The world economy faces a major problem: The largest banks in the US remain “too big to fail,” meaning that if one or more of them were in serious trouble, they would be saved by government action — because the consequences of inaction are just too scary.
This problem is widely acknowledged, not just by officials but by bankers themselves. In fact, there is near unanimity that fixing it is a top policy priority. Even Jamie Dimon, the powerful head of the very large JP Morgan Chase, emphasizes that “too big to fail” must end.
Unfortunately, the administration of US President Barack Obama’s proposed approach to ending “too big to fail” — now taken up by the US Congress — will not work.
The current center of legislative attention is US Senator Christopher Dodd’s financial reform bill, which has passed out of the US Senate Banking Committee and will presumably soon be debated on the US Senate floor. Dodd’s bill would create a “resolution authority,” meaning a government agency with the legal power to take over and close down failing financial institutions.
The bill’s proponents argue that this approach builds on the success of the Federal Deposit Insurance Corporation (FDIC), which has a long track record of closing down small and medium-sized banks in the US with minimal disruption and no losses for depositors. In this context, “resolution” means that a bank’s managers are fired, shareholders are wiped out and unsecured creditors can suffer losses. Essentially, this is a form of bankruptcy, but with more administrative discretion (and presumably more protection for depositors) than would be possible in a court-supervised process.
Applying this process to large banks and to financial institutions that are not formally banks — and that do not have insured retail deposits — sounds fine on paper. In practice, however, there is an insurmountable difficulty with this approach.
Think about the critical moment of decision — when a megabank, like JP Morgan Chase (with a balance sheet of roughly US$2 trillion), may be on the brink of failure. You are a senior decision maker — perhaps the Secretary of the Treasury or a key adviser to the US president — for this is the level at which the plug must be pulled.
You have Dodd’s Resolution Authority and you enter the decisive meeting determined not to save the troubled bank — or, at worst, to save it with a substantial “haircut” (ie, losses) for unsecured creditors. Then someone reminds you that JP Morgan Chase is a complex global financial institution.
The Dodd Authority allows the US government only to determine the terms of an official takeover within the US. In dozens of other countries where JP Morgan operates subsidiaries, branches or other kinds of business, there would be “plain vanilla” bankruptcy — while some governments would jump in with various ad hoc arrangements.
The consequences of this combination of uncoordinated responses would be widespread, scary and bordering on chaos. This is exactly what happened when Lehman Brothers failed in September 2008, and what happened when AIG was taken over by the US government (actually in a resolution-type structure, with losses implied for creditors) two days later.
The existence of a US resolution authority does not help contain the damage or limit the panic arising from a big global bank in trouble. The failure of such a bank could be managed in a more orderly fashion by using a cross-border resolution authority. There is no such mechanism in place, however, and there is no chance that one will be created in the near future. Responsible policymakers in other G20 countries are very clear on this point: No one will agree ex ante to a specific way of handling the failure of any global bank.
At the moment when JP Morgan Chase — or any of the US’ six largest banks — fails, the choice will be just like that of September 2008: Do you rescue the bank in question, or do you let it fail, and face likely chaos in markets and a potential re-run of the Great Depression?
What would the president decide? He or she may have promised, even in public, that creditors would face losses, but on the edge of the precipice, which way would you, the beleaguered adviser, urge the president to go? Would you really argue that the president should leap over the edge, thereby plunging millions of people — their jobs, their homes and their families — into a financial abyss? Or would you pull back and find some ingenious way to save the bank and protect its creditors using public money or the Federal Reserve or some other emergency power?
You would, in all likelihood, step back. When the chips are down, it is far less scary to save a megabank than to let it go.
And of course the credit markets know this, so they lend more cheaply to JP Morgan Chase and other megabanks than to smaller banks that really can fail. This enables the bigger banks to get bigger. And the bigger they are, the safer creditors become — you see where this goes.
Dodd’s bill, as currently drafted, would not end “too big to fail.” As you can infer from the title of my new book, 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown (co-authored with James Kwak), the global consequences will be dire.
Simon Johnson is a former IMF chief economist, a professor at MIT Sloan, and a senior fellow at the Peterson Institute for International Economics.
COPYRIGHT: PROJECT SYNDICATE
In the past month, two important developments are poised to equip Taiwan with expanded capabilities to play foreign policy offense in an age where Taiwan’s diplomatic space is seriously constricted by a hegemonic Beijing. Taiwan Foreign Minister Lin Chia-lung (林佳龍) led a delegation of Taiwan and US companies to the Philippines to promote trilateral economic cooperation between the three countries. Additionally, in the past two weeks, Taiwan has placed chip export controls on South Africa in an escalating standoff over the placing of its diplomatic mission in Pretoria, causing the South Africans to pause and ask for consultations to resolve
An altercation involving a 73-year-old woman and a younger person broke out on a Taipei MRT train last week, with videos of the incident going viral online, sparking wide discussions about the controversial priority seats and social norms. In the video, the elderly woman, surnamed Tseng (曾), approached a passenger in a priority seat and demanded that she get up, and after she refused, she swung her bag, hitting her on the knees and calves several times. In return, the commuter asked a nearby passenger to hold her bag, stood up and kicked Tseng, causing her to fall backward and
In December 1937, Japanese troops captured Nanjing and unleashed one of the darkest chapters of the 20th century. Over six weeks, hundreds of thousands were slaughtered and women were raped on a scale that still defies comprehension. Across Asia, the Japanese occupation left deep scars. Singapore, Malaya, the Philippines and much of China endured terror, forced labor and massacres. My own grandfather was tortured by the Japanese in Singapore. His wife, traumatized beyond recovery, lived the rest of her life in silence and breakdown. These stories are real, not abstract history. Here is the irony: Mao Zedong (毛澤東) himself once told visiting
When I reminded my 83-year-old mother on Wednesday that it was the 76th anniversary of the founding of the People’s Republic of China, she replied: “Yes, it was the day when my family was broken.” That answer captures the paradox of modern China. To most Chinese in mainland China, Oct. 1 is a day of pride — a celebration of national strength, prosperity and global stature. However, on a deeper level, it is also a reminder to many of the families shattered, the freedoms extinguished and the lives sacrificed on the road here. Seventy-six years ago, Chinese Communist leader Mao Zedong (毛澤東)
RSS