Winning the Too-Big-to-Fail Battle

After the financial crisis forced governments to bail out systemically important banks, regulators implemented measures to safeguard the financial system. Recent studies suggest that their efforts are working – but they still have a long way to go.

CAMBRIDGE – Headlines about banks’ risks to the financial system continue to dominate the financial news. Bank of America performed poorly on the US Federal Reserve’s financial stress tests, and regulators criticized Goldman Sachs’ and JPMorgan Chase’s financing plans, leading both to lower their planned dividends and share buybacks. And Citibank’s hefty buildup of its financial trading business raises doubts about whether it is controlling risk properly.

These results suggest that some of the biggest banks remain at risk. And yet bankers are insisting that the post-crisis task of strengthening regulation and building a safer financial system has nearly been completed, with some citing recent studies of bank safety to support this argument. So which is it: Are banks still at risk? Or has post-crisis regulatory reform done its job?

The 2008 financial crisis highlighted two dangerous features of today’s financial system. First, governments will bail out the largest banks rather than let them collapse and damage the economy. Second, and worse, being too big to fail helps large banks grow even larger, as creditors and trading partners prefer to work with banks that have an implicit government guarantee.

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