More than a year after the Dodd-Frank Act was supposed to put the issue to rest, the question of whether "too big to fail" still exists is once again consuming the financial services industry.
Moody's Investor Services provided powerful ammunition Wednesday to those who argue the regulatory reform law ended the era of bailouts by downgrading the long-term rating of Bank of America Corp. and Wells Fargo & Co., as well as the short-term rating of Citigroup Inc., citing increased probability that the government would let such firms fail.
All three are major players in residential finance, though B of A is downsizing its mortgage operations significantly.
The disagreement on whether the regulatory reform law went far enough to ensure the government would never again prop up a systemically important firm extended even to experts in the policy arena during a debate this week at a SourceMedia regulatory symposium in Washington.
On one side was Tom Hoenig, the president of the Federal Reserve Bank of Kansas City, who said too big to fail is alive and well.
"The interconnectedness that ... is there today will be there during the next crisis, and that will cause any Treasury secretary, no matter who appoints him, to hesitate," said Hoenig. "That's life. The reality is that you bail them out."
But H. Rodgin Cohen, a partner with Sullivan and Cromwell and one of the nation's top banking lawyers, disagreed. He argued that Congress went as far as it could to ensure the government could not again bail out large troubled firms, and noted a host of new regulations that are being put in place. Those included new resolution powers for the Federal Deposit Insurance Corp. as well as higher capital and liquidity standards.
"I would argue that Dodd-Frank has largely eliminated 'too big to fail' for major U.S. banks, perhaps even totally," Cohen said.
Although both Hoenig and Cohen spoke before Moody's announcement, the ratings agency appeared to support Cohen's view.
"The downgrades result from a decrease in the probability that the U.S. government would support the bank, if needed," the ratings agency wrote in a statement on Bank of America. "Moody's believes that the government is likely to continue to provide some level of support to systemically important financial institutions. However, it is also more likely now than during the financial crisis to allow a large bank to fail should it become financially troubled, as the risks of contagion become less acute. Moody's is therefore lowering the amount of support it incorporates into Bank of America's ratings to levels reflected prior to the crisis."
