Good News

by hilzoy

From MSNBC:

"Around Washington and Wall Street they have come to be known as TBTF — too big to fail. It's not just size, though. These companies are so far-flung, so intertwined and so precariously leveraged that a single one's collapse can create systemwide tremors that imperil the finances of millions of Americans.

With that fear in mind, the government stepped in to bail out Citigroup Inc., Bank of America Corp. and American International Group Inc. with tens of billions of public money last year.

Looking to avoid such a costly intervention, President Barack Obama's regulatory plan calls for large, interconnected companies to pay a heavy price for the systemwide risk they pose. (...)

Under the administration's proposal, companies such as Citi, Goldman Sachs and others in a broad top tier engaged in complex transactions would face stricter scrutiny and have to hold more assets and more cash as cushions against a downturn.

They also would have to anticipate their own demise, drafting detailed descriptions of how they could be dismantled quickly without causing damaging repercussions. Think of it as planning their own funerals -- and burials.

Obama's plan, in short, aims to make it far less appealing to be so big. That was the middle ground the administration sought, a step short of an outright ban on systemically risky companies. (...)

For those that qualify for top tier designation, the administration proposes a system that would dismantle them quickly if they get into financial trouble. Right now, the government has authority to step in and take down troubled banks, but not the conglomerates that pose greater risks to the economy. That lack of authority prevented the government from dissolving Bear Stearns Cos., Lehman Brothers and AIG in an orderly manner.

Under the administration's plan, the Treasury could decide to take a company swiftly through a bankruptcy-like process, appointing the Federal Deposit Insurance Corp. as a conservator or receiver. The FDIC currently now only has the authority to take over troubled banks."

This is really, really good news, if true. Lots of smaller banks have been, as Atrios says, EATED by the FDIC recently, and while I'm sure it hasn't been pleasant for them, it also hasn't had anything like the impact of, say, the demise of Lehman Bros. Having a quick procedure in place to deal with them, plus the additional capital requirements that will help smooth the process, is crucial.And making it less attractive to be big enough to pose systemic risk is also a very, very good thing.

I expect banks to be vehemently opposed to this. But this time, we should not let them win. One good long look down into the abyss has been more than enough.

Comments

[TJ]

This is really, really good news, if true.

Kind of sounds like a big nothing-burger to me. When they ask the foxes to develop a plan to orderly close down the henhouse, it doesn't bode well for us chickens.

[DaddyD]

Devil... details. Who decides, and how? Even then, will it matter in the long run?

Watch the crocodile tears of TBTF companies as they whine about Obama's oppressive new regs. Meanwhile, I have no doubt they already have teams of people already plotting how to water-down any new legislation and then circumvent whatever new rules are put in place.

Even if the new regs turn out to be well designed, here's my prediction: many years from now, things will get lax. Corporations that should be considered TBTF will slip by the radar. Think Madoff. Regs and agencies existed for Ponzie schemes such as his, and Bernie's fraud-train just kept chugging along well over a decade after people were sounding the alarm bells.

This kind of plan would only come from the minds of those who loath the idea of any real fundamental change. This is a concept designed to minimally impact the "free market" by allowing those companies to essentially keep doing whatever they had been doing, with the bulk of the burden of making things "safer" falling upon the government. But, as I pointed out above, our government has already shown it isn't up to the task.

[Mark]

What I want to know is why they keep letting these entities get bigger. Capitol One just bought out Chevy Chase Bank, which I imagine is one of the largest regional banks in the country, and is a dominant traditional bank in the DC area. We have antitrust laws on the books to prevent banks and other companies from getting too big to fail, or so big that they have too much market power. Why do we never enforce these rules in the banking sector?

There is clear evidence of anticompetitive practice in banking. Banks no longer compete on price, i.e. providing a service at a cheaper rate than competitors. The whole process works in reverse - when one bank invents a new fee every other bank jumps on board. In a competitive market, the banks would resist charging these fees in order to steal customers from other banks. Yet we allow them to get bigger and bigger so they can gouge us more and more and generate more risk for the financial system.

[russell]

don't know if the fed is the right agency to have this responsibility or not, but somebody damned well ought to have it.

failure is never an impossibility, so "too big to fail" simply means "too big". no need to wait for outright failure to break them up and sell off the parts.

[Fledermaus]

The problem is this plan will never be passed as described. The TBTFs have a strangle hold on legislation, they were able to pass a law giving them $700B in less than 7 days with no strings. A bill like that one would be DOA or stripped of all theeth with well meaning non-binding ponies

[Fred]

There is a need for something to address the problem of hugeness. But the solution offered makes things too tempting for any corruption that might be in the government.

Somebody from the Fed or whatever drops by and says "Pay me or I'll dismantle you" and a mere million is easy to cover up.

Imagine if the feds decide your blog is too big.

And the judgments are too subjective. Some ivy-league Treasury official or banker may decide that the women or ethnics or blacks who run a particular bank don't seem trustworthy. It could even be a subconscious error, if you don't look like the reliable bankers of yore...

[The Crafty Trilobite]

Hilzoy, how could the government enforce such a law? You would need an expensive audit to even begin the assessment process. I agree with DaddyO that the enforcement budget for something like this would be first on the chopping block in any budget cut or Republican administration. Also, as we saw with Enron, the first step in a major collapse is very often fraud -- so the audit and review may be based on cooked books in the first place, or books that are useless by the time the plan actually gets used.

