Federal Reserve Bank of New York president and former governor of Bank of England speak at Comfort Global Economic Policy Forum

The 2008 financial crisis continues to cast a long shadow. At the sixth annual Comfort Global Economic Policy Forum on November 7, William Dudley, president and chief executive officer of the Federal Reserve Bank of New York, gave a keynote address in which he made a powerful argument for tackling the “too big to fail” problem.

William Dudley

“Too big to fail” is invoked when the government intervenes to prevent the failure of large complex financial institutions from bringing down the entire economy with it. Dudley called the situation unacceptable: “The firm, by being too big to fail, gains an implicit guarantee at the taxpayers’ expense that it does not have to pay for.” If the market believes that a firm is too big to fail and will be rescued, he asserted, that firm becomes less restrained by market discipline. “Since the government does not charge for this implicit guarantee,” he said, “this reduces the firm’s cost of funds and incents the firm to take more risk than would be the case if there were no prospect of rescue and funding costs were higher.” This “artificial subsidy” tempts firms to grow even larger, thus skewing the entire system toward too big to fail entities.

While it is difficult to discern how much of larger firms’ funding advantage is due to the too big to fail perception, there is considerable evidence, Dudley said, to indicate that the advantage is significant, particularly in contrasting the advantage of large banks as compared to both large non-bank financial firms and non-financial firms. Further, he added, major ratings agencies boost the largest banks’ credit ratings because of the expectation of government support in dire circumstances. For Dudley, however, the unacceptable systemic risk of large firms’ failures is as crucial an issue as their funding advantage.

Turning to potential solutions, Dudley advocated building a credible resolution regime and boosting resiliency in the financial system to reduce the systemic costs of a firm’s failure, along with implementing other standards and protocols to further reduce the risk of failures in the first place. Conversely, he expressed skepticism regarding the idea of breaking up large firms, since certain benefits of scale, along with breakup costs and potentially limited gains, combined to make that option less attractive.

Dudley’s candor in criticizing the financial industry was significant, since, as MarketWatch noted, presidents of the Federal Reserve Bank of New York tend to side with Wall Street. He referred to an “important problem evident within some large financial institutions—the apparent lack of respect for law, regulation, and the public trust." He referred to evidence of deep-seated cultural and ethical failures at many large financial institutions that could be addressed by tough enforcement and high penalties. "But I am also hopeful," he said, "that ending too big to fail and shifting the emphasis to longer-term sustainability will encourage the needed cultural shift necessary to restore public trust in the industry.”

Following Dudley’s address were three different panels. The first focused on the recent Congressional budget standoff’s repercussions for federal spending, the second on the stalemate’s federal tax effects, and the third on market opportunity and market risk. Among the participants were Assistant Professor David Kamin ’09; Daniel Shaviro, Wayne Perry Professor of Taxation; Adjunct Professor Alan Rechtschaffen, who was co-chair of the Comfort Global Economic Policy Forum along with Geoffrey Miller, Stuyvesant P. Comfort Professor of Law; and Gerald Rosenfeld, Distinguished Scholar in Residence and Senior Lecturer.

Lord King and William Dudley

Capping off the event was an off-the-record evening keynote by Sir Mervyn King, who was governor of the Bank of England and chairman of its Monetary Policy Committee from 2003 to 2013. He is currently a Distinguished Visiting Professor at NYU School of Law and the NYU Stern School of Business. The Comfort Global Economic Policy Forum was hosted by the Law School’s Center for Financial Institutions and the Mitchell Jacobson Leadership Program in Law and Business.


Watch the full video of William Dudley's afternoon keynote (51 min):

Watch the full video of the first panel, "The Current Budget Stalemate and Beyond: Outlook for Federal Spending" (1 hr, 20 min):

Watch the full video of the second panel, "The Current Budget Stalemate and Beyond: Outlook for Federal Taxes" (1 hr, 12 min):

Watch the full video of the third panel, "Market Opportunity and Market Risk" (1 hr, 9 min):

Posted on November 12, 2013