Dealing with those 'too big to fail'

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Tuesday, November 03, 2009

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In the ideal world of economics, firms that take excessive risks go bankrupt, their competitors pick up the pieces and the economy marches on.

Some call it “creative destruction.” In the real world, certain financial institutions are so big and so interconnected that their collapse — no matter how richly deserved — threatens plain old destructive destruction. Government steps in, with taxpayer money, to prevent that.

The problem of “too big to fail” is at the heart of the current crisis, in a double sense. Despite government disavowals, the perception that the feds would bail out the likes of Bear Stearns or Fannie Mae permitted such firms to pile on risk. Once the downward spiral began, the Federal Reserve and Treasury, armed with uncertain legal authority, faced a series of ad hoc choices as to which institutions to bail out and how.

Draft legislation before the House Financial Services Committee, which the Obama administration supports, rests on the assumption that too-big-to-fail is not only a reality but one that should be acknowledged in law. It seeks to designate certain institutions, including banks and major players in the “shadow banking” sector, as eligible for government-led winding-down in a crisis.

In return for that security, they would face tighter regulation and higher capital requirements. Among the bill’s novel concepts is making financial institutions pay into a common fund to shore up failed giants, so taxpayers don’t have to.

While it is logical to admit the reality of too-big-to-fail, it is difficult to create the right mix of preventive incentives. For example: Should institutions pay into the insurance fund before one of them collapses, or after? Sheila Bair, chairman of the Federal Deposit Insurance Corp., favors the former, so the government won’t have to squeeze Wall Street in the middle of a panic. Treasury Secretary Timothy Geithner favors the latter, so that institutions have an incentive to stay out of trouble in the first place.

The Federal Reserve would take a bigger role in policing strategic institutions. This will make good use of the Fed’s expertise and independence — unless it erodes both by exposing the central bank to constant lobbying.

When it comes to solving the dilemma of too-big-to-fail, no one has a certain template — and all participants in the coming debate would be well-advised to remember that.

(This editorial originally appeared in the Washington Post.)

5 comment(s)

freeport56 wrote on Nov 3, 2009 7:10 AM:

" Let them fail! That gets rid of the dead weight and those that cannot compete. "

tripnote wrote on Nov 3, 2009 9:11 AM:

" Too big to fail is a ridiculous premise.
If a "too big to fail" failure happens, the government is there to back them up.
The greater oversight aka regulation will raise operating costs of the institution, therefore pricing them out of the competitive market.
So what's next then big brother, subsidies to then make the mega corp competitive again? Loans that are forgiven, congressional pork…

The cycle continues.

Let them fail, without big brother as a safety net they won't be taking substantial risk. "

PlasticPinkFlamingo wrote on Nov 3, 2009 9:39 AM:

" Any corporation that thinks it is too big to fail deserves to fail. Any corporation that the government thinks is too big to fail deserves to fail. It might be temporarily painful, but all that business doesn't just disappear - it has to go somewhere and new entrepreneurs will step in. New businesses will be started, new jobs created to replace those lost. The greedy perpetrators will be (and should be) the losers.

The very idea that government must sustain an unsustainable business is ridiculous in the extreme, so much so that only facists and socialists could possibly believe it to be a good idea.

We need a better attitude towards small and medium sized businesses. They are the ones who will lead a recovery and provide jobs. Unfortunately this administration loves its big business connections and despises Main Street (since they are usually conservative to independent and cannot be relied on to vote for leftist politicians). That is why we keep getting these phony "the economy has recovered" media messages, yet the truth is that jobs continue to be lost. As long as jobs are lost and unemployment remains high there cannot be a real recovery.

Until small and medium business turns around, we will continue to be in this Democrat recession and unemployment will remain high. Until the real engine of our economy gets stared again, all this administration propaganda that the economy has recovered will be merely attempts to ride herd on the voter sheep. Ignore this false propaganda until you can get a job - that's how you will know the economy is improving.

It's the jobs, stupid (to paraphrase Bill Clinton). "

Little Lord Fauntleroy wrote on Nov 3, 2009 9:46 AM:

" freeport, YES! let them fail. Then the government can assume control of all the US financial markets. I didn't realize you were a socialist too "

steph wrote on Nov 3, 2009 1:15 PM:

" They can fail before we taxpayers are forced to empty our wallets into their salaries and failed systems, OR, they can fail afterward, leaving us with the bill--with bankrupt schools and reduced police forces, and crumbling roads.

Someone is getting fat off the taxpayers' backs. "

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