David Wessel has a column in today’s Wall Street Journal laying out three approaches to solving our Too Big Too Fail (TBTF) problem. The first two amount to different ways of “busting them up,” as Wessel puts it. The third, which the administration and the Fed have endorsed, amounts to forcing banks to hold more capital, scrutinizing their balance sheets more vigorously, and obtaining some sort of “resolution authority.” That last reform would allow the government to liquidate a megabank in an orderly way (like the FDIC does with smaller banks), rather than either bail them out entirely or simply let them implode, a la Lehman Brothers.
I happen to support every one of the administration’s proposals on this score. But, despite their merits, I’m not convinced they address the consequences of bigness. For that, we probably do have to talk about shrinkage.
To see why, you need to start with what the TBTF problem actually is, which Wessel helpfully explains:
Investors who lend to or trade with these firms, for good reason, believe taxpayers will stand behind the debt of TBTF firms if things go bad. So, these firms can borrow more cheaply than too-small-to-save firms. That taxpayer subsidy -- and that's what it is -- means these institutions can make riskier bets, collecting rewards if they win and sticking taxpayers with the tab if they don't.
This is an old problem. But the rescues of Bear Stearns and American International Group and the uproar over the Lehman Brothers bankruptcy have expanded it beyond ordinary big banks. The past year has established a pattern: Executives of TBTF firms may be fired and their shareholders squeezed, but bondholders and trading counterparties will be protected.
The administration proposal that gets at this problem most directly is resolution authority. As I understand it, the key part of the proposal is to require banks to have a so-called "living will"--basically a road map that would guide the government on how to value and unwind all the assets on the bank’s balance sheet.
For anyone interested in debating where the economy and financial system stand a year after the Lehman collapse, TNR is hosting a conference on the subject this coming Monday, September 14, at the Willard Hotel in Washington. We've got a real murderer's row of speakers and panelists lined up--Rep. Barney Frank, Commodity Futures Trading Commission Chairman Gary Gensler, The Wall Street Journal's David Wessel, hedge fund manager (and TNR investor) Bill Ackman, former New York Gov. Eliot Spitzer, among them.
Exciting news from inside TNR: We just got Gary Gensler, chairman of the CFTC, to join our roster of dignitaries and pacemakers for our event on the current state of the economy. Gensler will tangle with Barney Frank, Eliot Spitzer, Christina Romer, Andrew Cuomo, Bill Ackman, David Wessel, and others on some of the most important questions facing the nation: How have we handled the financial collapse thus far? What could have we done better, and what can we do better still?
