Too Big to Fail: Let's Hope It's Just a Movie
HBO announced last week that it will release Too Big to Fail on May 23rd. The film will be must viewing for anyone who wants to revisit the financial crisis and couldn't read (or even lift) Andrew Ross Sorkin's 2.15-lb book of the same title. Right now the key questions are whether William Hurt really looks like Hank Paulson or Paul Giamatti like Ben Bernanke. (For my money: sort of, with the right haircut, and not at all, not even with the beard.) But what you really ought to worry about is whether the film will turn out to be a dramatization of the 2008 disaster or a prequel to the next one.
You might think that any lawmaker who can read a poll would make sure that taxpayers would never have to bail out the world's richest banks ever again. That was, after all, a key goal of the Dodd-Frank financial reform act. Hank Paulson's successor, Timothy Geithner (playing himself in Congressional testimony), explicitly promised that Dodd-Frank's "reforms will end 'too big to fail.'"
Actually, rather than ending the doctrine that launched a global financial crisis, the Dodd-Frank reforms make TBTF the law of the land and invite a sequel to 2008. I'm not the first to point this out. Smarter people than I, ranging from conservatives like Dallas Fed President Richard Fisher and American Enterprise Institute economist Peter Wallison to liberals like MIT economist Simon Johnson and Nobel laureate Joseph Stiglitz fought this aspect of Dodd Frank. Wallison calls it a "mad policy," and warns, "We've seen this movie before." He's talking about the $73 billion bailout of Fannie Mae and Freddie Mac, not HBO.
During the crisis, it was clear that Fannie & Freddie (along with AIG, Citibank and others) were so financially entangled that their failure might have brought down the whole house of cards. Hurt and Giama-er, Paulson and Bernanke-and the rest had no choice but to bail the behemoths out. But that doesn't mean a taxpayer rescue is the only possible course. Indeed the most obvious way to avoid the same situation is to break bloated banks into smaller, less dangerous entities. That's what reformers did in the 1930s, and the U.S. went 70 years without another financial meltdown. "If a bank is too big to fail," says Stiglitz. "It's too big." It seems so simple when you put it that way.
Instead of breaking up banks, however, Dodd-Frank separates them into "systemically important" ones--those with more than $50 billion in assets-- and everyone else. The systemically important firms have to submit to tougher scrutiny and stiffer capital requirements, both of which will make them safer, all else being equal.
Of course, all else is never equal. Inevitably, "systemically important" will come to mean "too big to fail" or, in other words, "protected by Uncle Sam." Banks enjoying the Fed's implied backing have a huge advantage over smaller rivals. Since creditors know Uncle Sam will bail them out, they'll lend to big banks at lower rates than to smaller ones --insuring that the big only get bigger and riskier to the rest of us. According to Johnson, big banks already can borrow for about three quarter of a percentage point less than smaller competitors. And they now control even more of the country's banking assets than they did before the crisis.
True, the law gives regulators broad powers to rein in big banks that take too much risk, and to wind them down if they do get into trouble. But the whole edifice depends on regulators doing what they couldn't seem to do before the crisis: To understand the risks that horrifically complex global financial institutions are taking (and may be doing their utmost to hide), to anticipate the onset of a crisis, to coordinate responses with regulators in other countries, and to avoid being won over by the firms they regulate.
It is, of course, possible that, starting now, the bureaucrats manning our regulatory agencies will find themselves graced with perfect wisdom, foresight, global coordination and restraint. But I wouldn't count on it. What do you think this is, a movie?
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