Earlier this week, Joe Nocera wrote a puff piece on Karen Petrou of Federal Financial Analytics. In the piece, Nocera and Petrou repeat a frequently-heard — but nevertheless exceedingly superficial — argument that has always bothered me. From Nocera’s NYT column:
[Petrou] also points to a contradiction in the way the Too Big to Fail institutions are being dealt with. On the one hand, Dodd-Frank is very clear that if a big bank becomes insolvent, there can be no taxpayer bailout. It must be wound down, just like any other bank. Yet, at the same time, she says, the federal and international regulators are adding a host of special Too Big to Fail capital requirements and rules. “They are acting as if these institutions are still too big to fail. The two thrusts are incompatible.”Oy. This is not a contradiction. Applying additional capital requirements and more stringent regulations to certain large financial institutions is absolutely not incompatible with ending Too Big to Fail — or with Dodd-Frank’s new resolution authority for large financial institutions.
The new resolution authority makes is easier for large financial institutions (known as SIFIs) to fail, which is the exact opposite of “acting as if these institutions are still too big to fail.” Moreover, the additional capital requirements and regulations for SIFIs in no way contradict the resolution authority. The purpose of the additional capital requirements and enhanced prudential regulations for SIFIs is to make it less likely that a SIFI will fail. The purpose of the resolution authority is to make sure that when a SIFI fails, it can do so without bringing down the entire financial system. These are not contradictory — they’re complementary.
These are pretty basic concepts of financial reform — I wrote a post way back in October 2009, before Congress even took up the financial reform bill, explaining how a SIFI regime and a new resolution authority would fit together. The fact that so many financially-focused pundits have yet to move beyond the “hey, if they’re ‘systemically important’ they must be TBTF!”-level of analysis is just sad.