TBTF Problem Research Articles

The Too-Big-To-Fail Problem and the Blockchain Solution

The paper seeks to ascertain whether and to what extent blockchain technology may contribute to solving the politically and socially intractable problems of effectively resolving distressed TBTF financial institutions. It revisits the TBTF problem in the light of the Global Financial Crisis and the COVID-19 crisis and provides an overview of the constantly evolving DLT/blockchain ecosystem. It further seeks to address the main arguments commonly advanced by blockchain sceptics/opponents against the more widespread adoption of crypto-assets. Given blockchain’s capacity for decentralization, transparency and automation, the technology seems particularly well suited for tackling TBTF. On that basis, the paper discusses the potential impact of blockchain technology on (TBTF) bank resolution in three possible scenarios. Gradual adoption over the next five years may significantly improve the resolution process primarily through enhanced transparency of the blockchain-recorded history of assets and transactions. Over the next decade, a ‘smart securities world’ may emerge where bail-in could be automated and systemically important assets and liabilities resolved through distributed financial market infrastructures (dFMIs). The final scenario, with a 20-year horizon, is a fiat cryptocurrency in a reformed financial system where banking panics are eradicated. These scenarios are speculation. However, the basic technological building blocks are already available today and with improved scalability, more reliable smart contract execution and widespread adoption over time they could help to significantly improve the resolvability of TBTF institutions.

Too Big to Fail: A Never Ending Issue

The twin financial and sovereign debt crisis occurred during the last decade fostered the already existent debate on the so called too-big-to-fail financial institutions (“TBTF”) issue. The present essay will try to critically discuss the effectivity of the main measures adopted insofar in order to address such topical problem, on which scholars and authorities in the field are still in disagreement, as the conflicting statements of the President of the FRB of Minneapolis, Neel Kashkari and the Governor of the BoE recently evidenced. In doing so, a first section will identify and define the TBTF issue, looking at the rationale and the consequences of such concept. Moving forward, the following section will focus on some selected regulatory initiatives recently adopted across the U.S. and the EU, aimed at eradicating the TBTF problem and the linked consequences. In the light of the analyses so provided, Section 4 will critically evaluate both positions of Mr. Kashkari and Mr. Carney, trying to assess whether the TBTF generating roots have been now eradicated by the regulations recently passed or if we are still far from a TBTF-free financial environment.

An assessment of the “too big to fail” problem for field dwarf galaxies in view of baryonic feedback effects

Recent studies have established that extreme dwarf galaxies – whether satellites or field objects – suffer from the so called “too big to fail” (TBTF) problem. Put simply, the TBTF problem consists of the fact that it is difficult to explain both the measured kinematics of dwarfs and their observed number density within the lambda cold dark matter (ΛCDM) framework. The most popular proposed solutions to the problem involve baryonic feedback processes. For example, reionization and baryon depletion can decrease the abundance of halos that are expected to host dwarf galaxies. Moreover, feedback related to star formation can alter the dark matter density profile in the central regions of low-mass halos. In this article we assess the TBTF problem for field dwarfs, taking explicitly into account the baryonic effects mentioned above. We find that 1) reionization feedback cannot resolve the TBTF problem on its own, because the halos in question are too massive to be affected by it; and that 2) the degree to which profile modification can be invoked as a solution to the TBTF problem depends on the radius at which galactic kinematics are measured. Based on a literature sample of ~90 dwarfs with interferometric observations in the 21 cm line of atomic hydrogen (HI), we conclude that the TBTF problem persists despite baryonic effects. However, the preceding statement assumes that the sample under consideration is representative of the general population of field dwarfs. In addition, the unexplained excess of dwarf galaxies in ΛCDM could be as small as a factor of ≈ 1.8, given the current uncertainties in the measurement of the galactic velocity function. Both of these caveats highlight the importance of upcoming uniform surveys with HI interferometers for advancing our understanding of the issue.

