Is Too-Big-to-Fail Over? Markets Don't Buy It, NY Fed Study Says

(Bloomberg) -- Even as Congress and the Trump administration move to ease post-crisis banking rules they say have gone too far, there's still evidence a central problem of the last crisis hasn't been fixed.

Despite the slew of regulations that were supposed to eliminate the need for government bailouts of the largest financial institutions, investors don't seem to believe they will work come next crisis, according to a new study released this week by the Federal Reserve Bank of New York.

The study found that the spread between the borrowing costs of the parent companies and their banking subsidiaries hasn't widened as they should have since new regulations put the creditors to the parent on the hook for the failure of a big bank. The same held true when looking at default insurance, the New York Fed found. The authors looked at the bond yields and credit default swaps of the four largest banks.

President Donald Trump has ordered regulators to review all post-crisis rules to see if they can be lightened to help banks do more for the U.S. economy. Senate floor debate started this week on how to roll back some portions of the 2010 Dodd-Frank Act, though the mechanism to handle a large bank failure isn't among those targeted.

Unlike bond spreads and default insurance, credit ratings of the parent companies and their banking units have diverged since 2013, the New York Fed study said. Creditors don't seem to share that view, authors of the study wrote.

“It's possible that investors are still skeptical about the new resolution tool since it has not yet been tested,” the authors concluded. It's also possible that the risk differentials are overlooked by the current "strong financial condition" of the biggest lenders, they said.

To contact the reporter on this story: Yalman Onaran in New York at yonaran@bloomberg.net.

To contact the editors responsible for this story: Michael J. Moore at mmoore55@bloomberg.net, Gregory Mott

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