One goal of the Dobb-Frank Wall Street reform is to end the \"too big to fial\"

Question

One goal of the Dobb-Frank Wall Street reform is to end the "too big to fial" problem. How does it propose to do so? Why might it fail? (Bold words are options to answers).

The government’s implicit willingness to bail out the creditors of a large intermediary causes the “too big to fail” (TBTF) problem, contributing to moral hazard or adverse selection. For example, if investors believe that an institution has TBTF status, they perceive relatively less or more risk when lending to it. Thus, the TBTF intermediary can borrow at a lower or higher interest rate and take on more or less risk. Dodd-Frank could fail to eliminate TBTF if investors doubt the willingness of the government or TBTF banks to let TBTF banks fail or adopt living wills.

Dodd-Frank attempts to limit the mechanisms for government bailouts. It does this through the following means:

Instructions: You may select more than one answer of the four.

Subjects large institutions to regular stress tests.

Calls for higher capital requirements.

Limits the FDIC's guarantee powers.

Requires all banks to have living wills.

Explanation / Answer

The government’s implicit willingness to bail out the creditors of a large intermediary causes the “too big to fail” (TBTF) problem, contributing to adverse selection. For example, if investors believe that an institution has TBTF status, they perceive relatively less risk when lending to it. Thus, the TBTF intermediary can borrow at a lower interest rate and take on more risk. Dodd-Frank could fail to eliminate TBTF if investors doubt the willingness of the government to let TBTF banks fail.

Dodd-Frank attempts to limit the mechanisms for government bailouts. It does this through the following means:

Subjects large institutions to regular stress tests.

Limits the FDIC's guarantee powers.

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