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The "too big to fail" genie has found a new way out of the bottle, and the battle to put it back is under way.
The debate has always been a crude, inaccurate distillation, but it is no doubt true that some financial entities have always existed in a separate realm in which sudden implosion is not an option.
Admission to this group has been about size only to the extent that it speaks to some larger truth about systemic risk. The Federal Reserve Board's decision to orchestrate — and support — Bear Stearns Cos.' rescue was a clear articulation that such risks extend beyond insured depositories.
"Whatever anyone thought they knew about 'too big to fail' is no longer relevant," said E. Wayne Rushton, special adviser to the chairman and chief executive at Promontory Financial Group LLC and a former chief national bank examiner.
Congress last addressed the issue in 1991 with the Federal Deposit Insurance Corp. Insurance Act, which detailed when and how the government could rescue a key depository institution.
The 1998 collapse of Long-Term Capital Management is perhaps a tangential chapter in this story, mostly because the Fed intervened in resolving the problem but did not put taxpayers' assets at risk.
That is what makes the Fed's Bear Stearns-inspired machinations so shocking for some former regulators. "The apparatus that Congress put in place for banks was not used," said William Isaac, a former FDIC chairman.
Though the Fed clearly extended the federal safety net to a nondepository institution, it remains easy to spot the fundamental "too big to fail" precepts in its actions: The risk is systemic, and the solution is stability.
"Although we assumed some risk in this transaction, that risk is modest in comparison to the risk of very substantial damage to the financial system and the economy as a whole that would have accompanied default," Timothy Geithner, the president of the Federal Reserve Bank of New York, said in a speech Monday at the Economic Club of New York.
He also used the speech to repeat his defense of the rescue.
"We did this with great reluctance, and only because it was the only feasible option available to avert default, and because we did not believe we had the ability to contain the damage that would have been caused by default," Mr. Geithner said. "Our actions were guided by the same general principles that have governed Fed action in crises over the years. There was an acute risk to the stability of the system."
By ensuring equity holders took a huge loss, the Fed can advance the argument that it dampened the problem of moral hazard, but that conveniently ignores the fact that the institution's many counterparties and debtholders might see a bit more freedom.
Still, the decision about which institutions must not collapse has evolved, and federal law may need to evolve with it.
The Fed's orchestration of the Bear buyout "underscores the lack of a playbook — there is an unevenness there [between commercial and investment banks], and taxpayer money is put at risk," said FDIC Chairman Sheila Bair. "We need a process for determining what 'systemic' is for all major institutions, not just commercial banks. We need some mechanism for resolving an investment bank."
Her recommendations include requiring investment banks to meet minimum leveraged capital ratios and subjecting them to Prompt Correction Action rules, which impose stiffer penalties as capital dwindles.
Capitol Hill must mandate such moves.
"We don't know what the rules are now. Would we do the same for a large insurance company? How about a hedge fund? Where do we stop with this?" Mr. Isaac asked. "There are a lot of questions that need to be answered here, and I think Congress has to answer them."
The problem, of course, is that markets will not wait for Congress to figure out what to do.
Given the tenuous state of the financial markets and an increasingly shaky economy, it is easy to see a crisis of confidence playing out at another major financial company.
The Fed may have been surprised by some of criticism it has received for saving Bear from collapse, the "too big to fail" doctrine survives. The only questions remain what they always were — who is it that must not fail, and what can regulators do to stop it?
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Proof of a Double Standard
The Bear Stearns bailout validated what all community bankers already knew — that there is a regulatory double standard in the finanical services arena.
We have two classes of financial institutions — "too big to fail/punish" and "too small to save/and are punished to the max". While the Fed may tout that the Bear shareholders took major losses (but still salvaged some value from nothing), community bank shareholders in a failed institution are totally wiped out, and in many cases, pursued by Federal regulators for additional money from their personal accounts!
In addition, the customers and counterparties of the 'too big to fail' institutions are not affected, while the customers of 'too small to save' institutions face possible loss of funds and repudiation of contracts.
And the treatment of senior managers is telling. The CEO/and senior officers of a failed community bank are many times barred from banking for life, and personally pursued by Federal regulators for damages — not to mention ruined reputations.
The CEO's/senior officers of "TBTF/TBTP" institutions that become unstable because of unsound practices (and require bailouts or recapitalization) walk away with millions in their pockets, no personal regulatory orders and are not pursued by Federal regulators.
It is time that Federal regulatory authorities publicly admit that we have a double regulatory standard of enforcement, and begin to deal with the implications of such a system. The inequitable treatment among institutions is likely to continue and worsen if our policy makers do not begin to squarely face these issues.
Cam Fine
President, Independent Community Bankers
Nothing Short of a TravestyInteresting article. There is nothing that makes my blood boil more than this debate.
We as community bankers run our banks conservatively, service our community, make donations locally and have our community's best interest in mind. The "too big to fail" banks are out there taking huge risks, losing money and in reality they have failed.
Look at Wachovia, Citicorp, Washington Mutual. They failed and were bailed out or the examiners looked the other way. Why weren't Cease and Desist or Memorandum of Understanding orders issued? This is a travesty.
But you know who will pay for this? It is the community banks. We will have more regulation, more scrutiny and tougher exams even though we are doing this right. We need a two tier examination policy and a two tier FDIC insurance fund in this country.
It is time the congress recognize that community banks are going to be the salvation of our banking system and do something to protect our franchises.
We are not driven by greed like the "too big to fail" banks. We actually serve our communities and have their best interests in mind.
Dale Torpey
President, Federation Bank
Signs Point to Single RegulatorIn a
Recent developments — including the notion that certain non-depository financial institutions are "too big to fail" — suggest that the Fed has concluded that insured depositories may no longer be special.
The logical conclusion to be drawn is that the financial services industry — consisting of banks, thrifts, credit unions, brokers, investment banks and perhaps insurers — should be regulated by a single regulatory structure.
If so, should one expect that the only future regulatory distinctions to be drawn will be between financial services providers that are "too big to fail" and those that are not?
Michael Carlson
Partner, Faegre & Benson LLP
