White House adviser Paul Volcker today criticized the Obama administration's sweeping financial regulatory reform proposals, specifically one that he warned could lead to future bailouts by designating certain firms as "too big to fail." In testimony prepared for a hearing Thursday morning before the House Financial Services committee, the former Federal Reserve chairman expressed doubts about the administration's proposal to designate certain firms that pose a threat to financial stability, subject them to stricter supervision, and make them submit resolution plans in the event of failure. "The clear implication of such designation whether officially acknowledged or not will be that such institutions, in whole or in part, will be sheltered by access to a Federal safety net in time of crisis; they will be broadly understood to be 'too big to fail'," Volcker said.
This designation, Volcker said, will only serve to encourage more risk-taking, thereby leading to even worse crises in the future. "What all this amounts to is an unintended and unanticipated extension of the official 'safety net,' an arrangement designed decades ago to protect the stability of the commercial banking system," Volcker stated. "The obvious danger is that with the passage of time, risk-taking will be encouraged and efforts at prudential restraint will be resisted. Ultimately, the possibility of further crises – even greater crises – will increase."
This approach, he predicted, will adversely affect both the firms that fall into the "too big to fail" category as well as the firms that do not.
"In fair financial weather," Volcker said, "the important institutions will feel competitively hobbled by stricter standards. In times of potential crisis, it would be the institution left out of the "too big to fail" club that will fear disadvantage."
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