Yellen testimony shows too-big-to-fail is still a very big problem

July 15, 2014, 7:20 PM UTC
Janet Yellen, chair of the U.S. Federal Reserve, speaks during a Senate Banking Committee hearing in Washington, D.C.
Janet Yellen, chair of the U.S. Federal Reserve, speaks during a Senate Banking Committee hearing in Washington, D.C.
Photograph by Andrew Harrer—Bloomberg via Getty Images

Elizabeth Warren has always been a fierce critic of big banks. But the Massachusetts Senator brought her calls for action against the largest financial institutions to a new level on Tuesday, when she argued in a Senate hearing featuring Federal Reserve Chair Janet Yellen that the central bank should use authority already granted it by Dodd-Frank legislation to force big banks to slim down.

For the past three years, the largest banks and systemically important non-financial firms have been required under Dodd-Frank to submit blueprints to the Federal Reserve and the FDIC that show how the companies could quickly be unwound in a bankruptcy process that wouldn’t involve public bailouts and would avoid the collapse of the financial system.

Warren, however, is skeptical that the largest banks, which are much bigger today than they were before the financial crisis, could be quickly unwound at all, given their size and importance. Warren argued that the bankruptcy of Lehman Brothers, the investment bank whose failure helped cause serious turmoil in financial markets in 2008, took more than three years to work itself through the courts even though it only had $639 billion in assets. Compare that to the $2.9 trillion in assets that JPMorgan, America’s largest bank, has today. Said Warren:

“JPMorgan has 3,391 subsidiaries … more than 15 times the subsidiaries Lehman had when it failed. JPMorgan has filed resolution plans in the past three years, and the Fed has not rejected them as not credible.”

In other words, Warren is wondering what many Dodd-Frank critics have asked in the years since the passage of the bill: How exactly will Dodd-Frank reforms prevent another round of bailouts during the next financial crisis?

Nobody from the government has explained to the public in clear language how a resolution of a firm the size of JPMorgan could proceed without a government backstop, given that no firm anywhere near its size and complexity has ever been unwound quickly enough to avoid needing a bailout.

Warren believes that the banks must be forced to downsize in order to be simple enough to be unwound during the next financial crisis, and she believes that the Fed should use its powers to reject these banks’ living wills and force them to sell off assets. “The statute is pretty clear here,” Warren said. “It’s mandatory that these plans be submitted each year and that each year you determine whether these plans are credible. I guess what I’m asking here is, have they ever gotten to a plan that you can say with a straight face is credible?”

Yellen’s response wasn’t at all reassuring for those who believe that the biggest banks are far too big. She believes that the production of living wills is an “iterative process” that should be produced with banks and regulators working together to make sure there’s an orderly way to resolve too-big-to-fail banks. She defended the collaborative nature of the process by saying that these living wills were “extremely complex documents” that run to “tens of thousands of pages.”

Of course, one could reasonably wonder how it would be possible to unwind an institution quickly (the FDIC usually unwinds small failed banks over the course of a weekend to avoid disrupting markets) when the living will along stretches beyond 10,000 pages.

For Warren, the answer is clear: force the banks to get smaller. “There are very effective tools that you have at your disposal if these plans aren’t credible,” Warren admonished the Fed chair. “Including forcing these financial institutions … to liquidate some of their assets.”

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