'Too Big to Fail' is simply TOO BIG to exist!

As I have been advocating for months now on my blog and in phones calls and letters to Congressional contacts, some of the Obama administration’s most resistant regulators and economists – such as Tim Geithner and Larry Summers – in recent weeks have finally conceded that the administration’s financial and regulatory reforms do not go far enough to prevent future financial catastrophe, and have been needlessly “industry-friendly.”  Consequently, in Congressional testimony this week, Geithener, following the lead of courageous reformers on ‘too big to fail’ (TBTF) policy such as former Fed Chair, Paul Volcker – an advisor to President Obama and a vocal proponent of de-coupling banks from investment firms; along with others whom I have also written about like Sheila Bair, Elizabeth Warren and the resurgent former New York Governor, Eliot Spitzer – the Obama administration economic policymakers now say that the government should consider breaking up the biggest banks and investment firms long before they fail, or at least impose stricter limits on their risky trading activities — steps that Mr. Obama himself continues to resist.

US Rep (I-VT) Bernard Sanders, Sept 2008 

By comparison, our friends across the pond seem to have their priorities in order.  The City of London’s top financial regulator, Adair Turner, Chair of the UK’s Financial Services Authority is adamant that banks and investment houses in Britain must bolster their capital ratio standards and put employee needs before addressing executive bonuses and compensation.  More on this topic here.

However, comparisons aside, Congress is leading on this issue and the Obama administration has finally endorsed aggressive ‘too big to fail’ reforms.  The House Financial Servies committee is about to take up one of the most fundamental issues that precipitated the near collapse of the global financial system last year, and seriously put at risk the financial health of our economy — namely, how to deal with ‘too big to fail’  companies such as AIG, Goldman Sachs and Bank of America.  These are banks and financial corporations that are so big, and so central to the operation of the nation’s economy and financial system that the government has no choice but to rescue them when they fail operationally or get into balance sheet trouble due to poor management or highly risky practices driven by greed and profits.  Congressman Barney Frank (D- MA),  Chair of the powerful House Financial Services Committee, has said his committee would take up more aggressive legislation on the topic, even as lawmakers and regulators continue working on other problems highlighted by the financial crisis, including overseeing executive pay, protecting consumers, pushing for stronger shareholder rights, and regulating the trading of risky derivatives.  Channeling the public mood and outrage over the huge taxpayer bailout of the financial industry, Rep. Frank’s recent observation that critics of the administration’s health care proposal had misdirected their concerns — and that Congress would now be adopting “death panels” not for infirmed people, but rather for gravely infirmed “zombie banks” and struggling major corporations.

The administration and its Congressional allies are trying, in essence, to graft the process used to resolve the troubles of smaller commercial banks onto both large banking holding companies and non-bank investment firms and financial services companies whose troubles could again threaten to undermine the markets, as well as the overall national economy.  By using this strategy, the administration has signaled its willingness to sign on to any such legislation that reaches the presidents desk.

I think someone was listening, after all. . .

Read more here. . .

 Web Resources:

Too Big to Fail, by Andrew Ross Sorkin

Too Big to Fail, in plain English Video

‘Too Big to Fail’?  Politico.com

Robert Reich on ‘Too Big To Fail’

AIG Executives have been given huge bonuses with taxpayer money, and everyone is furious. AIG claims that they have contractual obligations which predate the largest private sector bailout in history. Politicians say these obligations are secondary to satisfying taxpayers who are keeping them above water. Pundits, smelling blood in the water, have come out in force to grind their axes with issues ranging from from the outrage of international capital mobility to defenses of laissez-faire capitalism unfettered by government intervention. Everyone has taken this as an opportunity to hop up on the soap box.

Sen. Charles Grassley (R-IA) says:

“I would suggest the first thing that would make me feel a little better toward them [AIG executives] is if they follow the Japanese example and come before the American people and take that deep bow and say, ‘I am sorry,’ and then either do one of two things: resign or go commit suicide, and in the case of the Japanese, they usually commit suicide.”

Here’s the story behind the noise, as I see it.

What Did AIG Do Wrong?

Over the last several years, they sold lots and lots of Credit Default Swaps, without putting up any collateral. They weren’t required to put up collateral because they were Triple A rated by Moody’s and S&P. They were Triple A rated because they are an enormous, old company with a sound business model: selling insurance. They weren’t re-rated when they started CDS’s because the CDS’s appeared to be a small part of their overall business. They appeared to be a small part of the balance sheet because accounting standards were differently applied than they were to other sorts of insurance. It also seems likely that the ratings agencies were complicit. Accounting standards were uneven due to the same piece of legislation, the Commodity Futures Modernization Act, which allowed the Enron fiasco to happen.

Who’s to blame here? AIG, the ratings agencies, regulators, independent accountants and risk managers, not to mention the actual buyers of these massive quantities of CDS’s all seem to have more or less culpability. Essentially everyone. AIG was just the first to crack.

So Why Did The Feds Bail Them Out?

In early September AIG finally got downgraded by the ratings agencies, and it became immediately clear that they did not have the funds to back up their obligations. Now, the preposterous CDS system collapsing due to AIG’s default would itself have been terrible, but AIG is also a normal insurer, responsible for a variety of commercial and industrial insurance and reinsurance which are vital for the continued functioning of the global economy. The bailout gave the U.S. government 80% control over the company, rendered the stock virtually worthless, and charged a punitive interest rate of 8.5% plus LIBOR (About 10% total right now.) That is an inescapable debt if ever one existed. It was never intended to keep the company afloat indefinitely, merely manage the continuity of its obligations while it was dissolved in an orderly fashion.

So How Can We Let Them Steal Our Money Like That?

Continuity of obligations is a key concept here. Just like AIG is obliged to pay you if you get in a car accident or your supertanker sinks, they are likewise obliged to pay the bonuses they agreed to last year. Because, for reasons that are unclear, proper bankruptcy proceedings have not been initiated, and having not officially entered into receivership, their obligations are still valid, both internal and external.

And that’s the question I haven’t seen any of the grandstanding politicians have even pretended to try to answer. Why hasn’t this been handled as a dissolution? Why is AIG still allowed to behave as though it’s a going concern? There was a legal, systematic way to go about fixing this, and it was not pursued. That’s a shame, because if Obama and Geithner personally reach in now and grab the checks out of the hands of the executives, it will damage the sanctity of legal structure in a way that will take a long time to repair. It will also, in its own way, reflect an idea of executive privilege comparable to the Bush Presidency, the abolition of which was one of Obama’s campaign promises.

It is not the role of the executive branch to ride roughshod over private sector contracts, taking money from the wicked and giving it to the virtuous. So as much as I hate to see the greedy, stupid executives of AIG profit off of the misery they helped to create, at present I don’t see any better alternative. Suggestions?