Too Big to Fail, Again

Simon Johnson makes the point that it may be time for another stress test for the largest banks. The last one was largely a farce--for the reasons another one may be necessary now. Several of the big banks (Bank of America, in particular) may have outstanding exposures to the mortgage market that were not recognized in the first stress test. Some of these banks (Bank of America, in particular) are already in a precarious capital position. It's likely that few people anticipated that we would be faced with a looming "too big to fail" crisis this soon after the last one. The likelihood that major banks will have to buy back a significant portion of the mortgages they originated (thereby increasing their capital requirements) is high enough that hedge funds have begun to buy up depreciated mortgage paper. They expect that they will be able to put much of it back to the originating banks at par. In the financial reform bill, the Republicans shot down a proposal that would have created a fund financed by the banking system that could have been used if the worst occurred. They falsely labeled it as a bail out of too big to fail banks. Now we may looking at the prospect of the largest bank in the country facing insufficient capital with few options remaining for the government.