WASHINGTON — The question of whether some banks are still "too big to fail" will not be settled until the next crisis.
That, in a nutshell, was the takeaway from a House Financial Services Committee hearing on Tuesday, where lawmakers fought with each other over whether the Dodd-Frank Act adequately addressed the problem.
While regulators said that it had, there was a laundry list of unknowns: Which institutions should be deemed systemically significant? How will regulators supervise such firms? Will the market give serious weight to the new tools by U.S. regulators to eliminate the perception of "too big to fail" once and for all?
Nearly a year after the Dodd-Frank bill was signed into law, there is little evidence for answers to those questions.
"It's too early to tell whether Dodd-Frank will ultimately be successful in ending 'too big to fail,' and that success will be dependent on the market's perception of the effectiveness of the acts that are taken by [the Treasury Department] and the regulators now," said Christy Romero, the acting special inspector general for the Troubled Asset Relief Program.
That did not stop lawmakers from feuding over the issue, however.
Democrats — who view Dodd-Frank as a signal achievement of the past two years — said mandatory living wills for the largest firms, combined with new powers granted to the Federal Deposit Insurance Corp., will stop the government from bailing out a bank again.
But Republicans argue the opposite, contending that by identifying systemically important firms, Dodd-Frank has solidified, not eliminated, "too big to fail."
"The truth of the matter is, in times of crisis, regulators have always — they're always going to err on the side of more intervention and more bailouts," said Rep. Ed Royce, R-Calif. "Orderly liquidation authority under Dodd-Frank does little more than facilitate this process. And as a result, 'too big to fail' not only lives on, it is further compounded."
For their part, FDIC officials argue that just isn't true, saying the government has no choice but to shut a large institution down if it's in trouble. "Resolution plans are essential to ending 'too big to fail,' " said Michael Krimminger, general counsel for the FDIC. "This is no bailout. There is no statutory authority in the Dodd-Frank Act for us to bail out a failed financial institution. The company must be liquidated."
Democrats, led by Rep. Barney Frank, said Republicans are to blame for furthering the perception of "too big to fail."
"The only ones who are arguing that nothing will change and that if a large financial institution gets in trouble, the government will step in and bail it out and let it continue, are some of the Republican critics of the bill," Frank said. "They're the ones who are creating that false perception."
GOP lawmakers, and others, say that systemically important firms will have a built-in advantage over others. If that's true, Frank rejoined, then why are institutions trying to convince regulators and lawmakers they are not "too big to fail." Such firms will face tougher regulation and higher capital requirements, Frank said.
"According to some of the Republicans, the bill confers on these large financial institutions a great benefit of being considered 'too big to fail,' " Frank said. "And every single one of them is fighting against it. Apparently, this is a gift that no one wants."
At least part of the issue is ongoing uncertainty over which institutions regulators will deem as systemically important. While the FDIC has been steadily moving forward on building a new resolution system, the Financial Stability Oversight Council has provided scant details on how it plans to proceed on systemic designations.
Once that determination is made, the question of "too big to fail" may be partially addressed, regulators said.
"The markets will watch to see what a designation of systemically significant is," Romero said. "The markets will watch to see the level and type of enhanced supervision that comes with that designation. The markets will watch to see whether these companies are restructured and simplified."
For now, markets are using the government's recent actions during the crisis as a guide. In the case of Citigroup, it claimed to be healthy when it received an initial infusion of $25 billion in September 2008, but its situation significantly deteriorated shortly thereafter. (It later received a second bailout in November of that year.)
"There was devastating investor confidence in Citigroup, which was shown by, as you know, a dramatic drop in its stock price and a widening of the credit-default spread," Romero said.
Regulators agreed that the issue won't be settled once and for all until another large institution finds itself in similar straights — and this time the government acts differently.
"Rules … are only as effective as their application, and in order to convince the markets, the promise of the regulators and Treasury that to end 'too big to fail' must be matched with actions, actions that signal with certainty that the government will not make future bailouts," Romero said.