Howard Rich's Blog

May 28, 2009

The Need For Failure

From Forbes online

There has been constant chatter about the fact that our regulatory institutions don’t really know how to deal with firms that are deemed “too big to fail” but may be insolvent. Throughout 2008, policymakers improvised a solution for each case that came along–Bear Stearns, Fannie and Freddie, Lehman Brothers, AIG. But improvisation is not a policy, and the weakness of that approach has become increasingly apparent as we drag through 2009.

First, the very notion of “too big to fail” is dangerous. It suggests that there is an insurance policy that says, no matter how risky your behavior, we will make sure you stay in business. It encourages banks to get bigger (or more interconnected), and it subsidizes risky behavior.

Second, it leaves ambiguous the important issue of who gets protected in the event of insolvency–the equity holders, creditors, subordinated debt holders, etc. It seems fair to say that the solutions that have developed on the fly have done severe damage to the notion that there is a well-ordered capital structure that means something.

In recent weeks, two very independent voices have stepped forward to argue for the creation of mechanisms for taking over and shutting bank-holding companies and other large systemic institutions. Sheila Bair, chairman of the FDIC, has argued that the absence of an authority to shut failing systemic banks has cost the American taxpayers dearly because of the unprecedented government intervention in the financial sector.

Thomas Hoenig, president of the Federal Bank of Kansas City, has also been arguing a very similar position. In testimony before Congress and in several speeches, Hoenig has said that the notion of “too big to fail” should be eliminated from the public dialogue. If insolvent firms are not allowed to fail, it undermines the roll of markets in disciplining economic behavior.

The recent stress tests of 19 banks might have been expected to add some clarity to this issue if some banks were found to be too undercapitalized to continue to operate. Instead, the tests had just the opposite effect. The Treasury gave the banks that need more capital until June 9 to raise it. But it also signaled that, if required, it could provide more capital to those banks that cannot raise all that they need. In effect, it treated all 19 as “too big to fail.”

We find ourselves in this peculiar state of affairs because we are paralyzed by the very size and interconnectedness of the institutions that are insolvent or undercapitalized. Yet as Bair rightly pointed out, the FDIC has had lots of experience with the problem of resolving commercial banks that are in trouble. In the current year to date, 40 banks have failed in the U.S., and the process has been extremely orderly.

When an FDIC-insured bank or thrift is at risk of failing, the FDIC has a standard set of rules that are invoked. If a bank is approaching insolvency, the FDIC gives formal notification of its undercapitalized status and the need for a plan to address the issue. Typically, it is then very swift at assessing the bank’s health, organizing a sale, and helping the bank to close or re-open its doors under new ownership.

Sometimes, when there are more complicated issues, the FDIC operates a bridge bank for a period to keep essential services flowing. For instance, it has special resolution authority to prevent immediate close-out of an insured depository’s financial contracts. It has 24 hours after appointment as receiver to decide whether to transfer the contracts to another bank or to an FDIC-operated bridge bank.

Unfortunately, after more than a year of financial turmoil, there is still no resolution mechanism for bank holding companies. The lack of a resolution mechanism has required the government to improvise for each individual situation, making it very difficult to address systemic problems. What we need is a process that imposes losses on equity holders, unsecured creditors and others without triggering domino effects in the financial system. At the same time, the financial plumbing needs to keep working.

In my last column, I argued that a greatly empowered and more independent FDIC might be the best candidate to be the systemic risk regulator. It would be charged with measuring and pricing systemic risk and, most importantly, collecting insurance fees from those institutions that create it. It seems only natural to think that such an organization should also have the expanded responsibility to resolve and shut large systemic institutions.

One great advantage of having a well-articulated responsibility located in one institution like the “Super FDIC” is that it could have the authority to separate bad assets from good assets on an institution-by-institution basis rather than drag out that process with Rube Goldberg-like structures such as the Public-Private Investment Program–PPIP.

At the end of the day, the most important issue here is that we must demonstrate that we will not tolerate the continued existence of zombie banks dependent on taxpayer guarantees and handouts. Perhaps it was tolerable to use taxpayer money to prop up these institutions as an interim solution in the worst days of the crisis–but two years in it is not. We are bankrupting our children because we do not have the political will to address this challenge.


EDITORIAL: Song of Sonia

From the Washington Times

Justice is supposed to be blind, but some Democrats want everyone to focus on Sonia Sotomayor’s race and impoverished upbringing when considering her Supreme Court nomination.

New York Rep. Nydia Velazquez, chairman of the Congressional Hispanic Caucus, warned Tuesday that as Republicans look to make inroads with Latino votes, “they need to be very cautious and careful” in attacking the nominee.

