Still too big to fail

. . . and too big to regulate.  JP Morgan Chase, Goldman Sachs, Morgan Stanley, and seven other megabanks got permission from the Obama Administration to repay their combined $68 billion in TARP debt to the government.  The government made a profit on the loans, and the banks are now out from the under the thumb of the TARP restrictions on executive pay and hiring.  Win-win, right?

Well, no, not for the taxpayers who are still implicitly on the hook for these ten behemoths should anything go wrong.  They are no more regulated than they were before the crisis, and there is no FDIC-like resolution system in place that would allow for the orderly failure of these financial supermarkets should they become insolvent (again?).   It would be rational for their managers to conclude that the institutions are still “too big to fail” and to return to reckless decision-making a la “heads I win, tails the taxpayers lose.”  Today’s Financial Times has an excellent editorial on the matter.   Wish I’d written it myself; the next best thing is to cut and paste most of it here:

‘ . . . letting the banks out of Tarp at this point was premature. Supposedly weaned off public support, the 10 had to demonstrate they could raise funds without government guarantees. The temporary liquidity guarantee programme, however, remains available to them. In effect subsidised by the government, but freed from Tarp rules on compensation and hiring, they can poach both staff and business from competitors still in Tarp. This is more regulatory discrimination than it is restitution of market discipline. Even worse is that, for these 10, Tarp has been terminated without addressing the problem that it was supposed to stave off. That problem – or so many thought in the chaos that followed Lehman Brothers’ collapse – was that some banks are too big to be allowed to fail, lest they drag the whole financial system down with them.

‘This fundamental situation has not changed. The stress tests of the largest banks – now looking rather lenient – and the demand that some of them raise additional capital were designed to make failure less likely; they did nothing to make failure less intolerable to the public interest. A bank that was too large to fail in October is still too large to fail now, should another market freeze-up occur. These walking systemic dangers have every reason to restart their risky hunt for yield.

‘There is much to criticise about the government’s use of Tarp to influence the banks. But returning to the status quo ante is no remedy. Tim Geithner, Treasury secretary, should first have secured the promised special resolution regime for bank holding companies. Only then would exits from Tarp have sent the right signal to the market: that the released banks were now free to fail.’

The administration’s best excuse might be that political realities made it prohibitively difficult to keep these banks under the TARP restrictions any longer (though they’d have a stronger hand to play here if they hadn’t meddled with the GM and Chrysler bankruptcies) and that they do plan to get sweeping financial regulation passed as soon as possible, which presumably will include a resolution regime for financial institutions that are not subject to FDIC shutdowns.  (Alas, the FT‘s John Gapper rates the prospect of simple and effective regulatory reform as “frustratingly low.”)

But it ain’t much of an excuse.  As Kansas City Fed President Thomas Hoenig eloquently explained a few months ago, “too big” has failed.  At the very least, the administration could have combined its announcement of acceptance of repayment with a clarion call for a special resolution regime that would end the “too big to fail” policy once and for all.

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2 Responses to “Still too big to fail”

  1. bill Says:

    so if these banks are now out of the woods in terms of regulation and are still too big to fail, they could mess up in a similar fashion. The gov’t would have to bail them out again to avoid another Leahman Brothers collapse which helped put the economy into overwhelming strain….could this be the start of zombie banks in the long run?

  2. Ranjit Says:

    Hi Bill – Yeah, that’s what it looks like, unless effective regulation/oversight or a special resolution or a special resolution regime for insolvent bank holding companies can be put in place soon.

    I suppose the administration didn’t have much choice, as those banks got a clean bill of health from Geithner’s (possibly too-easy) stress tests. It’s hard to rationalize saying no to a “healthy” bank who wants to give the taxpayers their money back (even if it might be demanding a much bigger bailout down the road).

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