The U.S. Government Accountability Office (“GAO”) issued a report examining how financial reforms have altered market expectations of the potential government rescue of a failing large bank. The report examines whether funding advantages remain for the largest bank holding companies due to an expectation that these banks would receive government support if they were ever to fail.
“Too big to fail” is the notion that the federal government would intervene to prevent the failure of large, complex financial institutions to avoid destabilizing the broader economy. According to GAO, expectations that the government will rescue the too-big-to-fail firms can counterweigh investor incentives to properly price the risks of the firms they view as too big to fail and, potentially, as giving rise to funding and other advantages for these large firms.
The report found that any funding advantage that once may have been available to a financial institution deemed too big to fail has been reduced drastically or eliminated. Market participants with whom GAO spoke believe that recent regulatory reforms have reduced, but not eliminated, the likelihood that the federal government would prevent the failure of one of the largest bank holding companies.
Lofchie Comment: Here is a throwaway line from the GAO Report (page 16): “Since the onset of the financial crisis, the largest banks have grown bigger in many major advanced economies, even as the financial sector has shrunk. . . . ” It should be evident that the tremendous increase in largely fixed regulatory costs offers a major advantage to big players (whether banks, broker-dealers, advisers or funds) that can spread out these costs due to greater business volume. It is fairly inconceivable that a small investment firm could be competitive with a large firm as a registered swap dealer given the cost of compliance with the regulatory scheme. If, on one hand, it is the case that the regulatory requirements inherently favor large firms and, on the other hand, that regulatory policy is intended to foster competition from smaller and mid-sized firms in order to avert “too-big-to-fail,” then rulemakers should consider whether the regulatory requirements and regulatory policy are in agreement.
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