fresh voices from the front lines of change







Last week, Federal Chairman Ben Bernanke finally acknowledged that his preferred “solution” for ending Too-Big-To-Fail is likely unworkable. When the financial crisis exploded in 2008, top Fed and Treasury officials insisted that they did not have the legal authority to shut down faltering megabanks, leaving them no choice but to resort to massive bailouts. At a critical hearing last week, many of those same officials acknowledged that in at least one case, policymakers had plenty of authority, and actually went to extreme lengths to sidestep it in order to provide a bailout. Even Bernanke now seems to believe that we can expect the same insanity when the next crisis hits.

Bernanke has spent the past two years fighting efforts to break up the largest U.S. financial behemoths. Instead of downsizing dangerous banks, Bernanke, along with Treasury Secretary Timothy Geithner and other figures in the administration pushed to create a new “resolution authority” that allows regulators to unwind megabanks when they fail.

The FDIC has had this authority over boring commercial banks for decades, and it has worked very well, even through the crash of 2008. When these banks get into trouble, the FDIC wipes out their shareholders, kicks out their executives and liquidates the bank without much trouble. The trick is, these commercial banks are usually relatively small, with simple lines of business all housed in the United States. Last week, Bernanke acknowledged that Wall Street megabanks are different. Even when armed with the technical legal authority to shut them down, regulators will be extraordinarily reluctant to actually pull the trigger.

“Let me just be clear: this is not going to be easy to implement,” Bernanke said. “I think the one area that’s going to take a lot of effort is the international element.”

The resolution authority is a U.S. law, but the big Wall Street banks operate all over the globe, making it extremely difficult to coordinate the their liquidation. Former IMF Chief Economist Simon Johnson has been emphasizing this point for years, and has been ignored by Bernanke and Geithner as they insisted a resolution authority would end Too-Big-To-Fail. Now that Congress has adopted their plan, Bernanke wants to emphasize that it will be extremely difficult to actually use:

“One of the banks that we supervise has offices in 109 countries, each one with its own bankruptcy code and its own rules and so on.”

What’s more, the FDIC’s resolution authority doesn’t even work on simple, commercial banks if they’re big enough. Bernanke should understand this, since it was the Fed who pushed to bailout Wachovia when that bank teetered on the verge of collapse in 2008. The Fed official who demanded that Wachovia be spared was none other than Timothy Geithner, who was heading the New York Fed at the time.

Last week’s hearings detailed the bailout negotiations between Geithner and FDIC Chairman Sheila Bair that took place in late September, shortly after Lehman Brothers filed for bankruptcy. Bair wanted to simply shut down Wachovia and limit losses for taxpayers, while Geithner wanted to spare losses for the bank’s investors. Ultimately, bair relented to Geithner’s demands, declaring a “systemic risk exemption” to the FDIC’s ordinary procedures and arranging a merger that would make sure Wachovia’s creditors didn’t lose a dime, while the Treasury Department altered a decades-old tax rule in order to funnel billions of dollars to Wachovia’s shareholders.

It’s conceivable that Bair was actually right about the Wachovia bailout—it may have been unnecessary. But whether she was right or wrong about liquidating Wachovia doesn’t really matter so far as public policy is concerned. In the Wachovia episode, policymakers were too concerned about the prospective fallout from the bank’s failure to roll the dice and let the bank go down—even though they had a proven, codified, decades-old process for doing just that.

Resolution authority works very well with small, simple institutions. And it turns out that small, simple institutions work better than bloated financial behemoths. There is no economic evidence—absolutely none—that megabanks provide any economic benefits that cannot be provided by smaller banks. Our economy doesn’t need the massive banks that caused the worst recession since the Great Depression.

The Wall Street reform bill that Congress passed this summer codified several useful new policies. But the top official at the Federal Reserve just emphasized to the public that the job is not finished. Too-Big-To-Fail lives on, and breaking up the banks is the only way to kill it.

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