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The Public Policy
Failing Successfully
Speed bankruptcy expert Garett Jones on how to cure “too big to fail.”
(Page 2 of 3)
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?
About the Author
Joseph Lawler, former managing editor of The American Spectator, is editor of Real Clear Policy. Follow him on twitter: @josephlawler.
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Bill Hussein O'Stalin| 6.15.10 @ 6:23AM
Whenever you make plans in advance that automatically wipe out shareholder equity, you won't have any shareholders. No one with any brainpower will invest in a deal that could south behind closed doors wiping out their investment. If anything that idea will lead to less investment in banks.
The other concept of allowing debt to be turned into shares is weak. It would lead to high risk investing and probably wouldn't work anyway. Badly run banks don't turn positive overnight or realistically ever.
What's missed here is the fact that the government caused this financial crisis through central economic planning, which always fails.
Central economic planning has never worked, however it can't be done away with because politicians, promises and imprudent plans are always afoot.
As long as there is a taxpayer's dollar to be confiscated more bubbles are to come. In fact, we are headed to a health care bubble with disastrous effects, but that's another story.
ncatty| 6.15.10 @ 9:21AM
Bankruptcy is Constitutional and has been since ratification! (Article I, Section 8). Let's fashion remedies that are actually based on our Constitution, unlike TARP, EPA regulatory legislating, bailouts, etc. Keep up the good work Professor Jones!
Clinton nee Publius| 6.15.10 @ 11:49AM
The reality is that we are doing things that cannot work. Many (on the left) have opined that, like all democracies in history, America is doomed and is failing. Indeed it is on the brink of its final failure due to its own inherent corruptions that allow politicians to vote themselves the public purse.
Believe it or not, these people are right, but the die need not already be cast.
This is an "educational moment" and I would hate to deprive you of the opportunity to become participants in the ultimate free-market economy so please bear with me as I explain it.
The problem we face today is that government spending exceeds our revenues. Fiscal spending is - by definition - an unlimited activity because the people who make the decisions on spending are not made to suffer the consequences of their decisions (it doesn't come out of their pockets) so they have no reason to reduce spending.
Revenues are quite different. There are only three ways to obtain revenues: (i) gifts - and you can't think government will be financed that way; and (ii) stealing - government calls it "taxation"; and (iii) you earn it by your own labor and investments. There are no other ways. Currently, government uses taxation and taxation is a LIMITED RESOURCE. You can only tax so much before the economy grinds to a halt.
This is the heart of the problem that liberals don't realize in their words, but know in their actions - our system of fiscal finance MUST FAIL because we are using a limited resource (taxation) to address an unlimited activity (fiscal spending). Your own common sense tells you this must fail and that's how we got $13 trillion in national debt.
But the story goes a little further and we have to take a small sojourn in order to explain it all because the solution comes in how we create money for our economy and we have to understand some basic accounting to understand how currency (money) comes into existence in our economy.
Money is an asset and in the Western system of accounting, the value of assets are determined by the sum of their liabilities and equities (liabilities plus equities equals total assets). To create money, our government increases our collective liabilities (called "liability expansion") so every dollar that exists in our economy comes into existence only by virtue of being a loan that is owed to the banking industry, so there is no real wealth in our economy and this creates most of the problems we have in our economy today. Think of it like credit card debt for your family - the more credit card debt you have, the higher your credit card payments get until you can't pay anything but credit card bills and you go broke. Our economy works the same way for fiscal spending and the creation of currency.
The solution ("The Fix - Capitalism Version 2.0") is equity expansion. Now the same government that has been running up all these debts becomes our "white knight" and enters the private-sector economy to make equity investments in businesses (under controlled conditions) using new currency to buy these securities (that's how the money gets into the economy). The outcome is that our nation's "balance sheet" gets stronger each time, our currency is attached to something of real value (these equity securities) and now we create the conditions that allow us to have unlimited funding for government. The problem was a limited resource was being used to address an unlimited activity and we now have an unlimited resource addressing an unlimited activity to solve the problem.
This means that now all government spending is a "gift" to our economy and can only help it while our national debt is retired automatically without anyone suffering and government can no longer corrupt the economy or businesses, throw its weight around, take advantage of us or be taken advantage of.
