Not Everything Can Be Too Big to Fail!
This piece originally appeared in the WSJ in November. Given our recent posts on corporate governance, I feel this article is a nice continuation on the theme. Click Here To Read About Companies That Are Too Big To Fail
Article Introduction (Via Harvard Law School Blog)
There is a really bad idea circulating in the nation’s capital. Of course, that’s not surprising–but when it’s endorsed by the Treasury secretary, we’d better pay attention.
Recently, Henry Paulson said in an interview with the Washington Post that he wants the Federal Reserve to be able to regulate and ultimately take over any failing financial institution that it considers crucial–including hedge funds. This echoes a notion that has been endorsed by executives of some industry associations, that to prevent a recurrence of today’s financial crisis it will be necessary to impose tough new regulations on financial institutions deemed “systemically significant.”
If this approach were to be adopted in the panicked Washington of today, it would substantially change our financial system and guarantee–rather than prevent–future crises.
Article Excerpts (Via Harvard Law School Blog)
“In short, predicting the true sources of systemic risk in advance of their actual failure is probably impossible. But even if it could be done, should we want to?”
“An institution designated as systemically significant, or “crucial,” would be marked as too big to fail….But once we designate a financial institution as too big to fail, and regulate it as such, a lot of unpleasant things follow.”
“First, we will have created “moral hazard” and impaired market discipline. Second, systemically significant institutions would suddenly have an unfair competitive edge that would warp the market. Finally, the support voiced in Washington for the idea of regulating systemically significant financial institutions is based on the fundamental misperception that regulation can prevent them from taking the huge risks their protected status would permit.”
