- The Washington Times - Monday, April 19, 2010

Both Republicans and Democrats claim they want to prevent taxpayers from ever again having to bail out Wall Street goliaths in a crisis, but many analysts question whether either parties’ reforms would do the job while the surest way to prevent future bailouts — breaking up the “too big to fail” banks — is not an option in Congress.

Giants like Fannie Mae, JP Morgan Chase, Citigroup, and American International Group possess enormous power over governments and the economy by virtue of their huge balance sheets of up to $3 trillion and their financial ties with markets and businesses in every corner of the globe.

The biggest banks got even bigger as a result of mergers arranged during the 2008 crisis, even as institutions less than half their size like Lehman Brothers proved capable of bringing down the entire world economy and decimating small nations like Iceland the Ireland — forcing steep spending cuts and tax increases — when they fell into bankruptcy.

The debate over what to do with these behemoths has grown increasingly partisan in Congress, with both sides claiming to have the solution.

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Critics on the right and left are concerned that President Obama and Democratic leaders in Congress will try to ram a partisan bill through the Senate in coming weeks that panders to populist sentiment against Wall Street but does not resolve the real problem. Meanwhile, Senate Republicans appear to largely have given up trying to work with Democrats to improve the legislation and are seeking to use it to score political points.

“The mega-financial institutions today are ‘too big to fail’ and ‘too complex to manage,’” said Sung Won Sohn, an economics professor at California State University at Channel Islands. He noted that the “culprits” that created the financial crisis include huge quasi-governmental institutions, such as Fannie Mae and Freddie Mac, as well as the big banks and Wall Street firms often fingered in Congress.

Their size and the mind-numbing complexity of the alphabet soup of derivatives products they created — from CDOs and CDS to EFTs and RMBs — is a big part of what got them into trouble, he said.

“The products they offered were too complicated even for the institutions selling them to understand,” much less the investors who ended up losing big money on the instruments and the regulators who could not perceive the dangers of products they little understood, he said.

The government’s long history of bailing out the big institutions in a crisis, along with their ability to operate almost above and beyond the reach of any one government, has given them a kind of invulnerability, enabling them to borrow at cheaper rates than smaller institutions because of their implicit backing from taxpayers the world over.

“Should these institutions be broken up?” Mr. Sohn asked. “Would additional regulations on these too-big-and-too-complex institutions solve the problems?”

He said Mr. Obama and advocates for the Democratic legislative program have not satisfactorily answered these questions.

Legislation pushed by Mr. Obama and Democratic leaders relies heavily on the judgment of regulators who missed abuses in the past to try to prevent crises in the future, as well as to close large institutions when they fail. The House-passed bill would enable regulators to break up large companies that pose a danger to the financial system, but it does not target specific firms.

Federal Reserve Chairman Ben S. Bernanke, Federal Deposit Insurance Corp. Chairman Sheila C. Bair and other regulators have endorsed that discretionary approach, which also would require banks to outline an orderly process for closing themselves in case of insolvency.

But conservatives and some regulators, such as former Fed Chairman Alan Greenspan, have warned that it would take an army of supervisors to monitor banks with balance sheets in the trillions of dollars. Such a potentially stultifying bureaucracy could end up stifling the growth and dynamism of the financial markets, while in the end probably failing once again to foresee fatal problems, Mr. Greenspan said.

In a rare admission for a banking regulator, the president of the Fed’s Dallas bank, Richard Fisher, last week said that the best way to prevent another crisis and bailout of Wall Street banks is not to beef up regulatory authorities but to break up the banking leviathans into “manageable” pieces that can no longer exert such enormous influence.

“The disagreeable but sound thing to do … is to dismantle them over time into institutions that can be prudently managed and regulated across borders,” he told the Levy Economics Institute of Bard College in New York. He advocated “an international accord to break up these institutions” because they operate worldwide and said that would make them “more manageable” both for the bank executives and regulators.

The big banks remain ticking time bombs with the potential to explode the economy, especially since they in the past year resumed the kind of risky and highly leveraged trading activities that led to the last crisis. Because it may be only a matter of time before the next collapse, Mr. Fisher said, a downsizing of the banks is urgent.

Critics on the left voice many of the same concerns.

Robert Weissman, president of Ralph Nader’s Public Citizen, said the “overriding reason” Congress has failed to enact a reform bill more than a year and a half after the crisis is “Wall Street and the big banks continue to exert overwhelming and improper influence” over Washington policymakers.

“That is one reason why breaking up the big banks is arguably the most important reform needed,” he said. “We need to break up concentrations of financial power to rescue our democracy” as well as to diminish the odds of future bailouts.

Given that Congress is not even considering breaking up the big banks in the legislative reform bill, Mr. Weissman questioned whether regulators would be up to the task of closing huge institutions that pose a threat to the overall financial system in a time of crisis.

“It is in times of crisis when regulators will be least likely to take such aggressive action,” he said, predicting the Democrats’ measures to regulate and wind down big banks “are likely to have limited or no impact on the too-big-to-fail problem.”

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