The gap of stellar mass in galaxy groups: another perspective of the too-big-to-fail problem in the Milky Way

The Milky Way presents the too-big-to-fail (TBTF) problem that there are two observed satellite galaxies with maximum circular velocity larger than 55km/s, and others have velocity less than 25km/s, but the cold dark matter model predicts there should be more than 10 subhaloes with velocity larger than 25km/s. Those massive subhaloes with $25km/s<V_{max}<55km/s$ should not have failed to form stars. The TBTF problem severely challenges the CDM model. Most efforts are seeking the effects of baryonic feedback, decreasing the mass of the Milky Way, changing the properties of dark matter, so as to assign the observed low-velocity satellites into the massive subhaloes found in simulations. However, the TBTF problem can be avoided if the MW have not accreted subhaloes with velocity between $25km/s<V_{max}<55km/s$ although the probability of such a gap is lower as $\sim 1\%$ and can not be tested against observations. In this work we study the gap in stellar mass of satellite galaxies using the SDSS group catalogue and a semi-analytical model. We find that there are 1-2\% of galaxy groups with a large gap in the stellar mass of their satellites. These 'big gap' groups have accreted less massive subhaloes in their formation history and naturally display a gap between their satellite galaxies. If extrapolating our results to the Milky Way is appropriate, we conclude that it is very likely that our Milky Way has not accreted enough massive subhaloes to host those low-velocity satellites, and the TBTF problem is naturally avoided.

Is Dodd Frank Orderly Liquidation Authority Necessary to Fix Too-Big-to-Fail?

The Dodd-Frank Act (DFA) Orderly Liquidation Authority (OLA) has many legal issues that could prevent its use. Should there be a next financial crisis, regulators may again be forced to sell a large failing bank to a larger banking institution, creating yet another too-big-to-fail (TBTF) institution.Regulatory plans for using OLA focus on injecting parent holding company capital into the critical operating subsidiaries of systemically important financial institutions (SIFIs) to keep these subsidiaries open and operating. This goal can be achieved without OLA by imposing substantially higher minimum capital requirements on critical operating subsidiaries instead of imposing them on parent SIFIs. But, replacing OLA with this simple alternative, alone, will not solve the TBTF problem. Investor perceptions of TBTF arise naturally given flaws in the existing deposit insurance bank resolution process, and the predilection for regulatory forbearance created by conflicting responsibilities assigned to the Federal Reserve Board (FRB). The FRB duty to be the consolidated supervisor of largest BHCs and other designated SIFIs, the guardian of financial stability, and the lender of last resort make it rational for investors to expect large financial institution to receive special assistance to forestall their failure or protect their creditors from loss. In contrast, other institutions that offer similar financial services will be allowed to fail and impose losses on similarly situated creditors. To end TBTF, financial regulation must be refocused on: (i) ensuring the uninterrupted operation of important subsidiaries by increasing capital requirements on banks and critical functionally-regulated affiliates ― not parent holding companies; (ii) reforming the deposit insurance bank resolution process to mandate the break-up of large failing banks; (iii) removing the regulatory structure that creates TBTF investor expectations; and (iv) requiring SIFI parent companies to reorganize or liquidate using a judicial bankruptcy process in which similarly situated creditors are treated equally. The alternative approach of higher capital requirements at operating subsidiaries does not require OLA or new regulations to operationalize OLA — rules requiring minimum total loss absorbing capacity or contingent convertible debt. If higher capital requirements at critical subsidiaries are funded with debt issued by the parent holding company, there will be no reduction in SIFIs’ consolidated interest tax shields and consequently no increase in the cost of commercial and consumer credit. These reforms will simplify regulation, improve transparency, protect taxpayers from the expense of future SIFI bailouts and eliminate the TBTF subsidy without abridging property rights and legal protection for parent SIFI creditors.

Comprehensive assessment of the too big to fail problem

We use a semi-analytical model for the substructure of dark matter haloes to assess the too-big-to-fail (TBTF) problem. The model accurately reproduces the average subhalo mass and velocity functions, as well as their halo-to-halo variance, in N-body simulations. We construct thousands of realizations of Milky Way (MW) size host haloes, allowing us to investigate the TBTF problem with unprecedented statistical power. We examine the dependence on host halo mass and cosmology, and explicitly demonstrate that a reliable assessment of TBTF requires large samples of hundreds of host haloes. We argue that previous statistics used to address TBTF suffer from the look-elsewhere effect and/or disregard certain aspects of the data on the MW satellite population. We devise a new statistic that is not hampered by these shortcomings, and, using only data on the 9 known MW satellite galaxies with $V_{\rm max}>15{\rm kms}^{-1}$, demonstrate that $1.4^{+3.3}_{-1.1}\%$ of MW-size host haloes have a subhalo population in statistical agreement with that of the MW. However, when using data on the MW satellite galaxies down to $V_{\rm max}=8{\rm kms}^{-1}$, this MW consistent fraction plummets to $<5\times10^{-4}$ (at 68% CL). Hence, if it turns out that the inventory of MW satellite galaxies is complete down to 8km/s, then the maximum circular velocities of MW satellites are utterly inconsistent with $\Lambda$CDM predictions, unless baryonic effects can drastically increase the spread in $V_{\rm max}$ values of satellite galaxies compared to that of their subhaloes.

