Friday, Apr. 23, 2010

Too Big to Fail

During the crisis, the government stepped in with taxpayer money to rescue firms like AIG and Citigroup because of fear about how the failure of such a company would ripple through the rest of the financial system. One school of thought on how to prevent that in the future: only let companies get so large and risky.

Both the bill the House passed in December and the one the Senate is currently contemplating tells regulators to clamp down on capital and liquidity requirements — that is, how much debt a firm is allowed to have and how easily it can raise cash. These changes are meant to discourage firms from growing unwieldy.

The House bill goes farther when it comes to leverage, stipulating that financial firms deemed to be "systemically important" won't be allowed to have a debt-to-equity ratio of more than 15-to-1. (Before Lehman Brothers collapsed, its ratio was 30-to-1.) The Senate bill leaves exact ratios up to a new Financial Stability Oversight Council. It also commissions a study of the so-called Volcker rule (named for the former Federal Reserve chairman and current Obama adviser), which, if later enacted, would prohibit banks that take retail deposits from trading in markets as a way to make money for themselves. Neither bill breaks up companies simply for being too large and complex — a step endorsed by some regulators, including the head of the Federal Reserve Bank of Dallas.

Both bills also set up an industry-funded bank bailout fund that would be tapped should a firm start to teeter. In the last go-around, Congress authorized $700 billion of taxpayer money for this purpose. The new set-up would levy a tax on the firms themselves in order to pay for the stabilizing or dismantling of any problem companies. Critics worry that such a fund would only underscore the notion that big financial firms have a safety net no matter how big a risk they take.