Improving the Administration’s Too Big to Fail Approach
Economics of Contempt has an excellent post up noting that the Obama administration’s proposed regulatory reforms actually do quite a bit more to deal with the “too big to fail” problem than is generally acknowledged. In particular, along with various regulatory steps, they’re asking for specific “resolution authority” over so-called “Tier-1 Financial Holding Companies. This would create a non-bankruptcy approach to dealing with insolvent big financial firms, much as the FDIC process exists for conventional banks.
But he also notes a substantial flaw in the proposal:
I think the administration makes a big mistake by requiring a separate “systemic risk” determination in order to use the proposed resolution authority for Tier 1 FHCs. This introduces needless uncertainty. Remember, a financial company is a Tier 1 FHC, by definition, if “material financial distress at the company could pose a threat to global or United States financial stability or the global or United States economy during times of economic stress.” An institution thus can’t even be a Tier 1 FHC in the first place if it doesn’t pose a systemic risk. Why require an additional, albeit slightly different, determination of “systemic risk” before the new resolution authority can be used? This will leave the market guessing as to which resolution regime — the Bankruptcy Code or the new resolution authority? — will be used to resolve a distressed Tier 1 FHC. Creditors, unsure which resolution regime will apply and thus how their claims will be treated, will be less likely extend credit at exactly the time we don’t want creditors to be pulling back from a Tier 1 FHC.
I would make the new resolution regime automatically applicable to Tier 1 FHCs. By requiring a second “systemic risk” determination, the administration is essentially saying that there are Tier 1 FHCs that can be resolved in an orderly fashion under the Bankruptcy Code as it’s currently written. You’d be hard-pressed to find any market participant who agrees with that statement (in fact, I don’t believe Tim Geithner honestly believes that statement). I continue to be confused by the insistence on a second “systemic risk” determination.
I think the real problem here isn’t that there’ll be uncertainty about whether or not the Bankruptcy Code will be used. The problem is that given policymakers clearly indicated (and correctly so) unwillingness to resolve big financial firms through bankruptcy, this seems to continue to hold the door open to future bailouts rather than actual use of the new resolution authority.
Either way, the proposal could be greatly improved by making this more automatic.
9 Responses to “Improving the Administration’s Too Big to Fail Approach”
Register
RSSLogin
Topic Cloud
ArchivesBlog RollAbout Matt YglesiasContact Me
Donate
October 21st, 2009 at 2:52 pm
This sort of chicanery in the regulatory definition of “too big to fail” should not be praised. When it’s written to be opaque and complicated, the goal is to preserve autonomy for officials, which amounts to letting industry do whatever it wants and then having the semi-legislative cover to bail out if things don’t work.
The solution to “too big to fail” is easy. Either a firm isn’t too big, or it won’t fail. So your regulation is “any firm above size X must maintain an equity:debt ratio of Y%,” i.e. high enough such that failure would never happen. That would make big banks MUCH less profitable, but that’s the whole point: you incentivize operating a financial institution at a small size so that no one failure poses systemic risk.
October 21st, 2009 at 3:11 pm
Bad picture to have directly under “too big to fail.”
Not only does Tim have a big head, he talks in Sarah Palin-like phrases, while never addressing the question.
Financial holding companies are the watering down of bank holding companies. Uncle Sam should not be propping up anyone in the nonbank financial marketplace. Let the shadow boys implode.
October 21st, 2009 at 3:16 pm
This article fails to mention the dilution of “bank holding company” regulations.
Goldman Sachs fled to the “bank holding company” safe harbor ever so briefly. They got billions in government ka-ching.
Now they’re back to the mentioned “financial holding company.” I do not want to backstop Goldman Sachs for anything. I didn’t want to the first time and surely don’t want to back up shadow bankers. Break ‘em up or let their big arses fail.
October 21st, 2009 at 3:32 pm
Is that Geithner’s real hair?
October 21st, 2009 at 3:53 pm
I can just quote myself from a prior thread:
I agree with Yves Smith that instituting a new Glass-Steagal is not sufficient. You also have to limit, if not ban, lending by commercial banks to speculative ventures – which is hard to define properly.
Outlawing CDSs, a Tobin tax, increased capital reserve requirements and international capital-flow regulations are also needed.
October 21st, 2009 at 7:29 pm
MY says:
…this seems to continue to hold the door open to future bailouts rather than actual use of the new resolution authority.
Hmmmmm… I wonder why Geithner & co. didn’t notice that flaw in their proposal?! Couldn’t possibly be because they want to ensure that when the next financial crisis hits, their BFFs at Goldman and Morgan Stanley will get bailed out again. Surely they can’t want that. After all, it’s not as though any of them expect to go back to working for Goldman after Obama leaves office.
October 21st, 2009 at 11:48 pm
I agree that the addtional systemic risk determination seems redundant, but for that very reason I have a hard time seeing there being much real world uncertainty over whether a federal regulator would prefer to exercise such resolution authority or leave it up to a bankruptcy court instead. And in fact any such uncertainty could be resolved in about a thirty second announcement anyway.
October 22nd, 2009 at 2:56 am
Outside of Nevada, most Casinos in the United States sit on “foreign land.” The section of Manhattan that Wall Street sits on might as well be “foreign land.” Wall Street finance houses self admittedly have no particular loyalty -whatsoever- to the United States of America. Many Wall Street “owners” are in fact FOREIGNERS. So called “americans” working on Wall Street repeatedly brag -LOUD AND CLEAR- that money PRECEDES everything. Alan Greenspan himself, Chairman of the Federal Reserve Board of the United States of America from 1986 until 2007, stated that his primary loyalty as was to CAPITALISM, that his duty was to serve CAPITALISM first, the United States of America second.
In many ways, one of the main functions of Wall Street serves the same function as an Indian Casino. Both allow people to gamble, and both provide state and Federal tax revenue. But there is a vast difference between the two Casinos. Theoretically and practically, an Indian Casino can never fail, and never requires a bailout, whereas our foreign based Wall Street Casino not only regularly fails but it can and does explode costing trillions in taxpayer dollars.
Reinforcing failure is dumb. Planning to continually reinforce failure in the future is even dumber, regardless of the technique. And for a Nation to reinforce the repeated failures of FOREIGN BANKS that have shown ample capacity to destroy that Nation is the single dumbest policy of any Nation in history.
Why intelligent Americans are not DEMANDING a simple, conservative, national banking system of their own -completely separate from FOREIGN BANKS- is beyond me. Americans seem to accept -actually prefer- to be ruled by FOREIGN BANKS.
And it makes no sense for a Nation, as a political entity, to voluntarily hand over almost all of its power to a small cabal of FOREIGN BANKS -to utterly give up control of its destiny.
October 22nd, 2009 at 4:09 am
Who’s that psycho-vampiric looking guy in the photo? Oh yeah right, that’s the guy who’s supposed to be helping engineer us out of this financial abyss we’ve been in. Wait, he’s one of the key figures that helped get us into this mess in the first place with all of his deeply erroneous assumptions and severe misjudgements about what sound economics looks like. What great thinking to have him in charge now! Seamless logic, gotta hand it to Obama. He knows how to pick ‘em.
Does the country get how deeply psychotic this all is? This takes the rewarding of failure to a whole other cosmic level. Truly amazing. You really wouldn’t be able to make the screwiness of the people in charge of our country up. Better than the most deranged psychedelic fiction out there.