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Bailouts r us?

Scott Jagow Jun 18, 2009

One burning question over financial regulation is this: Does the administration’s plan, as Kai Ryssdal put it this morning, codify “too big to fail?” In other words, are we making bailouts a permanent part of the financial system?

Under the plan, firms that could potentially rip apart the economy will be called Tier 1 Financial Holding Companies. They will have to meet special requirements, but they will also have a special status. Is it possible this will encourage companies to get bigger?

A New York Post column answers:

Instead of putting an end to bank bailouts, the plan makes bailouts a permanent feature of our regulatory landscape. In fact, it extends the possibility of taxpayer-funded bailouts to any company choosing to become a financial-holding company. This will likely include every large insurer, as well as major consumer-finance companies like GMAC…

By assembling a list of institutions deemed “too big to fail,” the president is announcing that any of these select corporations will be bailed out if it fails. As a result, these institutions will face lower funding costs than smaller lenders — which will allow them to gain market share.

But in testimony on Capitol Hill this morning, Treasury Secretary Tim Geithner told Congress:

“No one should assume the government will step in in the future to bail out these institutions…

Under our proposals, the largest, most interconnected, and highly leveraged institutions would face stricter prudential regulation than other regulated firms, including higher capital requirements and more robust consolidated supervision. In effect, our proposals would compel these firms to internalize the costs they could impose on society in the event of failure.”

Here’s another take from the British newspaper, the Guardian:

If the goal was to minimize the “too big” phenomenon, then Team Obama would have proposed capping asset levels or reinstituting Glass-Steagall. Maybe it would have even outlined the use of antitrust tools to prevent companies from getting “too big” in the first place.

But the administration chose a different path, one that wouldn’t entail a political war on Capitol Hill and deplete precious political capital needed to push through healthcare reform and climate change legislation — both of which are stumbling right now. Obama didn’t need to open up a third bloody front.

Britain is having a similar debate about the matter of size. The governor of the Bank of England, Mervyn King, says instead of policies that afford large banks special protections, they should be cut down:

“If some banks are thought to be too big to fail, then, in the words of a distinguished American economist, they are too big. It is not sensible to allow large banks to combine high street retail banking with risky investment banking or funding strategies, and then provide an implicit state guarantee against failure.”

Marketplace will have more on this tonight. In the meantime, what are your thoughts?

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