In Defense of a Large Prefunded Resolution Fund

Here’s a press release from November 4th, 2009, from Luis Gutierrez: “”It’s simple: we need a plan that says the riskiest firms will pay an assessment proportionate to the risk they pose to the system…We will never be able to legislate away the financial crisis that continues to burden so many hardworking taxpayers…but we can take steps so that the riskiest financial institutions —and not the taxpayers— pay for the costs of any future crisis.”

I agree. And it was a tough fight to get a $150 billion dollar resolution authority prefund into the House bill. Pat Garofalo covered how Geithner and Treasury wasn’t interested in this idea, and that a post-fund would be fine. Now Geithner and Treasury can toss overboard something that they never wanted to appease the GOP, who won’t even be remotely appeased, and we can see this with everything else progressives fought for in the House. There were some wins on resolution authority (large prefund) and on the risk levels of the financial sector (hard 15:1 cap), that were well fought for, and are likely to go under the bus in the Senate.

So once again, here’s why I think a large resolution fund that is prefunded is better than post-funded.

The Handshake Conservatives are doing this entirely wrong. If their real worry is the moral hazard that firms would want to become systemically risky, instead of trying to appease Wall Street for fundraising purposes, then something that makes them pay insurance for crossing the threshold will cause those firms to grow larger if and only if there is real value in doing so.

The argument against this is that those firms who are too risky will be subject to such prudential regulation that the regulation and capital reserves ratios themselves will be enough to do this. But that’s not what I’m hearing in the background. Start listening for dogwhistles about the Canadian banking sector being replicated here, where the biggest financial firms shake hands with the government and are celebrated for their international competitiveness and the whole market failure and the difficult-to-impossible resolution of large concentrated firms thing is swept under the rug. If you are worried about this handshake, something that requires there to be prefunding will at least discourage as many firms from getting on the inside.

In a crisis… Here’s my real worry, and why I push for this. We don’t have a sense for how this resolution authority will work in the middle of a crisis. It might go smoothly, or it might not. But either way, adding the costs to the remaining firms will further depress their balance sheets in the middle of a downturn, further increasing the chances that it will cascade. It might not be a problem, but it might be.

It’s not fair for a firm to get insurance without having to pay for it in some way, so the idea that only the remaining firms would have to contribute into this fund is a bad one. But the idea that those that pay wouldn’t pay in the up-cycle, which would be counter-cyclical and better from a regulatory point-of-view, but instead have to add the liability to their balance sheet in the down-cycle, is the wrong way to do it. And as such, it wouldn’t surprise me if Congress wanted to pass an emergency bill picking up the tab.

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2 Responses to In Defense of a Large Prefunded Resolution Fund

  1. Pingback: Morning Must Reads: Indefatigable - Swampland - TIME.com

  2. Pingback: Gutierrez Statement About the Dissolution Fund « Rortybomb

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