If you watch daytime television, you’ll know what I’m talking about.
It doesn’t matter whether it’s Dr. Phil or Jerry Springer. The viewing public has a ceaseless fascination with the phenomena of toxic relationships.
Sex sells. Watching other people’s relationships head for the rocks keeps us from changing the channel.
Congress is no different.
Now that it has indentified what it believes are the potential toxic relationships in the financial industry, it has turned its attention to developing policies to prevent banking future train wrecks. The policy currently gaining the most traction is the notion of breaking up mega-banks before they become too big to fail.
As part of an omnibus package of bills being promoted to overhaul our financial system, U.S. Rep. Paul Kanjorski (D-PA) is sponsoring an amendment that would give the government the authority to break up financial firms that could threaten our economic stability, even if they appear healthy.
The call to limit the size of financial firms has come from several quarters. Former Federal Reserve Chairmen Alan Greenspan and Paul Volker, along with several prominent economists, have endorsed the idea.
For Greenspan in particular, this is a sharp departure from his lifelong advocacy of laissez faire financial regulation. Europeans are considering a similar move. The Fed's British counterpart, the Bank of England, recently said it would force three bailed-out giants to downsize.
Last week, a House committee voted to give regulators the power to break up large financial institutions that pose a “grave threat to the financial stability or economy of the United States.”
Comparing Two Strategies
This plan goes further than the so-called resolution authority the Obama administration has requested.
Under the White House plan, the government would be able to dismantle large companies if they were on the brink of bankruptcy and were so interconnected that their failure could cause financial disarray. That was the rationale in the government’s approach to the breakup of American International Group last year.
Kanjorski's proposal would require regulators to give special attention to the 50 largest financial institutions, those with more than $17 billion in assets. Under Kanjorski’s amendment, a forced divestiture of assets worth more than $10 billion could not take place without the Treasury secretary's approval, and a divestiture of assets of more than $100 billion would require consultation with the President.
Other influential policymakers, such as Sheila Bair, the Chair of the Federal Deposit Insurance Corporation (FDIC), have been decidedly tepid in their support for this pro-active approach to financial industry oversight. Bair’s opinion carries substantial weight with lawmakers who have lauded her for her early warnings about the dangers posed by subprime mortgages and for her aggressive actions in pushing lenders to modify loans.
Although Bair shares Kanjorski’s concern about the systemic dangers posed by these financial behemoths, she sees such early action as being problematic. From her perspective, it not simply a matter of the government being able to identify the hazards, but determining the scope of actions that should be taken to assure continued financial stability.
Unwinding a failing firm like AIG has, by anyone’s measure, been a complex equation. But it is a relatively simply exercise compared to the task of identifying and dismembering firms before they become a systemic risk.
Is Legislation Ultimate Panacea?
With AIG, the government breakup is guided by the billions in financial aid it provided to keep the company from collapsing. Under government supervision, valuable chunks of AIG have gone on the auction block to repay the taxpayers for their largesse. In the end, it’s straightforward mathematical computation.
A similar stratagem will not be possible under Kanjorski’s proposal. Kanjorski’s approach to oversight runs the risk of being far less precise and substantially more subjective.
Bair, for her part, has offered an alternative to Kanjorski’s heavy-handed approach.
The FDIC Chair has called for economic disincentives, such as higher capital requirements and fees paid into a resolution fund, to dismantle failing financial giants. The idea is that those costs would discourage firms from getting too big to fail.
Bair’s idea is sort of like the luxury tax in professional basketball. Under the NBA rules, basketball team payrolls can exceed the ceiling set by the league, but they must pay a one-for-one tax for every dollar paid to their players in excess of the salary cap.
By the same notion, if banks were forced to self-insure in a similar fashion, this may not only prevent them from growing beyond government control, but also create a ready fund from which the taxpayers can draw if one or more of these firms actually fails .
While this approach to bank oversight may be easier to implement, it will not replace the continuing need to monitor and enforce capital requirements that comport with the outstanding risk being taken by the individual banks. It may also push some American-based banks to move their operations offshore to avoid the tax.
In the end, however, if the government does not improve its oversight of bank capital reserve risk ratios, no amount of legislation, no matter how draconian, will prevent future failures.
John Cohn is a senior partner in the Globe West Financial Group based in West Los Angeles. He may be contacted at www.globewestfinancial.com
