, the Treasury Department has been an outlier, arguing the evidence either is mixed or shows that the biggest banks pay more to borrow than smaller rivals.

The gap between the Treasury and banking agencies was seized on by Sen. Sherrod Brown (D-Ohio), a top lawmaker on the Senate Banking Committee, who has proposed legislation that would in effect force the biggest banks to break into several pieces. Brown also has agitated for regulators to impose rules that would force the largest banks to either shrink or abandon key businesses. Other lawmakers, including a bipartisan group led by Sen. Elizabeth Warren (D-Mass.) and Sen. John McCain (R-Ariz.), have pushed for similarly aggressive measures.

Lawmakers' interest in too-big-to-fail comes as the White House and Treasury Department are set to celebrate the three-year anniversary of the 2010 overhaul of financial regulation known as Dodd-Frank. The law was written in part to end the notion that some banks, either due to size or their importance to the larger financial system, would always be rescued by government officials if they neared default, or failure.

The 2007-09 financial crisis cemented the view in some market participants that the government would always bail out the nation's largest banks, due to the bailout schemes that helped big banks such as Citigroup and Bank of America survive the market meltdown.

"As a matter of law, Dodd-Frank ended the notion that any firm is too big to fail," Lew said Wednesday. But three years after Dodd-Frank, ending too-big-to-fail remains an incomplete task, regulators and lawmakers have said, adding significance to Lew's remarks of possible further action.

In a sign that the Fed remains committed to further action, Ben Bernanke, Fed chairman, told House lawmakers Wednesday during a congressional hearing that regulators need to take additional steps to accomplish their goal of ending too-big-to-fail. Bernanke has previously said that the era of too-big-to-fail is not yet over.

"I think there's more work to be done before we feel completely comfortable about systemic firms," Bernanke said. "The Dodd-Frank Act and Basel III and other international agreements provide a framework for working toward the day, which is not here yet, where we can declare too-big-to-fail as a thing of the past," he said, referencing the international banking accords named after the town of Basel, Switzerland.

Bernanke added: "But I wouldn't be saying the truth if I said that the problem is gone. It is not gone. We need to keep ... following through on the various programs here. And I think we need to keep doing what's necessary to make sure that this problem is solved for good."

To that end, the Fed has said it plans additional measures targeting the biggest banks to end the perception that some of them benefit from an implicit government backing. Earlier this month, Daniel Tarullo, Fed governor and the central bank's lead official on regulatory matters, crystalized four upcoming rules that he had either previously proposed or had been coming due to international agreements.

One involved a stricter cap on bank borrowing known as the leverage ratio, which limits banks' ability to borrow relative to their equity capital. The measure would either force banks to stump up more capital to back their loans and securities, or shrink their balance sheets. The FDIC, Fed and OCC have since proposed this rule.

Another measure involves a minimum amount of equity capital and long-term debt that the biggest banks should maintain in order to make it easier for them to be resolved, should they near failure under new and untested resolution schemes regulators created under Dodd-Frank.

The third proposal calls for the largest financial institutions to fund their loans and securities with additional equity capital, beyond present minimums, in a move that effectively seeks to penalize banks for either being too big or complex.

The fourth and final proposal, according to Tarullo, would force banks such as Goldman Sachs and Morgan Stanley that rely on short-term funding -- basically borrowed funds beyond bank deposits and debt that is sold as bonds -- to fund their balance sheets with even more equity capital.

"Once final, these measures would round out a capital regime of complementary requirements that focus on different vulnerabilities and together compensate for the inevitable shortcomings in any single capital measure," Tarullo said July 2. "This regime would conform to the mandate given us by Congress to apply to large banking organizations more exacting regulatory and supervisory requirements that become progressively stricter as the systemic importance of a firm increases."

The various measures probably will be finalized by year's end, or will have been formally introduced to solicit comments, perhaps presenting Lew with an opportunity in December to declare too-big-to-fail's final days.

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