Providing The Right To Fail

In today's edition of the New York Times, Andrew Ross Sorkin penned a column lamenting the fact that so little has been done to pass legislation which would give the government the authority to resolve large financial institutions. The ones he's talking about are those which are commonly referred to these days as being "too big to fail." The financial crisis put the government in the awkward position of feeling forced to save these large firms, rather than allow them to fail, given the systemic risk failure posed to the system. While I agree with Sorkin that such legislation is important, I'm not at all surprised we haven't seen it passed.

I have argued several times that no firm should be immune from failure. Allowing such a luxury has terrible consequences in a capitalist economy. The firm will necessarily have a competitive advantage over others, which will create market inefficiencies. The problem, however, is that our intertwined financial system can get really screwed up when giant financial institutions have to suddenly seek bankruptcy protection.

One solution would be to give the government resolution authority over all large financial services firms, like AIG and Citigroup. The FDIC has such authority to take over regular banks and place them into a conservatorship. It can then wind the bank down, or nurse it back to health.

The Treasury offered some legislation back in March to give the government precisely the kind of power I just explained. It went nowhere. Sorkin seems appalled. I think my cynicism prevents me from having a similar response.

Financial regulation was never at the front of the mind of the power in Washington. Congress and the Obama administration weren't opposed to it; they just had other priorities. In March, the news cycle was so busy with Congressional and Executive legislation proposals, that I can barely even remember reading the Treasury's plan for resolution authority. Washington's focus has been elsewhere and will likely remain elsewhere throughout 2009. The healthcare debate is shaping up to be extremely challenging for Democrats; cap and trade won't be a whole lot easier.

That leaves the kind of regulation Sorkin calls for to hit Congress' agenda in early 2010, at best. And the longer they wait, the harder it will be to pass. When the economy is sick, regulation sounds a lot more compelling. By year's end, however, we should begin seeing some legitimate improvements in some important economic indicators and especially the health of the financial system.

Does that mean the government obtaining such resolution authority is doomed? Not necessarily. Democrats may be able to conjure up enough votes. But given the difficulty they're having in getting their greater priorities passed in the Senate, I wouldn't hold my breath.