Tuesday, May 25, 2010

The Future of "Too Big to Fail"

Continuing our discussion of the financial reform bill passed by the Senate, some of the most talked-about aspects are the "Too Big to Fail" provisions. These arose out of the feeling that during the recent banking meltdown, we were stuck between a rock and a hard place: Several banks weren't going to survive without major assistance from the federal government, but as the Lehman Brothers collapse demonstrated, letting them fail could have disastrous effects on the economy.

So how do we combat that? There was some discussion of limiting the sheer size of financial institutions, but that didn't end up in the Senate bill. The Senate version now calls for these institutions to pay back the costs of any bailout after the fact - which is in many ways what we saw after the last bailout. The House version has a little more teeth, creating a $150 billion fund - filled by a tax on banks and other financial institutions - that would be available to pay for any needed bailouts.

Just as the FDIC has the power to close troubled banks, the bill would give the government the power to liquidate, in an orderly fashion, other institutions such as investment banks. It would also be able to impose emergency regulations on these institutions. These provisions might have helped with a more orderly unwinding of Lehman Brothers, and might have ended up costing the government less when it intervened with other large banks. This sort of language is in both the House and Senate bills, and thus seems likely to become the law of the land.

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