Liberty Street Economics

« | Main | »

March 5, 2018

Did the Dodd‑Frank Act End ‘Too Big to Fail’?

LSE_Did the Dodd-Frank Act End ‘Too Big to Fail’?

One goal of the Dodd-Frank Act of 2010 was to end “too big to fail.” Toward that goal, the Act required systemically important financial institutions to submit detailed plans for an orderly resolution (“living wills”) and authorized the FDIC to create an alternative resolution procedure. In response, the FDIC has developed a “single point of entry” (SPOE) strategy, under which healthy parent companies bear the losses of their failing subsidiaries. Since SPOE makes the parent company responsible for subsidiaries’ losses, we would expect that parents have become riskier, relative to their subsidiaries, since the announcement of the SPOE strategy in December 2013. Do bond raters and investors share this view?

SPOE through the Lenses of Rating Agencies

Below we plot the gap in ratings (parent minus subsidiary) by Fitch, Moody’s, and Standard & Poor’s (S&P) for the four largest bank holding companies (BHC) by assets.

Did the Dodd-Frank Act End ‘Too Big to Fail’?

The rating gap has widened for all four banks at all three rating agencies, suggesting raters perceive that SPOE has increased the risk of the parent relative to that of its subsidiary bank. This widening gap coincides with announcements by Moody’s, Fitch, and S&P that SPOE has reduced the expectation of government support for these four BHCs in the event of failure.

Do Financial Markets Share Rating Agencies’ Views?

To answer that question, we first look at how spreads have evolved for a matched pair of bonds—one issued by the parent and one by its bank subsidiary. If bond investors agree that SPOE has made the parent riskier, we should see the parent’s option-adjusted spread (OAS) widen relative to that of the subsidiary bank. Contrary to our hypothesis, and the views of rating agencies, the chart below shows that the spread gap has not widened consistently for three of the four holding companies; for the fourth, Bank of America, it has actually narrowed. Nor did the difference in spreads widen noticeably after each of the agencies started to increase the rating gap between parent companies and their bank subsidiaries (points in time marked by vertical lines).

Did the Dodd-Frank Act End ‘Too Big to Fail’?

This finding might reflect certain frictions in the bond market—illiquidity or market segmentation, for example. However, we also observe a similar result in the credit default swap (CDS) market, as reflected in the chart below. The difference in CDS spreads (parent minus subsidiary) has not increased persistently since the SPOE was announced. A temporary increase in this difference emerged in July 2016, but that gap has since closed. Overall, we do not see the kind of persistent increase in the difference in spreads that would support the rating agencies’ view that parent companies have become riskier relative to their subsidiaries.

LSE_Differences in CDS Spreads: Parent Minus Bank Subsidiary

Did the Dodd-Frank Act end “too big to fail”? In a pair of blog posts published in 2015, we argued that, at the time, bond and CDS markets and rating agencies did not agree on the answer to that question. The updated evidence in this post suggests that there remains a difference of opinion on the effectiveness of the SPOE. It’s possible that investors are still skeptical about the new resolution tool since it has not yet been tested. It’s also possible that bond markets’ perceptions of risk differences between parent and subsidiary banks are concealed by the generally strong financial condition of the four institutions that we consider. Nonetheless, the absence of a market response is notable.


The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.

Gara Afonso
Gara Afonso is a research officer in the Federal Reserve Bank of New York’s Research and Statistics Group.

Michael Blank
Michael Blank is a senior research analyst in the Bank’s Research and Statistics Group.

João Santos
João A.C. Santos is a senior vice president in the Bank’s Research and Statistics Group

How to cite this blog post:

Gara Afonso, Michael Blank, and João A.C. Santos, “Did the Dodd-Frank Act End ‘Too Big to Fail’?,” Federal Reserve Bank of New York Liberty Street Economics (blog), March 5, 2018, .


Feed You can follow this conversation by subscribing to the comment feed for this post.

Wilson: Thanks for your comment. While liquidity in the bond market may be an issue (though it is unclear in which way it would bias our results), we obtain a similar conclusion when we rely on CDS spreads. As for the data request, we are not at liberty to share proprietary data, but it can be accessed via subscription to Bloomberg and Markit.

Hi: this is an interesting topic, but the outcome looks different from other work i’ve seen. I wonder if this is affected by the small/ illiquid outstandings of bank level debt. Is your data available? kind regards, wilson

Cornelius: Thank you for reading our post and for your comments. To the extent that there was a “subsidy,” the widening in the rating gap could be a sign of its reduction, consistent with rating agencies’ announcements of a decline in their expectation of government support in the event of financial distress/failure. However, the absence of a similar widening in bond and CDS spreads is not consistent with such a reduction. It would be interesting to extend the analysis to the next tier of institutions, as you suggest, but data availability limits our ability to implement this idea.

Greetings– Thanks for this research. There is much talk of the TBTF “subsidy” enjoyed by several banks and BHCs. The subsidy is a main component of pending legislation addressing the TBTF problem. (H.R. 493) I’d be interested in what the authors (and others) say about whether their analysis helps in determining the existence or the magnitude of the subsidy. Perhaps for contrast an identical study should be conducted for the next tier of non-TBTF banks and BHCs. With appreciation. CKH

The comments to this entry are closed.

About the Blog

Liberty Street Economics features insight and analysis from New York Fed economists working at the intersection of research and policy. Launched in 2011, the blog takes its name from the Bank’s headquarters at 33 Liberty Street in Manhattan’s Financial District.

The editors are Michael Fleming, Andrew Haughwout, Thomas Klitgaard, and Asani Sarkar, all economists in the Bank’s Research Group.

Liberty Street Economics does not publish new posts during the blackout periods surrounding Federal Open Market Committee meetings.

The views expressed are those of the authors, and do not necessarily reflect the position of the New York Fed or the Federal Reserve System.

Economic Research Tracker

Image of NYFED Economic Research Tracker Icon Liberty Street Economics is available on the iPhone® and iPad® and can be customized by economic research topic or economist.

Economic Inequality

image of inequality icons for the Economic Inequality: A Research Series

This ongoing Liberty Street Economics series analyzes disparities in economic and policy outcomes by race, gender, age, region, income, and other factors.

Most Read this Year

Comment Guidelines


We encourage your comments and queries on our posts and will publish them (below the post) subject to the following guidelines:

Please be brief: Comments are limited to 1,500 characters.

Please be aware: Comments submitted shortly before or during the FOMC blackout may not be published until after the blackout.

Please be relevant: Comments are moderated and will not appear until they have been reviewed to ensure that they are substantive and clearly related to the topic of the post.

Please be respectful: We reserve the right not to post any comment, and will not post comments that are abusive, harassing, obscene, or commercial in nature. No notice will be given regarding whether a submission will or will
not be posted.‎

Comments with links: Please do not include any links in your comment, even if you feel the links will contribute to the discussion. Comments with links will not be posted.

Send Us Feedback

Disclosure Policy

The LSE editors ask authors submitting a post to the blog to confirm that they have no conflicts of interest as defined by the American Economic Association in its Disclosure Policy. If an author has sources of financial support or other interests that could be perceived as influencing the research presented in the post, we disclose that fact in a statement prepared by the author and appended to the author information at the end of the post. If the author has no such interests to disclose, no statement is provided. Note, however, that we do indicate in all cases if a data vendor or other party has a right to review a post.