Opinion: Too big to regulate?
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We’re entering the home stretch in the debate over how to overhaul the financial regulatory system, with the Senate expected to take up the proposal from Banking Committee Chairman Christopher Dodd (D-Conn.) on Wednesday or Thursday. On the other hand, that may simply be when the bill encounters its first Senate filibuster. The chamber’s 41 Republicans signed a letter last week pledging to oppose the current version of the bill, but it’s not clear whether they’ll filibuster a motion simply to begin debate.
Anyway, one of the points made by opponents of the bill is that it enshrines the notion of ‘too big to fail’ banks, all but guaranteeing future bailouts. Peter Wallison, director of economic policy at the conservative American Enterprise Institute, complained on a conference call with reporters Monday that Dodd would create a new regulatory category for financial institutions that the government deemed ‘systemically important’:
It means that if some such institution fails, it will cause some kind of financial collapse or systemic breakdown or something of that kind. Of course, as soon as you have designated an institution as systemically important … you have in effect have said that it is too big to fail.
The designation will be a huge advantage when it comes to raising capital, Wallison said, because it will assure creditors that the firm won’t be allowed to go to a garden-variety bankruptcy. Instead, he said, the government will be able to tap a $50-billion fund to ease creditors’ pain.
Wallison’s summary of the bill left out a few noteworthy details. The point behind the ‘systemically important’ designation is to identify the companies that will be subject to stricter regulation -- not exactly a a magnet for capital, which typically flows into the least regulated environments. The details of these rules would be left up to a new council of top regulators, but they could include such things as requiring more money to be kept in reserve and in liquid assets, limiting the amount of debt, requiring diversification of assets and forcing greater public disclosures. Such companies could also be required to draw up plans for how they would be dismantled if they ran into distress. And the Fed could break up a firm whose size and interconnectedness posed a threat to the financial system as a whole.
The $50-billion fund is more problematic. Although the bill would require big failing firms to be dissolved, with shareholders and unsecured creditors losing their stakes and managers losing their jobs, the $50-billion fund implies that secured creditors will have a backstop if they lend money to a systemically important company. The money -- which would come from the financial industry, not taxpayers -- won’t necessarily keep them whole, but it could narrow their losses.
Nevertheless, dispensing with an industry-financed fund means that taxpayers may be tapped if a big firm’s failure threatens to cause a devastating run on the financial system. The point, after all, is to move from a too-big-to-fail system to one that permits failures by limiting the collateral damage. It’s not too hard to imagine regulators missing the signs of another bubble down the road, one that delivers another shock to the entire system when it bursts. It’s one thing to want the companies that make imprudent bets to suffer the unmitigated consequences. It’s another to say that the industry shouldn’t put up some extra reserves to help deal with the mess that failed firms leave behind.
-- Jon Healey
