By Mary Ann Pekara
In 2008, the American people were faced with an abrupt request on the part of then-Treasury Secretary Henry Paulson to invest $700 billion toward bailing out some of the nation’s largest banks. Without this bailout, the American people were told, their entire economic system would soon be crippled or destroyed.
Naturally, the Bush Administration and legislative branch jumped on the threat and invested the requested funds. But could it happen again? Is anything keeping big banks from failing now?
The “Dodd-Frank Wall Street Reform and Consumer Protection Act” was enacted in 2010 and contains some sixteen major reforms to regulate banks deemed “Too Big to Fail.” One of the changes outlined in Dodd-Frank has to do with placing a big bank into a state of “receivership” following quantitative failure.
This provision of Dodd-Frank effectively grants the United States government full authority to take over a big bank should it teeter toward failure. This practice represents a massive increase in authority.
Prior to the recession of 2008, the United States government was only allowed to overtake certain subsidiaries within any given company. Now, the government can overtake and overhaul most of the holdings of a company should it fail.
This practice is less like a bailout than it is a bankruptcy. The government steps in and takes over the liquidation or expansion of bank holdings in an attempt to return the company to stability.
Failure Under Dodd-Frank
The ability of the United States government to take over banks may do more harm than good should a really large bank fail. The liquidation process outlined in Dodd-Frank likely doesn't take into account the truly global nature of banking these days.
This misunderstanding, however, isn't the only threat facing America should a big bank fail. The nation’s largest banks have only grown in size and influence since the recession of 2008.
In the case of Wells Fargo, the acquisition of Wachovia in 2008 led to double-digit gains and expanded the company’s sphere of influence by leaps and bounds.
Interconnectedness is still a problem among big banks as well. Institutions like Bank of America (which holds an amount of revenue roughly equivalent to 18% of US GDP) would not only collapse individually, they’d likely take an almost unthinkable number of institutions with them.
This domino effect was a major fear in 2008, and remains so today; the difference now is these banks are bigger and more connected.
Could It Happen
Hypothetically, were a big bank to fail, the United States government would step in through the FDIC and take over operations.
First, they would likely implement planned strategies for dealing with the economic fallout across international borders, some of which include: Identifying foreign problem areas prior to the failure; coordinating with regulators; and homing in on resolutions by district.
Next, the FDIC would get to work on restructuring the affected bank to fit pre-established models. Part of this restructuring would be the reallocation or liquidation of assets and placing the company into a state of receivership.
Theoretically, after these two steps, the FDIC and U.S. government would then oversee the company until the entire process is finished.
It’s important to keep in mind that the criticisms leveled against the provisional regulatory power of the United States government under Dodd-Frank may or may not come into play. It’s uncertain now whether the interconnectedness, size, and global nature of today’s banks would hinder the processes outlined in Dodd-Frank or not.
The primary reason behind this uncertainty is simple: There hasn't been a collapse since the recession in 2008.
Dodd-Frank’s regulations may keep collapses from having the heavy impact they did in 2008, they may have no affect at all, or the FDIC’s stewardship of large, failing banks may prove more disastrous for the country than outright collapse. We simply don’t know.
However, should another financial crisis strike this country on the scale of the recession, conditions are ripe for it to be the worst yet, should the provisions of Dodd-Frank prove ineffective.