Speed bankruptcy expert Garett Jones on how to cure “too big to fail.”
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Yes, sure the resolution authority gives them the power to take banks over and sell off bits and pieces, and it gives the government the power to borrow some money on good collateral to keep the company running for a few weeks. So maybe that’s enough of a safety blanket to allow the government to say, “OK, we’ll resolve a failing bank next time. We caved last time but maybe we’ll do it this time.”
I just can’t tell. This really is about predicting what people are going to do when the next crisis hits. It’s ultimately going to be voter rage that prevents us from having another bailout, not some piece of legislation.
Does that mean that, for instance, it was a waste of time to have that recent heated debate in the Senate over whether the resolution authority should get $50 billion in funding up front from the banks, with Republicans calling it a “permanent bailout” and Democrats defending it? Was that a meaningful argument?
Not really. No, I think that was a lot of sound and fury. Fifty billion dollars was a nice big round number that Republicans could get mad at. I can’t imagine it really rattled financial markets that much to learn that they weren’t going to have the $50 billion supposed slush fund to play around with, because the government will have unlimited authority to borrow as long as they can say they’re using the banks’ good assets as collateral.
For an example, Citigroup right now, I’m guessing, has at least a trillion dollars in assets that a judge would say was good collateral. Half of Citigroup probably looks OK on paper. Fifty billion dollars is only one-twentieth of that. Clearly there’s plenty of authority for government borrowing built into the current resolution authority. As it would have to be! The government would have to hold Citi for a week while it dismantled it. It’s got to have the authority to go and do some borrowing, even if just for a week.
The real question is whether we are building a system where, after a couple of days or maybe a couple of weeks, we’ve decided that the bondholders, the people that have actually lent money to the bank, are going to lose money. What we’ve done instead is created a world where every single big bank in the country is Fannie Mae and Freddie Mac. Nobody’s writing it on paper, nobody’s saying in public that these bonds are guaranteed by the government, but everybody knows deep down that they really are.
If you’re a big financial institution you know you’re too big to fail. You know you’re basically like Fannie and Freddie in that you can issue debt that is not openly, but implicitly guaranteed by the government. Just like Greek debt is implicitly guaranteed by the French and German governments right now.
If the current Senate bill had been law in September of 2008, would things have shaken out differently?
No, I think that regulators would have been terrified and would have said, “We can’t let anybody lose money here.” They would have said, “A lot of Citigroup’s bonds are owned by Chase. A lot of Chase’s bonds are owned by Bank of America. A lot of Bank of America’s loans are owned by Wells Fargo. They’re all connected.” They would have said, “We can’t cancel any of these debts. We can’t tell any of these people they’re not going to get their money paid because the whole structure might come down.”
I think that claim is wrong, and I think it’s a fear that makes them unwilling to use anything that looks like normal bankruptcy. They feel like everybody who’s dived into the firms so far needs to get everything back, or else the whole system might collapse. That’s really what they’re afraid of. They’re afraid that if anybody loses, if anyone out there gets repaid only 80 cents or 90 cents on the dollar, that the whole economic system could collapse. They’re really afraid of someone out there losing a dime or a nickel on the dollar. They’re going to find one way or another to tell the American people that we’re going to have bailouts again.
We saw this happen with the money market funds. One fund in September of 2008 broke the buck. Reserve Primary Fund said, “Oh, we only have enough to repay our depositors 98, 99 cents on the dollar, we’re sorry.” And all of a sudden the feds came in and guaranteed them. Losing 5 cents on the dollar — that was enough to make the entire financial world panic. This is after stocks had declined 20 percent. People really do feel differently about bonds and bank deposits than they do about stocks. Politicians just don’t seem willing to embrace bankruptcy on a wide scale.
Has that always been the case? Or was it a product of insufficient regulation regarding bailouts during the Bush years?
I think it’s a pattern. Bailouts for massive firms are a grand American tradition. Usually they’re only involved in politically connected fields. Or, they’re banks. Citi had a backdoor bailout during the Latin American financial crisis. Many Wall Street firms got bailed out during the Long Term Capital Management Crisis. And then, Bear Stearns got bailed out in the spring of 2008. We saw this pattern of bailouts. We would need something pretty big to break that pattern, I think.
Basically, when the next crisis comes around, a little law on the books isn’t going to be enough to prevent a panicked Congress from either passing their own law or going to the Fed and saying, “Please buy up shares or bonds, or whatever, from distressed firms.” So this is really a political commitment problem. This is really a problem of getting politicians to make a commitment and to keep a promise. That’s pretty hard to do.
One argument we’ve heard often recently is that the financial crisis was at least in part caused by the emergence of a “shadow banking” sector that went completely unregulated. Was the problem really a political commitment problem, or was it a problem of an outdated regulatory system?
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