The Wall Street Takeover and the Next Financial Meltdown: Problems and Solutions

James Kwak:

The debate over how to address institutions that are “too big to fail” is itself a debate over politics. The administration’s position is that the bill currently on the floor of the Senate solves this problem by giving the government the power to liquidate megabanks in a financial crisis without endangering the larger financial system; as a result, the argument goes, large banks will no longer enjoy an implicit government guarantee and the competitive advantages that come with it.

Skeptics, however, point to the risk of relying on a solution that depends on political will. In 13 Bankers, we wrote, “Even leaving aside the issue of direct pressure from bank executives who happen to be major political donors, it would be politically difficult for any president to order a government takeover of an iconic American bank that was insisting through the media and its lobbyists that it was perfectly healthy” (p. 206). Noam Scheiber adds, “authority to dismantle a firm and impose losses isn’t the same as the will to use it. . . . I have an easy time imagining a future Citigroup pleading that it shouldn’t be resolved because it employs hundreds of thousands of people, many of whom will be thrown out of work.” In The New York Times, David Leonhardt quoted a former government official saying, “Don’t kid yourself into thinking that if J. P. Morgan were on the rocks, it would disappear.”

Simon and I favor breaking up the large banks now because it reduces our reliance on the backbone of a future administration facing the next financial crisis. Scheiber thinks that it is politically infeasible to break up the banks now, and so resolution authority is the best we can get. Leonhardt, along with the International Monetary Fund (and perhaps even Tim Geithner), favors a bank tax that will increase the cost of risk-taking and provide the funds to rescue creditors in a future crisis.

But these are the right debates to have. There is no chance that a perfect regulatory system will come out of this session of Congress, especially since no one can know with certainty what a perfect system would look like. If we can at least recognize the political roots of any financial system and agree on what its core problems are, we have a chance at gradually adapting regulation to the demands of today’s modern, sophisticated financial system. That alone would be progress.

Posted via email from Jim Nichols