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Resolving Too-Big-to-Fail Banks in the United States

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Resolving Too-Big-to-Fail Banks in the United States

Mercatus Center,

15 min read
10 take-aways
Audio & text

What's inside?

“Too-big-to-fail” banks can still fail, but regulators’ ability to resolve them remains untested.

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Editorial Rating

8

Qualities

  • Analytical
  • Eye Opening
  • Background

Recommendation

This report from George Mason University’s Mercatus Center provides a detailed, articulate analysis of US large-bank regulation and its historical context. Economists James R. Barth and Apanard Prabha address the “too-big-to-fail” (TBTF) issue and its impact on federal agencies’ policies and practices. The report examines how regulators have handled this problem before and considers how TBTF might again rear its head in the future. The authors also evaluate how the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and other regulatory changes might help or hurt bank resolution. Because it presents a complex issue in language that a layperson can understand and from which an expert might gain new insight, getAbstract recommends this levelheaded analysis to regulators, policy makers, financial industry professionals and anyone with a bank account.

Summary

Insuring Deposits

The economic history of the United States is replete with bank failures. During the Great Depression of the 1930s, massive withdrawals of deposits – known as “runs” – forced thousands of banks to close. In 1933, the US government created the Federal Deposit Insurance Corporation (FDIC) to rebuild confidence in the banking system.

Formation of the FDIC 20 years after the 1913 establishment of the Federal Reserve was acknowledgement that the US central bank couldn’t prevent runs on bank deposits. A fast outflow of deposits can make bank liquidity – that is, immediate access to cash – evaporate overnight. Illiquidity can lead to insolvency – that is, negative net worth – when a bank tries to raise cash rapidly through sales of loans, securities and other assets at prices below their market value.

The FDIC provided a solid foundation for the growth of the US banking industry because it insures bank deposits up to a maximum amount. Before the creation of the FDIC, many bank deposits were uninsured.

Failed and Troubled Banks

Under the Federal Deposit Insurance Act, the FDIC had two options for handling the shutdown of a failing bank. ...

About the Authors

A senior finance fellow at the Milken Institute, James R. Barth is the Lowder Eminent Scholar of Finance at Auburn University. Apanard Prabha is an economist at the Milken Institute.

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