I was wrong in my FT column on Monday when I said:
Indisputably, an orderly resolution regime is required for all financial institutions, banks and non-banks alike.
To my dismay, this is disputable after all.
The Treasury secretary... released more details on Wednesday on a plan for a legal framework to put a "non-bank" into receivership at the behest of the government. With the backing of Ben Bernanke, Federal Reserve chairman, Mr Geithner wants powers to "resolve'' ailing companies that are deemed systemically important.He told legislators on Tuesday that such powers would have allowed the government to handle better the collapse of AIG, the giant insurer now surviving on $173bn of taxpayer funds.
House Republican leader John Boehner said on Tuesday that Mr Geithner's plan sounded like "an unprecedented grab of power".
That is the kind of comment that makes me wonder if the Republicans ever intend to be taken seriously on these issues. How can one intelligently oppose an FDIC-like resolution regime for AIG and other systemically significant non-banks?
I've heard it said that the FDIC's pre-bankruptcy powers should be seen as a quid pro quo for deposit insurance, which AIG did not enjoy, since it was not a deposit-taker. Fine, but do you mean to tell me that AIG's liabilities were not underwritten by taxpayers? Of course they were. See what happened to that $173 billion. Well then, what is wrong with plain bankruptcy in such a case? Perhaps you remember Lehman, an experience nobody cared to repeat. AIG was kept out of ordinary bankruptcy for a reason.
As my column pointed out:
Bankruptcy was tried, of course, in the case of Lehman, and was not a great success: many see that as a catalyst for the worst phase of this crisis. After the Lehman debacle, keeping counterparties whole to avoid systemic collapse was the entire point of coming to the rescue of AIG and the others.Apparently, the lesson of the Lehman case was drawn too hastily. Do not worry too much about moral hazard, many concluded. Letting banks that took excessive risks fail in order to encourage more prudent behaviour is all very well in theory; in practice, you pull the ceiling down on your head.
Yes, but then one must also understand that the AIG outcome - keep everybody whole but taxpayers - is the alternative, and this no longer looks so good either. It fails the test of fairness, which is what the outcry is all about. It fails the test of efficiency too. The company's death-wish business model, which involved insuring risks being taken by other financial groups on a literally insupportable scale, had moral hazard written all over its transactions. As James Hamilton of the University of California at San Diego has pointed out, if AIG's counterparties were betting that the government would stand behind those suicidal credit default swaps, which in turn allowed them to keep rolling the dice, they turned out to be right.
So the question is this: if you cannot let a systemically significant bank or shadow bank collapse, and you cannot keep it whole at taxpayer expense, how do you dispose of it in an orderly way? How do you arrange a fair and efficient sharing of the losses? A template exists for US banks, though not for shadow banks or for hedge funds pretending to be insurance companies, in the resolution procedures of the Federal Deposit Insurance Corporation.
If the best the
Republicans can do in opposing this line of thinking is issue
all-purpose admonitions against government power, it would be better
for everybody including themselves if they just shut up.