Commentary by David Reilly
August 6, 2009
SourceAug. 7 (Bloomberg) -- Political drama over how to regulate the financial industry, replete with an f-bomb-filled rant from Treasury Secretary Timothy Geithner, has obscured a huge unresolved issue: what to do about too-big-to-fail financial institutions.
If anything, questions surrounding these institutions -- banks, insurers, brokers, and who knows what else -- have grown. This leaves a big question mark hanging over a vast swath of the financial system.
Not only has the government failed to figure out how to treat these companies during a crisis, it can’t decide how to handle them during normal times. Should these firms keep their current shape, be broken up, or put on a tight leash and turned into financial utilities?
Instead of receiving answers, investors are watching political turf battles. That led to a Wall Street Journal story about Geithner’s expletive-filled blast during a meeting last week with financial regulators such as Federal Reserve Chairman Ben Bernanke, Federal Deposit Insurance Corp. Chairman Sheila Bair and Securities and Exchange Commission Chairman Mary Schapiro.
In the meantime, it’s Christmas every day for the too-big- to fail crowd, with taxpayers playing Santa Claus. Just look at interest expenses that have been halved at banks like Citigroup Inc., thanks to loan guarantees and zero-percent interest rates, or the 46 $100-million-plus trading days racked up by Goldman Sachs Group Inc. in the second quarter.
‘Vicious Circle’
“The notion of too big to fail creates a vicious circle that needs to be broken,” the FDIC’s Bair said earlier this week during a Senate Banking Committee hearing. “Today, shareholders and creditors of large financial firms rationally have every incentive to take excessive risk. They enjoy all the upside but their downside is capped at their investment, and with too big to fail, the government even backstops that.”
She added, “Too big to fail must end.”
Great sentiment. Too bad the government can’t provide the simplest answers to help us reach that goal. Take the question of what exactly is a too-big-to-fail firm and how many exist.
No one is willing to say with specificity. Sure, we know the group must include the big four banks: JPMorgan Chase & Co., Bank of America Corp., Citigroup and Wells Fargo & Co. Goldman and Morgan Stanley would also make the cut.
Maybe insurer American International Group Inc. and mortgage giants Fannie Mae and Freddie Mac belong to this club. Then again, they’re already owned by the government.
Bernanke’s Guess
Do we include quasi-financial firms like General Electric Co. or Berkshire Hathaway Inc.? Is Warren Buffett too big to fail?
During a hearing of the House Financial Services Committee last month, Bernanke was asked to come up with a number. “A very rough guess would be about 25,” he replied without elaborating.
Wow. Twenty-five is a scary big number. The more too-big- to-fail companies there are, the tougher it will be for the government to rein them in. After all, there is lobbying strength in numbers, not to mention a wider source of campaign contributions.
And what makes an institution too big to fail? The key might be the size of its deposits relative to the FDIC’s insurance fund. Maybe the critical thing is the company’s exposure to the $600 trillion over-the-counter derivatives market. Another yardstick might be the system-wide reach of firms like custodian banks State Street Corp. and Bank of New York Mellon Corp.
Need to Know
If nothing else, knowing who these firms are and why they are on the list would allow investors to monitor their performance and better assess their value.
If, for example, Berkshire Hathaway is on the list, insuring against default at that company probably shouldn’t cost more than twice as much as buying protection through credit- default swaps on JPMorgan.
The bigger issue is that policy makers can’t decide how to deal with these firms if they don’t know what the phrase means. Nor can firms understand how to leave this club.
“If the definition of systemic risk is sufficiently loose, companies can find ways around the definition, become too big to fail without being defined as too big to fail,” Senator Robert Bennett said during the hearing.
Of course, such gaming would be more likely if being too big to fail stigmatized firms. As things now stand, it doesn’t.
Being too big to fail today is a license to print money. It is something to aspire to -- who wouldn’t want to make money like Goldman Sachs? And, since there are so many members of this club, the real danger is being left out of it.
That’s not the way it should work. The too-big-to-fail question needs to take center stage and get sorted out soon.
Otherwise Treasury Secretary Geithner and the rest of us really will have reason to curse.
(David Reilly is a Bloomberg News columnist. The opinions expressed are his own.)
To contact the writer of this column: David Reilly at
dreilly14@bloomberg.netLast Updated: August 6, 2009 21:01 EDT