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Fixing 'Too Big To Fail'

Fixing 'Too Big To Fail'

A proposed set of US financial regulations aims to prevent a repeat of the 2008 financial collapse. Will they work?

U.S. congressional lawmakers are considering a controversial slate of reforms for the nation's largest institutions. The proposed legislation aims to prevent so-called 'too big to fail' enterprises that analysts say could have the ability to damage or bring down the U.S. financial system.

One of the ideas coming out of the House Financial Services Committee is to set up an oversight panel that would identify and monitor "too big to fail" mega-companies, such as Bank of America, insurance giant AIG and automaker General Motors. It will not be an easy task.

"It will be a series of yardsticks that have to do with their assets and liabilities," says economist and National contributor John Maggs, "and the relationship between those two."

Fixing 'Too Big To Fail'
Fixing 'Too Big To Fail'

The largest institutions, worth tens of billions of dollars, may be asked to contribute to a federal "dissolution fund" that would be used for potential future financial firm bailouts. Additionally, the largest firms may be asked to keep more money in their reserves.

Another idea under consideration gives regulators the ability to dismantle large financial groups that may be in trouble or are on the verge of collapse, such as happened to Lehman Brothers and insurer American International Group.

Fixing 'Too Big To Fail'
Fixing 'Too Big To Fail'

"Think of it as a kind of bankruptcy process for financial firms," says Maggs. "There was no such procedure in place during the financial crises, so they were making it up as they went along."

Not everyone is on board with this proposal. "My personal belief is the breaking up of corporations is a very difficult thing to do," notes Ken Rubin, senior partner with London's PA Consulting firm. "How does the government know what to break up, and why? Because the minute you set that threshold, every business will get one notch below that threshold, and therefore you probably shouldn't have done it in the first place."

Gary Burtless of the Brookings Institution agrees it would be difficult for a government panel to determine a line between firms that are merely large, and those that are "too big to fail." But he says, governments have accomplished far more difficult tasks.

"It's conceivable for the national government to restrict the size of the largest financial institutions so that they're much smaller than they currently are. I just don't think it will happen politically."

In the proposed House of Representatives bill, the costs of dismantling failed financial firms would come first from the assets of the firm, and from the federal dissolution fund if necessary. "So when an institution does indeed make risky bets that go bad," says Burtless, "the equity owners in the bank are going to accept a bigger percentage of the losses than was the case in 2007 and 2008."

Economist John Maggs sums it up differently. "In short, the purpose of this reform plan is to give the government more leverage," he says.

Fixing 'Too Big To Fail'
Fixing 'Too Big To Fail'

Even with such new regulations, fending off another U.S. financial crisis may still be a challenge. Says the Brookings Institution's Gary Burtless: "What will not change is the huge financial stake that big banks have in regulations. They will still be making large contributions to people running for political office. They will be make large contributions to the people who sit in crucial positions in the legislature."

In the end, whatever new regulations may get passed, Ken Rubin of PA Consulting notes that economics - and economists - will find a way to adapt. "I have no doubt that whatever regulation the smartest government regulators can write, markets will find a way to adjust."

The financial reform legislation has moved to the Senate and whatever its fate in that chamber. Whatever its fate, the Obama Adminstration has already made it clear it will be keeping a much closer eye on the activities of Wall Street.

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