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Obama's Too Big to Fail Rules Too Late to Matter

by Deadman 7/6/2009 - 6:33 pm   |

The AP has posted an article detailing Obama's new regulatory plan that would if enacted impose serious penalties on financial institutions when they get too large.

Although there aren't many specifics in the article about what those disincentives would be or exactly how the government would define 'too big', this is a much-needed step back on the road to financial sobriety. We should never as an economy or a country be held hostage to the failings of one single entity.

As deeply as I hated all of the bailouts we've been throwing around to woefully (borderline criminally, in my opinion) mismanaged institutions like Citigroup and AIG, I do believe their balance sheets may have been so enormous, their footprints and obligations so intertwined in the world economy, that their failure could have crippled the entire foundation of our credit-based system and brought it to its knees.

Yet don't be fooled - our problems didn't lie with any one or two entities, but with the entire system. What we had instead was a complete failure by the market as a whole - and even more damning, by the regulators in charge of watching those markets - to recognize the emerging credit/debt/mortgage bubbles whose eventual bursting forced this country to its day of reckoning.

A law breaking up large financial institutions or disincentivizing them from forming in the first place will help make future problems easier to spot and solve, perhaps, but it won't by itself save us from our own worst behavior.

And it will do very little if anything to impact our current situation and economic crisis.

In fact, the most ironic thing about the Obama plan is that the entity which may now be most accurately considered 'too big to fail' is our own U.S. government, which through actions taken by the Fed and the Treasury has taken on much of the bad debt and obligations (and added a bunch of new ones) that will be stifling our economy for years to come.

We can only hope that the Chinese and other foreign governments continue to agree that the U.S. government is indeed too big to fail and allow us the time to work through our issues and restore some amount of fiscal and monetary discipline without cutting off their support in one fell swoop.

Great post, D. The government being too big to fail is point is pithy. It's good to have you back on the economy watch.

Now that the immediate peril of complete financial collapse has lessened, I'm warming up to austerity measures. But how to do it? A health care program will inflict real cost, at least in the near term, so where can we get some savings? The Iraq withdrawal will help, but that will be offset by additional operations in Afghanistan. Repealing the Bush tax cuts is critical, and if the economy recovers, there will also be higher tax revenues. But I doubt that these changes will be sufficient to put the U.S. on a sound footing, especially as the baby boomers retire. The only two massive government programs besides health care are social security and the military. I suspect that either will be incredibly difficult to reduce for political reasons, as would raising additional taxes. So where does that leave us?

Second, what can we do to enforce future discipline? That is, even if Obama and Congress manage to reduce our debt a bit, how do we keep a future government (Republican or Democratic) from putting us right back where we started, as G.W. did after Clinton. It's nice to talk about changing our culture, but how does one go about it?

by Genghis 7/6/2009 - 7:13 pm
Really, the reason the government couldn't allow AIG to die was that no legal authority existed to manage its bankruptcy. It wasn't a bank, so it didn't fall under FDIC rules. Moreover, the FDIC doesn't even have enough people today to cover the small and regional banks that are failing. So IMHO, the most significant thing about the report from AP is the idea that big financial institutions would have to prepare a kind of "last will and testament" to manage their assets in the event they fail.
by Matt Osborne (not verified) 7/7/2009 - 1:19 am

Thanks for that comment, Matt, and welcome to dagblog, but i don't really buy that excuse about the government lacking legal authority to handle AIG for one second. The Fed/Treasury, in their attempt to combat the credit/mortgage crisis, have done all sorts of things that have had zero precedent and bordered on the 'do they have the authority' line? I do think that trying to allowing AIG to go bankrupt or even trying to take it into receivership and extricate it from all of its counterparty obligations and transactions would have been the straw that broke our credit system's back.

i agree that the rules being discussed by the obama admin seem eminently reasonable in that they don't outright ban financial companies of a certain size but are requiring a fair amount of added regulations and precautions to make it more unlikely a financial insitutition will find it profitable to get too big.

but like i said, if the system as a whole engages in dangerous speculation, it's very unlikely one or two large companies will be the main culprits.

by Deadman 7/7/2009 - 2:32 am (re: Matt Osborne)

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