Liberty Street Economics – New York Fed – First in a two-part series, Gara Afonso and João Santos: “Did the Dodd-Frank Act end ‘‘too-big-to-fail’’ (TBTF)? In this series of two posts, we look at this question through the lens of rating agencies and financial markets. Today we begin by discussing rating agencies’ views on this topic. The belief that very large banks may be too big to let fail appears to date back to the demise of Continental Illinois Bank in 1984. Continental, then the seventh largest bank in the United States by deposits, experienced deposit runs following news of significant loan losses. Concerns that Continental’s failure might topple other banks led regulators to take the unprecedented step of protecting even uninsured investors, including large depositors, bond holders, and the shareholders of Continental’s holding company.  In the financial crisis beginning in late 2007, the U.S. government provided liquidity and capital support to some of the largest U.S. financial institutions out of concern that a potential failure would threaten the entire financial system. A problem with such support is that it engenders expectations of future support that could motivate further increases in size to preserve or gain too-big-to-fail status. Moreover, when market participants expect institutions to receive support, they underprice their risk which invites excessive risk-taking (moral hazard) and pressures competing firms to do likewise. To address TBTF, the Dodd-Frank Act requires the Federal Reserve to impose enhanced prudential standards for the largest bank holding companies, and introduces new resolution mechanisms to deal with large financial institutions in distress. Large, systemically important financial institutions must now submit to the Fed and the Federal Deposit Insurance Corporation (FDIC) resolution plans (“living wills”) that detail their plan for rapid and orderly resolution under the U.S. Bankruptcy Code in the event of failure. In addition, Title II of the Dodd-Frank Act authorizes the FDIC to wind down financial companies whose resolution under ordinary bankruptcy law might destabilize the financial system. The FDIC has developed a “single point of entry” (SPOE) strategy (discussed below) for implementing its Orderly Liquidation Authority (OLA) for resolving large financial companies…”