Bernanke: Some Banks Really Are Too Big to Fail

By Paul Jackson

Throughout the ongoing credit crisis, pundits and skeptics alike have alluded to “too big to fail” — the idea that some financial institutions, however irresponsible, had become too fat, too large, and too systemically important to the global financial machine to be allowed by regulators to fail.

U.S. Federal Reserve chief Ben Bernanke admitted in a speech Friday morning that the notion of “too big to fail” was correct, and suggested that Federal regulators were moving to ensure that some of the nation’s largest banks would not be allowed to fail.

In remarks delivered to the Council on Foreign Relations in Washington D.C., Bernanke said that “reforms to the financial architecture” were needed to prevent this sort of crisis in the future — but said that some firms were too large to be allowed to fail. Read the full speech.

“We must address the problem of financial institutions that are deemed too big–or perhaps too interconnected–to fail,” Bernanke said. “Given the highly fragile state of financial markets and the global economy, government assistance to avoid the failures of major financial institutions has been necessary to avoid a further serious destabilization of the financial system, and our commitment to avoiding such a failure remains firm.”

In other words: I don’t like it, but, yes, some firms really are too big to fail. Bernanke suggested the U.S. needed to prop up ailing financial giants like Citigroup, Inc. (C) and American International Group Inc (AIG), while also suggesting that a new regulatory framework be put into place to prevent “too big to fail” from being an issue in the next financial crisis.

“It is imperative that policymakers address this issue by better supervising systemically critical firms to prevent excessive risk-taking and by strengthening the resilience of the financial system to minimize the consequences when a large firm must be unwound,” Bernanke said.
AIG was clearly on Bernanke’s mind here, as well: “The United States also needs improved tools to allow the orderly resolution of a systemically important nonbank financial firm, including a mechanism to cover the costs of the resolution.”

The ailing insurer has received more than USD 160 billion in direct Federal assistance to keep it afloat as bets of credit default swaps and other derivative contracts — including mortgage-related bets — have soured.

The Fed chief also suggested that the recession could be over by the end of 2009, if policymakers and regulators are able to right the ship of the U.S. and global financial machine. Doing so quickly, however, might be a tall order; as Bernanke noted in his speech, addressing this crisis will require a coordinated global response.

Pundits have suggested for months now that Wells Fargo & Co.’s (WFC) acquisition of troubled Wachovia Corp. last year was the result of the bank’s desire to remain “too big to fail” in the eyes of regulators; a similar strategy was cited behind Bank of America’s (BAC) purchase spree, which included troubled mortgage originator Countrywide Financial Corp. and Merrill Lynch. Whether he intended to or not, Bernanke’s speech Friday clearly gives some strong credence to such thoughts.