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October 27th, 2009

White House Proposes More Authority Over “Too Big to Fail”

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A White House official has said that Barney Frank, chairman of the House Financial Services Committee, will introduce legislation as early as this week designed to tackle what the New York Times refers to as “one of the most fundamental issues stemming from the near collapse of the financial system last year:” institutions deemed “too big to fail.”

The legislation would be an alteration to an existing White House strategy on how to deal with some of the nation’s largest financial firms:

The measure would make it easier for the government to seize control of troubled financial institutions, throw out management, wipe out the shareholders and change the terms of existing loans held by the institution.

Setting up the equivalent of living wills for corporations, that plan would require that they come up with their own procedure to be disentangled in the event of a crisis, a plan that administration officials say ought to be made public in advance.

“These changes will impose market discipline on the largest and most interconnected companies,” said Michael S. Barr, assistant Treasury secretary for financial institutions. One of the biggest changes the plan would make, he said, is that instead of being controlled by creditors, the process is controlled by the government.

Lawmakers claim that the increased government authority of banking and non-banking institutions is designed to prevent costly taxpayer bailouts and wind downs of failing companies (see Lehman Brothers).

However, while the masses agree that something needs to be done to regulate these “too big to fail” institutions, investors on Wall Street don’t like the idea of being kicked to the curb:

“Of course you want to set up a system where an institution dreads the day it happens because management gets whacked, shareholders get whacked and the board gets whacked,” said Edward L. Yingling, president of the American Bankers Association. “But you don’t want to create a system that raises great uncertainty and changes what institutions, risk management executives and lawyers are used to.”

T. Timothy Ryan, the president of the Securities Industry and Financial Markets Association, said the market crisis exposed that “there was a failure in the statutory framework for the resolution of large, interconnected firms and everyone knows that.” But he added that many institutions on Wall Street were concerned that the administration’s plan would remove many of the bankruptcy protections given to lenders of large institutions.

How inclined will the private market be to invest in nation’s large banks (which offer credit to thousands of Americans) if they’re faced with the chance of never being paid back? This proposal could make permanent changes to long-standing (and existing) contracts between lender and institution.

We see two possible negative consequences to Washington’s current proposal to dealing with the “too big to fails”: one, lending costs could rise if big banks can’t readily find lenders, and two, this seems like another opportunity for Washington to cement their foothold in the banking industry.

As Mr. Ryan stated, there is a failure in the framework of how we deal with these “large, interconnected firms,” but this may not be the best strategy to solve it.

What do you think — is Washington going for too much control of the baking industry?

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2 Responses to “White House Proposes More Authority Over “Too Big to Fail””

  1. Esko Kiuru Says: October 27th, 2009 at 3:39 pm

    Tim,

    Most observers do agree that “too big to fail” has to be taken seriously. Something needs to be done to remove the possibility of last year’s implosion coming to revisit our financial system again. Debate is raging over what exactly should be done. Here’s one idea. Reinstall Glass-Steagall. It worked for decades and it would do so again.

  2. Tim Manni Says: October 27th, 2009 at 4:19 pm

    Hey Esko,

    I agree, TBTF must be addressed!

    Your idea of reinstating Glass-Steagall got me thinking (dangerous, I know). I won’t claim that I did extensive research by any measure, but, on Wikipedia (I know, I know) of all places, I found four points that were supposedly written in favor of keeping the act alive. Despite its source, I think you’ll find these points particularly interesting (#3 in partic.):

    The argument for preserving Glass-Steagall (as written in 1987):

    1. Conflicts of interest characterize the granting of credit — lending — and the use of credit — investing — by the same entity, which led to abuses that originally produced the Act.

    2. Depository institutions possess enormous financial power, by virtue of their control of other people’s money; its extent must be limited to ensure soundness and competition in the market for funds, whether loans or investments.

    3. Securities activities can be risky, leading to enormous losses. Such losses could threaten the integrity of deposits. In turn, the Government insures deposits and could be required to pay large sums if depository institutions were to collapse as the result of securities losses.

    4. Depository institutions are supposed to be managed to limit risk. Their managers thus may not be conditioned to operate prudently in more speculative securities businesses. An example is the crash of real estate investment trusts sponsored by bank holding companies (in the 1970s and 1980s).

    Just some food for thought…good hearing from you, thanks,
    Tim

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HSH.com's daily blog focuses on the latest developments in the mortgage and housing markets. Our mission is to relate how changes in mortgage rates and housing policy, as well as the latest financial news, impacts consumers, homebuyers and industry insiders alike. Our 30-plus years of experience in the mortgage industry gives us an edge as we break down the latest changes in an ever-changing market.

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Tim Manni is the Managing Editor of HSH.com and the author of their daily blog, which concentrates on the latest developments in the mortgage and housing markets.

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