Re-examining the too-big-to-fail problem for dark matter haloes with central density cores

Recent studies found the densities of dark matter (DM) subhaloes which surround nearby dwarf spheroidal galaxies (dSphs) to be significantly lower than those of the most massive subhaloes expected around Milky Way sized galaxies in cosmological simulations, the so called "too-big-to-fail" (TBTF) problem. A caveat of previous work has been that dark substructures were assumed to contain steep density cusps in the center of DM haloes even though the central density structure of DM haloes is still under debate. In this study, we re-examine the TBTF problem for models of DM density structure with cores or shallowed cusps. Our analysis demonstrates that the TBTF problem is alleviated as the logarithmic slope of the central cusp becomes shallower. We find that the TBTF problem is avoided if the central cusps of DM haloes surrounding dSphs are shallower than $r^{-0.6}$.

Supersize Them? Large Banks, Taxpayers and the Subsidies That Lay Between

In 2013, media reports sent shockwaves across financial markets by estimating that the value of the combined financial advantages and subsidies for the six biggest U.S. banks since the start of 2009 was at least $102 billion. Follow-up reports estimated that the profits of two of America’s largest banks would have been negative if not for implicit and explicit government subsidies. The most significant implicit subsidy stems from market perception that the government will not allow the biggest banks to fail — i.e., that they are “too-big-to-fail” (TBTF) — enabling them to borrow at lower interest rates. While the Dodd-Frank Act attempts to solve the TBTF problem, it does not prohibit the government from giving financial support framed in a general fashion.This article focuses on two main things. First, it explores the TBTF subsidies and their unintended consequences. Specifically, the article examines whether there are in fact TBTF subsidies or not, as some of the megabanks believe, and reviews the different estimates of the arguable subsidies. The article describes why it is difficult to measure and quantify the subsidies given the lack of any formal or transparent data, and discusses the perverse effects and incentives that result from the subsidies, such as pushing the banks to borrow more, take excessive risks, and act unethically. Second, the article examines the various proposals that have been suggested to address the TBTF problem, and suggests a new user-fee framework that could be useful in addressing the issue and used together with other approaches.The article’s contributions are three-fold. First, it provides a theoretical framework for understanding how government subsidies have worked in the past, especially in the TBTF context, which enables parallels to be drawn across disparate settings going forward. Second, the article applies that framework to demonstrate that the current body of work on the issue is incomplete because it under-theorizes the TBTF subsidies’ impact on the economy and politics. Finally, the analysis in this article usefully supplements the existing legal writing on regulation of banks, and adds important elements to its future development. As a first step, the article explains the problems created by the subsidies, and suggests that policymakers and market participants should be more transparent about the explicit and implicit subsidies, especially since taxpayers do not have standing to challenge such subsidies. As a second step, the article reviews the advantages and the shortcomings of the suggested solutions to the TBTF problem and suggests using user-fees to help address the negative issues resulting from the subsidies, and minimize the impact of future financial, social and political crises.

Banking for the public good

Bank shareholders cannot be expected to provide good stewardship to banks because there is a conflict of interests between the shareholder owners and a non-mutually owned bank's depositors; who provide the bulk of the funds in traditional retail banks and are willing to accept a lower return on their savings than shareholders, in return for lower risk exposure. Regulation is required to protect depositors where deposit insurance schemes are at best partially funded and underwritten by taxpayers, who in turn need to be protected, and to deliver financial stability, a public good. Once some banks become ‘too big (to be allowed) to fail’ (TBTF), they enjoy additional implicit public (taxpayer) insurance that enables them to fund themselves more cheaply than smaller banks, which gives them a competitive advantage. The political influence of big banks in the US and the UK is such that they can be regarded as financial oligarchies that have hitherto successfully blocked far reaching structural reform in the wake of the ‘Global Financial Crisis’ and lobbied successfully for the financial sector liberalisation that preceded it. The TBTF problem and associated moral hazard have been worsened by mergers to save failing banks during the crisis and as a result competition within a number of national banking systems, notably the UK, has been significantly reduced. Solutions alternative to making the banks small enough to be allowed to fail are considered in this paper, but it is difficult to be convinced that they will deliver banks that promote the common or public good. It is argued that regulating retail banking as a utility and pooling insurance against financial instability using pre-funded deposit insurance schemes, with risk related premiums that can also serve as bank resolution funds, should be pursued; and that capital leverage ratios and/or Financial Activity Taxes might be used to ‘tax’ the size of banks.