In the end, this is the only solution as there are only three (3) ways to get money. You know you can't do it with gifts. You know that stealing (taxation) is a limited deal and won't work (or we'd have all $13 trillion in debt paid off). There is only one way.
Did I mention the result of this was that investment income (the money the government receives for its investment activities in the future) is what pays these bills and not a single dime of taxes. That's right - "The Fix" - ends taxation along with all the other things we don't like about government and that beats bankruptcy any day if you ask me.
dcd| 6.15.10 @ 12:37PM
You need more nuance on the taxation=stealing. Military, police, courts, roads, etc provide services that are generally considered necessary even by the more idealogical libertarians.
Charles Stevens| 6.15.10 @ 2:45PM
Your proposals deserve thoughtful consideration, and of course will raise some questions along the way, for example:
What do you suggest as "proper" (as in useful, wise, etc.) investment for government? Doesn't this get into the issue of government making decisions based solely on politics, with the effect being a crowding-out of otherwise useful investment, and subsequent market distortions?
Could one example of a "useful" government investment be the solution to 'the problem of the commons', e.g., ownership paper is issued for each specific area now designated as public land, with the intent being to make money off of capital investments, and associated protection of whatever pristine qualities made it desirable in the first place?
Clinton nee Publius | 6.16.10 @ 2:22PM
In this new system government cannot crowd-out the private-sector, cannot be defrauded and cannot distort the economy - that was the "magic" of The Fix. I call it the "Goldilocks Solution" because it allows the government to invest enough, but not too much, provide stability without distortion, prevent fraud from happening, but also prevent corruption from entering the system.
Based upon that the useful government solution for public lands is to make them private. Government ownership - with control - always results in corruption.
Dixie Pixie| 6.15.10 @ 12:57PM
Let me get this straight.
The shareholders get nothing, the bondholders get the banking company and the trigger gets pulled on the whims of the banking regulator. So a regulator can wipe out a bank for what reason?
What fool would want to buy a bank stock then.
Jerome Brick| 6.15.10 @ 2:00PM
I have a better idea. Let's go back to the Glass-Steagall days (pre 1999) when the full faith and credit of the USA stood behind the deposits of Federally insured commercial banks and nothing more. In all liklihood no shadow banking system would have evolved and the Wall Street purveyors of financial weapons of mass destruction, otherwise known as credit derivatives, would not have infected our financial system to the extent that it did.
axbucxdu| 6.15.10 @ 4:02PM
I have an even better idea: Eliminate the Fed, return to the era of Free Banking in the U.S., and force ALL consumption to synchronize with production.
For more info, consult a paper that reviewed the wildcat era by Rolnick and Weber, formerly of the Minnesota Fed.
Louis Jenkins| 6.15.10 @ 4:03PM
With all the catawallering about the banks being too big to fail- well- they will fail. There's too much debt out there for the banks to handle, and not enough (stealing) taxes being paid even if we paid every penny we made. Regardless of which side of the fence you're on you'd best get ready for a bad ride. Of course the Fed could always monitize the market, but then a bushel of money would buy you a bushel potatoes. Bad times are a coming and they're not for the faint hearted.
aware| 6.15.10 @ 7:19PM
It is not failure that government is preventing, the crappy businesses DID fail obviously! It is the consequences of failure that the State can not allow its "favored" to suffer. Who's the "robber baron" now?
No amount of "regulations" can change a rotten, money created by debt, smoke and mirrors, Wizard of Oz banking system controlled by a cartel owned central bank. To even believe that can be "reformed" is pure crack-induced fantasy.
Yosemeti Sam| 6.16.10 @ 2:54AM
" ... government ...."
Can. We. Get. Rid. Of. That. Metonymous word?
The gubberment is a SET of people!
People on medications.
People subject to venality.
People who are Leftoids.
People who border on senility.
People, some of whom are psychotic - statistically speaking.
People who are apparatchiks - closet or otherwise.
People who are general dummkopfs.
People who are bent.
Offering SOP - set of people - as a useful acronym versus the metonym 'government'.
I think SOP connotes better!
SOPs dish out - sop by the trillions, self-evidently, to preserve their capitalizing tenures in 'government'.
fdjk| 7.1.10 @ 5:08AM
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