As the House Financial Services Committee marks up its financial stability regulation proposal, one amendment is getting a lot of attention. Rep. Paul Kanjorski (D-PA) has proposed (.pdf) to provide the plan's systemic risk council the authority to break up firms that pose too great a risk to the economy. In my reading of the House plan the Federal Reserve would already have a weak version of this power. Kanjorski's suggestion would explicitly allow the council to break firms up. The Senate's proposal, more explicitly provides this power to the systemic risk agency it would create. For the House's plan to really seek to end to the too big to fail problem, Kanjorski's amendment is vital.
Both House and Senate plans already provide resolution authorities. The general idea there is large, interconnected firms would provide failure plans to the regulators, which would be followed if they collapse. It might sound like this would prevent future bailouts, but that isn't necessarily true.
This assumes that the failure plans would actually work -- but what if they won't? What if a firm is so large and so intertwined in the market that its collapse would necessarily throw the financial industry into chaos? In that case, resolution wouldn't work, and the firm would have to be bailed out.
One option to deal with those firms is to treat them like utilities. I think that's crazy from every standpoint. Taxpayers shouldn't be supporting financial companies who might make poor decisions, and those firms almost certainly don't want to be micromanaged by the government.
The only other solution I can see would be if the systemic risk regulator has the power to break up firms if their resolution would not work in practice. Kanjorski's amendment doesn't take this authority lightly. It stresses breakup as a last resort, even noting the concern of international competitiveness. I don't think the intent here is to punish big banks -- and it shouldn't be. It supports the idea that if a bank can fail without a major market disturbance, then it should not be broken up no matter how large.
But make no mistake: you do not solve the too big to fail program unless you provide the systemic risk regulator the power to break up firms that cannot be resolved without taking the economy down with them. This is the only way to be sure to get the government out of the business of bailing out banks. A resolution authority is a good first step, but it will be useless in addressing too big to fail without breakup power also provided.
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