Too Big to Fail: Causes, Consequences, and Policy Responses

Governments cannot credibly commit to eschew bailouts of creditors when large financial institutions become distressed. This too-big-to-fail (TBTF) problem distorts how markets price securities issued by TBTF firms, thus encouraging them to borrow too much and take too much risk. TBTF also encourages financial firms to grow, leading to competitive inequity and potential misallocation of credit. This review discusses evidence that such distortions are empirically relevant and also discusses the policy efforts to limit them. In the wake of the Financial Crisis of 2007–2008, it seems increased concentration in the financial industry has worsened the TBTF problem. Nevertheless, markets price the risks of large financial firms more now than before the Financial Crisis.

Triumphs and tribulations of ΛCDM, the double dark theory

AbstractΛCDM has become the standard cosmological model because its predictions agree so well with observations of the cosmic microwave background and the large‐scale structure of the universe. However ΛCDM has faced challenges on smaller scales. Some of these challenges, including the “angular momentum catastrophe” and the absence of density cusps in the centers of small galaxies, may be overcome with improvements in simulation resolution and feedback. Recent simulations appear to form realistic galaxies in agreement with observed scaling relations. Although dark matter halos start small and grow by accretion, the existence of a star‐forming band of halo masses naturally explains why the most massive galaxies have the oldest stars, a phenomenon known as known as galactic “downsizing.” The discovery of many faint galaxies in the Local Group is consistent with ΛCDM predictions, as is the increasing evidence for substructure in galaxy dark matter halos from gravitational lensing flux anomalies and gaps in cold stellar streams. However, the “too big to fail” (TBTF) problem challenges ΛCDM. It arose from analysis of the Acquarius and Via Lactea very high‐resolution ΛCDM simulations of dark matter halos like that of the Milky Way. Each simulated halo has ∼10 subhalos that were so massive and dense that they would be too big to fail to form lots of stars. The TBTF problem is that none of the observed satellite galaxies of the Milky Way or Andromeda have stars moving as fast as would be expected in these densest subhalos. This may indicate the need for a more complex theory of dark matter – or perhaps just better understanding of dark matter simulations and/or baryonic physics.

Banking for the Public Good

Bank shareholders cannot be expected to provide good stewardship to banks because there is a conflict of interests between the shareholder owners and a non-mutually owned bank’s depositors; who provide the bulk of the funds in traditional retail banking and are willing to accept a lower return on their savings than shareholders, in return for lower risk exposure. Regulation is required to protect depositors in the presence of partially funded deposit insurance schemes and taxpayers need to be protected from the resulting moral hazard under which insured banks have an incentive to take on more risk in pursuit of profit. Once some banks become ‘too big (to be allowed) to fail’ (TBTF), they enjoy additional implicit public (taxpayer) insurance that enables them to fund themselves more cheaply than smaller banks. This gives them a competitive advantage. The political influence of big banks in the US and the UK is such that they can be regarded as financial oligarchies, or autarchies that have successfully blocked far reaching structural reform in the wake of the 2007-09 Global Financial Crisis. The TBTF problem and associated moral hazard has been worsened by bank mergers of during the crisis. Alternative solutions to making the banks small enough to be allowed to fail are considered in this paper, but it is difficult to see how they will deliver banks that promote the public good. It is however argued that regulating retail banking as a utility and the pooling of insurance against financial instability should be pursued.

Systemic risks and the 'too-big-to-fail' problem'

The financial crisis of 2007–9 resulted in state intervention in financial markets around the world, and the state became a major shareholder in many banks. While state bailouts were politically sensitive, policy-makers had little alternative but to supply funds to financial institutions that were viewed as ‘too big to fail’, or TBTF. In this paper, I review the history of, and the rationale for, the TBTF policy. I argue that, from a policy perspective, the most important costs of the TBTF problem are incurred ex ante, in the form of distorted incentives that arise as a consequence of distortions to the capital markets, and to the choice of banks’ scale and scope. I argue that it is impossible credibly to withdraw the TBTF policy, and, hence, that it should be managed so as to minimize the costs of these distortions. In this context, I discuss the role of policy in institutional design, in the restriction of bank scope, and in designing appropriate capital regulations.