Democrats haven’t always been so sensitive. Internal 2001 Democratic Senate Judiciary staff memos to current Senate Majority Whip Richard Durbin, Illinois Democrat, and Sen. Edward Kennedy, Massachusetts Democrat, used race as a justification for rejecting Miguel Estrada’s nomination by President Bush to serve on the D.C. Circuit Court of Appeals. According to the Democratic memos, Mr. Estrada was “dangerous” because of his “minimal paper trail, he is Latino and the White House seems to be grooming him for a Supreme Court appointment.”

Some of the most vocal opposition to Mr. Estrada’s nomination on Capitol Hill came from within the Congressional Hispanic Caucus. Sen. Robert Menendez, at the time a New Jersey congressman, argued that Mr. Estrada’s ethnicity was irrelevant to his daily work as a judge. But he noted critically that while Mr. Estrada “shares a surname” with Latinos, he had done little to help mentor young Latino lawyers.

Republicans aren’t above racial politics. In 2005, before the Senate approved Alberto Gonzales’ nomination to become the nation’s first Hispanic attorney general, Sen. Orrin Hatch, Utah Republican, warned that, “Every Hispanic in America is watching.” A few wrongs don’t make a right.

Judge Sotomayor’s judicial record and views of the law are what must be examined, not the color of her skin or where she grew up. With the first Hispanic woman positioned to serve on the Supreme Court, Liberal Democrats are diverting attention from Ms. Sotomayor’s troubling record by playing the race card.

America’s Hidden Trillion-Dollar Tax

From Investor’s Business Daily

We need a breather to take it all in: TARP, a $787 billion stimulus bill and a projected $1.845 trillion budget deficit. But lost among all the spending commotion is yet another trillion-dollar poker hand — federal regulation.

Compliance costs from thousands of regulations — pouring out from over 60 departments, agencies and commissions — amounted to $1.17 trillion in 2008. The federal government spends an additional $49.1 billion just to administer and enforce its rules. This figure is on par with federal income tax revenue ($1.2 trillion) and Canada’s entire 2006 GDP ($1.265 trillion).

How To Hide Trillions

When doing business becomes so expensive, there tends to be a lot less of it. Of course, businesses pass on their costs, so regulation becomes a hidden trillion-dollar tax on consumers. This is bad policy at any time.

During a recession, it’s economic hara-kiri.

The numbers are up as well as the costs. The 2008 Federal Register reached a record 79,435 pages, up 10% from the previous year.

Even as the economy dipped into recession, agencies issued 3,830 new final rules. As you read this, 4,004 new federal regulations fill the pipeline, 753 of which affect small businesses.

“Economically significant” is the bureau-speak description for rules costing at least $100 million per year. There are 180 of them in the 2008 Register, up 13% from 2007 — which was itself up 14% from 2006.


Some rule makers are more active than others. Out of 61 rule-making agencies, just five — the departments of Treasury, Agriculture, Commerce and Interior, and the Environmental Protection Agency — account for 46% of all rules in the pipeline.

This economy needs stimulus. Taxing and spending are anti-stimulants — and so is regulating. The administration’s fiscal “stimulus” amounts to taking money out of the economy and putting it back in. That is like ladling water out of the deep end of a pool only to pour it back in at the shallow end — all the while paying somebody to make the pointless transfer.

Worse, today’s deficits are tomorrow’s tax increases. And more spending is usually followed by more regulation. The Bush spending explosion was accompanied by more than 30,000 new regulations.

What the economy needs instead is a deregulatory stimulus. There are three fronts in the battle to achieve it.

The first is disclosure. The more that policymakers and the public know about over regulation, the more likely they are to do something about it.

To that end, our organization, the Competitive Enterprise Institute, issues the annual Ten Thousand Commandments report. Official Washington needs its own such report card. Each year’s federal budget, or the annual Economic Report of the President, should include in-depth chapters exploring the regulatory state.

The second front is installing sunset provisions. Like a carton of milk, every newly created regulation should have an expiration date, beyond which it gets discarded unless renewed by Congress. Obsolete rules should not be on the books at all.

The third front involves Congress reasserting its lawmaking authority.

Article I, Section 1 of the Constitution says, “All legislative powers herein granted shall be vested in a Congress.” Much of that power has been given away to federal agencies. Congress passed 285 laws last year, compared with 3,830 final rules from agencies. The alphabet soup of agencies should answer to Congress for the regulatory burdens they impose.

Congress Should Step Up

At the very least, Congress should take the time to review the most onerous rules. Overdelegation allows Congress to shift blame to the agencies for excessive or unpopular regulations.

But the people’s elected representatives should perform their rightful duty and approve all new laws, not just 285.

In this age of trillions, we cannot afford the regulatory state as it now stands. It is a hidden trillion-dollar tax on consumers, on top of what they already pay.

A deregulatory stimulus is in order, the sooner the better. In the game of government poker, perhaps it is time to fold.

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