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Beware, Taxpayers: The Days of U.S. Bank Bailouts Might Not Be Over

By , Associate Editor, Money Morning •

The U.S. government has spent more than $12 trillion to prop up large financial institutions since the 2008 financial meltdown, but more taxpayer money could still be used for U.S. bank bailouts.

A Standard & Poor's report Tuesday said that despite the government's efforts at financial reform through the Dodd-Frank Wall Street Reform and Consumer Protection Act, the U.S. Treasury, U.S. Federal Reserve and Congress could still bail out a "too-big-to-fail" bank if it felt it necessary to contain risk.

"We believe the government may try to avoid contagion and a domino effect if a Sifi [systemically important financial institution] finds itself in a financially weakened position," the S&P wrote in a research note.

S&P acknowledged that policymakers have been trying to make it clear that bank bailouts are over, but that the government's track record says otherwise.

"Time and time again, the U.S. government has found ways, many times reluctantly, to contain systemic risk and limit economic fallout when large financial institutions are on the brink of failure," said S&P.

The government bailed out U.S. financial institutions to the tune of about $700 billion through the Troubled Asset Relief Program (TARP) after the financial crisis, and distributed billions more through other programs.

After billions of dollars was handed out to banks like Goldman Sachs Group Inc. (NYSE: GS), JPMorgan Chase & Co. (NYSE: JPM) Bank of America Corp. (NYSE: BAC), and Citigroup Inc. (NYSE: C), financial firms deemed "too big to fail" only got bigger as they fed off the government subsidies. Bailouts that were supposed to be used for lending to U.S. businesses and consumers were actually put toward other investments. And many banks kept the use of bailouts a secret since they were doled out quickly in a "no strings attached" fashion.

U.S. bank bailouts also have been blamed for encouraging reckless behavior from banks that knew the government would step in with extra money if the bank got in financial trouble.

The Dodd-Frank Act attempted to end forced bailouts of "too big to fail" institutions by preventing the Fed from emergency lending to a financial institution. It gives the Federal Deposit Insurance Corp. (FDIC) the power to dismantle a failing bank and impose losses on shareholders and bondholders. The provision was intended to avoid taxpayer-funded bailouts and market-disrupting bankruptcies, like that of Lehman Bros.

But many analysts are skeptical about whether or not this "Orderly Liquidation Authority" mechanism will ever be invoked, or work as intended.

Changes to the liquidation authority are still being hammered out in Washington. The latest alteration was approved last week, giving the FDIC the power to take up to two years of Wall Street executives' pay if the compensation is found responsible for a firm's collapse.

U.S. Treasury Assistant Secretary for Financial Markets Mary Miller this week warned against making too many changes to Dodd-Frank because they could threaten the intended protection of the U.S. financial system.

"Scaling back or repealing major parts of the Dodd-Frank Act or not providing regulators with the funds they need to implement the Act will leave our economy exposed to a cycle of collapses and crises," Miller said in remarks to the Securities Industry and Financial Markets Association's (SIFMA) Regulatory Reform Summit.

Washington is still debating the specifics of the law, which was approved last July. S&P said any decisions altering the Dodd-Frank Act as it's finalized could change its views on the chances of future U.S. bank bailouts.

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