Even if the business and the government came to the review honestly, though, how could anyone really evaluate whether the dismantling plan was adequate? Enforcement before failure would be based on speculation, enforcement after failure would be useless.

In a familiar sequence (see Sarbanes-Oxley), the assigned agency would be pressured by industry to give it 'guidance,' resulting in ever-more epicyclic rules and forms, which would be blindly used to prove the plan was adequate. Meanwhile, actual problems not on the form would be ignored. We would employ a lot of bureaucrats and compliance personnel on useless paper. Worse then useless, in fact, because once the plan was in place, corporate interest groups (management, equity holders', union, and powerful debt holders) would distort income and expense allocation to serve their interests in the event the plan was implemented.

The only way this might actually solve the problem would be as part of a real-time, full-time government supervision of the giant companies' activities -- basically, a commissar or fascist/corporatist system. Not a good idea.

I agree with russell, break the d**mn things up. We don't need 'em that big.

Fred, the "proposed solution" in which somebody from the government drops by to dismantle you is the Sherman Antitrust Act. The corruption preventing enforcement of that Act has usually been more systemic and less particular than you describe -- the DOJ adopted unduly persmissive standards because of industry lobbying.

Not sure what your point is about a 'too big' blog, since blogs are generally not profit-making enterprises and cannot conceivably monopolize the internet or cause harm when they fold.

There is always some room for subjective judgment about trustworthiness, but the FTC, OSS et al. have to show that a bank meets a lot of fairly rigid formulas before they put it into receivership, precisely to prevent the sort of problem you describe.

[russell]

"And the judgments are too subjective."

Some very useful judgements can be made which are not in the least subjective.

For example: from 1933 until 1999 a bank could not operate as both a commercial and an investment bank.

Easy peasy.

It ain't that hard, there's just too much money on the table so we won't do it.

When a blog gets big enough that it can demand $700 billion or it will turn off the lights on the economy of the entire freaking world, we can take a look at regulating the financial operations of blogs.

Give us 5% of the whole damned GDP of the nation or we'll burn the whole house down.

That deserves some attention.

[Marty]

"Some very useful judgements can be made which are not in the least subjective.

For example: from 1933 until 1999 a bank could not operate as both a commercial and an investment bank."

Exactly, very easy. Although interstate banking was a convenience it also allowed risk to be consolidated.

[Gary Farber]

"Even if the business and the government came to the review honestly, though, how could anyone really evaluate whether the dismantling plan was adequate?"

We have a history of anti-monopoly laws since Teddy Roosevelt.

Most laws are administered imperfectly, but we have them anyway.

[Marty]

"Even if the business and the government came to the review honestly, though, how could anyone really evaluate whether the dismantling plan was adequate? Enforcement before failure would be based on speculation, enforcement after failure would be useless."

I had to think about this for a while.

Enforcement before failure is not speculation. Reviewing a financial institutions balance sheet is complex but not speculative. Any business with a negative balance sheet and inadequate credit facilities should be subject to enforcement.
In most cases this precedes failure.

If it does not precede failure, there is still the capability to distribute the assets in an orderly way, while recognizing the legitimate heirarchy of claims against those assets.

The government has the mechanisms and experience to manage this activity. There have been 52 bank failures this year, most people have not heard of any of them due to the efficiency of the FDIC.

[The Crafty Trilobite]

Marty, I agree that the FDIC (when given adequate budget and authority) is good at reading financial reports, and at operating a bank in receivership. But how would it go about evaluating a liquidation plan that would go into effect only after a presently-unknown series of events causes a failure? Especially since the huge mega-institutions this proposal is aimed at have so many moving parts -- how could anyone predict which divisions would still be there to liquidate after a meltdown? By definition, a meltdown is something you don't see coming.

Even if it could be done, it seems like it would require as much money and information as making the plan in the first place -- so shouldn't the FDIC demand the information and make the plan in the first place rather than duplicate the effort?

[Marty]

"so shouldn't the FDIC demand the information and make the plan in the first place rather than duplicate the effort?"

Absolutely, while I disagree that a meltdown is unpredictable, I agree that the plan should be in place. I think the separation of commercial and investment banks should be done before any of this. Investment banks should be vastly more capitalized, commercial banks probably less.

[CAMP]

There is no need for institutions of this size. If incentives were properly aligned then the government could let any bank fail. But it would not need to do so. As long as Investment Banks are partnerships the partners/owners act as the brakes on excess leverage since they can judge the soundness of the investment portfolio. The countries that do not allow publicly traded private equity funds and investment banks did not have the problems from a collapse in leverage. The government should disallow regulatory arbitrage. If you borrow short and lend long you are a bank. If you take deposits you are in a special category, and require regulatory oversight by the FDIC and must hold additional capital. There really isn't anything new since 1825 in banking. The old regs served the country well for 60 years. Goldman should be a partnership. The monster that Ken Lewis cobbled together should be de-fanged. The country might be able to run prudently at a higher gearing than 10x leverage, but we are not likely to get back to 40x leverage, nor should we want to. GS wins and the rest of us lose.