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Journalism of Courage
In late 2008 the American government threw its weight behind its biggest financial institutions to avert a systemic meltdown. It worked. The banking crisis has largely passed,but the guarantees many of them implicit ones remain and therein may lie the seeds of another crisis. America8217;s financial system is now dominated by a few dozen firms that are assumed to be too big to fail. The danger is that they will in the coming years exploit that assumption to add leverage,girth and risk,leading to another collapse and more bail-outs.
As regulators around the world try to work out how to bombproof the financial system,dealing with the problem of 8220;too big to fail8221; is the most vexing issue. The initial response has been to prescribe thicker buffers of capital and liquidity in the hope that this will insulate banks from future crises. But this is a partial solution. Even the bigger buffers could not have prevented the worst blow-ups of the past two years. Regulators therefore need a way to unwind firms when they teeter on the brink of failure a 8220;resolution8221; regime,as it is known.
So give a welcome then to the bill that Chris Dodd,chairman of the Senate Banking Committee,unveiled this week. This doorstep of a bill deals with pretty much every aspect of finance,not just resolution. Whether it passes may well depend on a far less significant consumer financial protection agency it seeks to create; it also packs in other ideas,such as the 8220;Volcker rule8221; seeking to stop banks engaging in proprietary trading. But its resolution part deserves support.
Mr Dodd would set up a special council of regulatory chiefs,with the power to insist that any financial company that is systemically important must be regulated by the Federal Reserve,whether or not it is a bank. If a firm got into trouble,the Fed,FDIC and Treasury,with the approval of three bankruptcy judges,could then impose an 8220;orderly liquidation8221; upon it,paying off immediate dues and forcing shareholders and unsecured creditors to take losses.
To counteract the risk that these new measures are seen to increase the odds that big firms will be bailed out by the government,Mr Dodd would permit regulators to break up companies deemed to be at risk of failure and would compel big firms to put money into a resolution fund. The bill would further reduce the risk of contagion by moving derivatives trading onto clearing-houses,which would make it easier to determine firms8217; exposure to counterparties and would guarantee payment in the event of a default. Making banks carry debt that automatically suffers a loss in the event of a crisis could help,too.
Something for nothing
The bill has its flaws: the process of invoking the resolution regime is cumbersome and the penalties for size are clumsily designed. Those should be improved. But many critics seem motivated by politics. On the left,some want banks cut down to size. That is unrealistic: reducing America8217;s biggest banks to truly innocuous dimensions would mean breaking them into 12 times as many constituent pieces. On the right,critics will argue that the resolution regime and broadened Fed oversight amount to an extension of state support to large financial firms. Yet today the likes of Citigroup and JPMorgan Chase enjoy that implicit backing and give nothing in return. Above all,Mr Dodd8217;s approach is better than the status quo. If only more financial regulatory measures passed that test.
