Solving Too Big To Fail

I have some commentary on the new Too Big To Fail resolution bill going through the Financial Services up here at The Nation, you should check it out.

A few things I didn’t get the chance to bring up.

1) Steve Waldman has an overview of financial bloggers that met with the Treasury earlier in the week. It would have been interesting to see Steve tell Treasury officials “”I’ve read your bill, and it’s terrible – no offense…too big to fail is too stupid a criteria.” Heh.

2) I’m really encouraged by this:

Representative Paul Kanjorski said today regulators should get authority to dismantle firms, preventing them from getting so big their collapse would harm the financial system. He said he is coordinating with the European Union, which is forcing asset sales by state-aided banks to limit their advantage…

Senator Richard Shelby, the top Republican on the Senate Banking Committee, said today he liked the idea.

“I don’t think anything is too-big-to-fail,” said Shelby, of Alabama. “We ought to be looking at legislation to deal with a bank beforehand if we can, or an institution that would cause systemic risk, to make it stronger, or make it smaller.”

Like most, I’m conditioned to think that bills start off great and then it’s a matter of holding on against all hope that it doesn’t get too corrupted in the political process by the time it gets to be signed. Could it be that this part of the bill might do the opposite; starting off weak and getting stronger the more people add amendments to it? I wouldn’t even know how to process that.

3) I don’t address the the capital markets shadow banking system since that’s a headache to try and shoe-horn into a paragraph, but it’s important to watch where and how a liquidity backstop for this system will be created. I worry this ‘fund’ that the bill is trying to fund through fees on the largest banks will evolve into such a backstop, at least implicitly. And the only person credible enough to do that is ultimately the taxpayer.

4) I get the impression that, in realizing “Too Interconnected To Fail” isn’t necessarily the same as “Too Big To Fail”, some people are going too far in thinking that the first is the only problem, rather than them being two problems that amplify each other.

Check out Felix’s review of a Taleb paper, in which risks grow exponentially with size. I’ll unpack this more critically next week when we talk about the debate on ‘returns to scale’ in the financial sector, but step back for a second: How much would you trust a “living will” for an entity with $100 billion in assets? $1,000 billion? For the risk quants and/or financial lawyers out there, am I wrong to be skeptical that this “living will” for large institutions will look more like a Jackson Pollock painting than a coherent roadmap of how to unwind an institution when the time comes, especially in the middle of a crisis?

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3 Responses to Solving Too Big To Fail

  1. financeguy says:

    This may be contrarian to popular sentiment, but I’m starting to worry more about the shadow banking than the TBTF problem. Everyone’s got TBTF in the crosshairs. I’m not so sure enough people understand how shadow banking works, and why it can be really dangerous. No liquidity backstop, as you note. Also the larger the shadow banking system, the less effective your monetary policy is going to be. And if you regulate the TBTF punitively (i.e., make them somehow pay for the implicit TBTF “insurance”), will that drive more players into shadow banking? And, and, and … lots of questions. I don’t think shadow banking will be a problem immediately, but soon enough complacency will set into the financial system again, risks will ramp up. I think the regulators have to sit down and figure this one out.

  2. Not the Mike You're Looking For says:

    “… am I wrong to be skeptical that this ‘living will’ for large institutions will look more like a Jackson Pollock painting than a coherent roadmap …”

    … or create a living will for a firm whose assets and liabilities are continuously changing? That’s the part that I find most mysterious.

    • Not the Mike You're Looking For says:

      Sorry, that last comment may have been confusing. I meant to express skepticism that anyone could make a workable resolution plan for a dynamic firm.

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