Former Federal Reserve chairman Ben Bernanke had a striking assessment of the dangers faced by the U.S. economy in 2008, according to a recently disclosed document filed as part of the ongoing litigation related to the government bailout of American International Group. Bernanke reportedly said that 12 of the 13 largest U.S. financial institutions were on the verge of failure in autumn of 2008. Thus the Fed needed to take extraordinary rescue measures to save AIG and other banks to avoid financial catastrophe. Bernankes comment provides a vivid reminder of the danger posed by too-big-to-fail institutions.
The 2010 Dodd-Frank Act, which included the orderly liquidation living wills requirement, was meant to prevent future rescues of systemically important financial institutions. But the idea that current regulations are capable of solving the too-big-to-fail problem was challenged by the recent regulatory rejection of 11 banks' living wills. Some argue that living wills are a work-in-progress that will improve over time. However, the truth is that living wills are a myth meant to calm the populace. It is impossible to neatly unwind a failed SIFI, since the failure of such a large institution will necessarily cause unacceptable collateral damage.
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