Bair on ending “too-big-to-fail”
FDIC Chairwoman Sheila Bair is right now testifying in front of the Senate Banking Committee on “establishing a framework for systemic risk regulation.” This is of course hugely important. How do we end “too-big-to-fail?” And how do we resolve failures that are so big they pose a systemic risk?
There’s so much valuable stuff in this testimony, readers should really see all of it. To help you get through all 30 pages, I’ve highlighted key passages and provided commentary (in pink italics…I didn’t choose pink, btw, Scribd just read my formatting that way!).
Bair clearly knows what’s wrong with the system, and she articulates it more clearly than any other policymaker in Washington. She really does want to put the screws to big banks in order to end too-big-to-fail. She would do so by establishing a Financial Services Oversight Council to, among other things “actively control” leverage. She would also beef up resolution authority so policymakers could wind down bloated behemoths like Citi.
Right now they can’t resolve anything. Regulators’ choice is between bankruptcy and taxpayer-funded life support. Bankruptcies don’t work with systemically important institutions. This we learned from Lehman. Taxpayer subsidies only allow failed companies to keep operating on the public dime. Neither is desirable.
My chief worry in what she’s proposing is that whoever ends up becoming the systemic risk regulator may not have the same cojones she does. Who’s to say they will actually put the screws to the firms being regulated?
If they don’t, its sheer presence may backfire, especially if–as she proposes–there’s an “insurance fund” backing its resolution authority. Private market players will then misinterpret the systemic risk regulator as an implicit government guarantee that protects them from risk. Exhibit A is OFHEO with Fannie and Freddie. Exhibit B is FDIC itself and its Deposit Insurance Fund. Investors and/or depositors in these federally-backed institutions take MORE risk that creates BIGGER systemic problems than if there was a credible possibility they’d eat their own losses.
All of this would be much easier if the Fed just exercised its authority over bank reserve requirements. Requiring banks to hold significantly more capital in reserve, and preventing them from hiding risk off their balance sheets, would solve just about every problem we face.
(For ease of reading, click on the top right button to toggle to full screen. If that doesn’t work, click on the link at the top to go directly to Scribd.)