Dodd Liquidation Panel

by Chidem Kurdas

There is one new regulation that is truly needed—a way to wind down, without major disruption to markets, failing broker-dealers and other financial companies. The new financial industry bill introduced by Senator Christopher Dodd claims to do this and solve the “too-big-to-fail” problem.

Reading the particulars of the bill, however, makes one queasy. To use a metaphor, what’s needed is a commitment to defensive war when necessary. What this and a related bill  sneak under the radar is authority for pre-emptive war—with all the wide-open discretion that implies.

Lehman Brothers’ bankruptcy in September 2008 had a big impact on markets largely because the assets of its clients got tied up in courts, not just in the US but in the UK. With their capital frozen in years-long litigation, the clients – in particular hedge funds – sold securities to raise money. This selling put downward pressure on markets.

So, instituting a process by which large financial companies can be shut down without a lengthy bankruptcy case would reduce the impact of failures and get rid of the notion that investment banks need to be bailed out—expeditious and orderly winding down of a failed firm is the obvious solution.

While this process may be similar to established procedure for dealing with insolvent commercial banks, broker-dealers don’t have Federal Deposit Insurance Corp.-insured deposits. Their customers get only limited aid from the Securities Investor Protection Corp.—as the Bernard Madoff investors discovered.

The bill would establish a liquidation fund financed by the industry and authorize the appointment of FDIC as receiver for insolvent companies, with SIPC acting as trustee for broker-dealers. All that sounds reasonable. You don’t notice the danger until you’re deep into the 1,336 page bill. Continue reading

Big Bad Bank and Little Red Trustbuster

by Chidem Kurdas

A surprising new Small-Is-Beautiful movement is afoot.  Mario Rizzo, Jerry O’Driscoll, Harry Kaufman and others make a case for  breaking up too-big-to-fail financial institutions. As Mr. Kaufman puts it, otherwise those companies will become financial public utilities backstopped by the government.

It’s not likely that the 2008 crisis would have been prevented had top investment banks like Goldman Sachs been smaller. Traditional little banks are going down in droves. They fail because real estate loans are going bad. So many depository banks have gone under that the FDIC, the federal agency that insures deposits, itself ran out of money and asked to be bailed out by prepayment of bank premiums.

The same real estate bubble-and-bust hit larger banks through mortgage-backed securities. That’s regardless of size. Moreover, the government does not just bail out big investment banks. It bailed plenty of small savings & loan associations in the 1980s. The concept of “too-big-to-fail” is remarkably elastic.  Consider that GM and Chrysler both received federal aid. Chrysler is a lot smaller, but the political preference is to treat it as too-big-to-fail. Keeping banks relatively small will not stop such bailouts.

That said, there is a serious quandary. Continue reading