Current efforts may not be enough to solve the too big to fail problem, and Federal Reserve Bank of Philadelphia President Charles I. Plosser said the government shouldn't bail out failing firms and rules and capital requirements need to be set to attempt to reduce the risk of failures.
"The first aspect of this approach is establishing a framework that permits a large financial institution to, in fact, fail without placing the financial system at risk. Large financial firms, and particularly their creditors, should not be rescued or protected by government guarantees or supports or by regulatory discretion," Plosser told the 4th Annual Simon New York City Conference, according to prepared text released by the Fed. "The second line of defense that I will discuss is to expect all financial firms to maintain sufficient levels of capital to significantly reduce the ex-ante risk of failure. Increased capital requirements can lower the incentive for financial institutions to become systemically important and lower the probability that such firms will fail in the first place."
The financial crisis showed that regulators lacked "adequate tools for handling the failure of seriously troubled financial firms that were perceived to be systemically important," and the response to failures "were inconsistent, to say the least."
"If we are to end discretionary bailouts and the associated moral hazard problems that they create, we should seek more rule-like methods to resolve failing firms, such as a new Chapter 14 bankruptcy mechanism," he said. "But we also should accept the idea that more capital is an important buffer against financial distress. Importantly, we should seek to simplify capital regulation and reduce or eliminate the ever-increasing complexity of risk-weighted capital calculations. Finally, we should design regulations that encourage rather than discourage markets to monitor risk-taking. These steps will provide us with a better chance of ending too big to fail and promote a more stable financial system."
