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Simon Johnson <http://www.huffingtonpost.com/simon-johnson>

MIT Professor and co-author of 13 Bankers <http://13bankers.com/>
Posted: March 26, 2010 07:21 AM

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Senator: Which Part Of 'Too Big To Fail' Do You Not
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*Read More:* Citigroup <http://www.huffingtonpost.com/tag/citigroup> ,
Financial
Crisis <http://www.huffingtonpost.com/tag/financial-crisis> , Financial
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When a company wants to fend off a hostile takeover, its board may seek to
put in place so-called "poison pill"
defenses<http://en.wikipedia.org/wiki/Poison_pill> -
i.e., measures that will make the firm less desirable if purchased, but
which ideally will not encumber its operations if it stays independent.

Large complex cross-border financial institutions run with exactly such a
structure in place, but it has the effect of making it very expensive for
the government to takeover or shut down such firms, i.e., to push them into
any form of bankruptcy.

To understand this more clearly you can,

1. Look at the situation of Citigroup
today<http://online.wsj.com/article/SB10001424052748704266504575141834273554878.html?mod=crnews>,
or
2. Read this new
speech<http://kaufman.senate.gov/press/floor_statements/statement/?id=4abbbb91-1374-42ca-92a9-5b2f3b325922>
by
Senator Ted Kaufman.

The Citigroup situation is simple. They would like to downsize slightly,
and are under some pressure to do so. It is hard to sell assets at a decent
price in this environment, so why don't they just spin off companies - e.g.,
quickly create five companies in which each original shareholder gets a
commensurate stake?

The answer is that Citi's debt is generally cross-guaranteed across various
parts of the company. US and foreign creditors have a claim on the whole
thing, more or less (including the international parts), and you can't break
it apart without upsetting them. The cross-border dimensions make
everything that much more knotty.

Senator Kaufman explains what this means - essentially the "resolution
authority" proposed in the Dodd legislation is meaningless. How would any
administration put a huge bank into any kind of "resolution" (a FDIC-type
bank closure, scaled up to big banks) when it knows that doing so would
trigger default across all the complex pieces of this multinational empire?

You could do it if you are willing to accept the costs - and if you
understand there are big drawbacks to providing an unconditional bailout of
the 2009 variety. But will a future administration be willing to take that
decision? The Obama administration was not - and big finance will only
become bigger and more complex as we move forward.

If you look into the eyes of the decision-makers from Spring 2009, they
honestly believe that taking over Citi or Bank of America would have caused
greater financial trouble and a worse recession. You can argue about their
true motivation all you want; this is irrelevant. The point is that the
structures in place last year remain unchanged today. If a megabank
shut-down under pressure was impossible for our policymakers last year, how
exactly will the situation change after the Dodd bill passes - remembering
that our current policymakers or a close facsimile will run this country for
the indefinite future?

Senator Kaufman is strong too on what this all means. By all accounts, this
Senator is not a person who came to the boom-bust-bailout debate with strong
preconceived notions, just someone who has listened carefully to the
arguments on all sides. And, unlike most
politicians<http://www.commercialappeal.com/news/2010/mar/25/corker-cancels-meetings-offering-access-10000/>,
this Senator does not need to raise
money<http://www.huffingtonpost.com/arianna-huffington/celebrating-sen-ted-kaufm_b_505136.html>
.

Banks that are "too big to fail" are simply too big. Making them smaller
may not be sufficient to prevent major crises in the future - Senator
Kaufman sensibly also supports a long list of related reforms, including for
derivatives markets (see his other speeches on this topic:
first<http://baselinescenario.com/2010/03/10/the-speech-for-which-we-have-been-waiting/>
, second<http://baselinescenario.com/2010/03/15/senator-kaufman-fraud-still-at-the-heart-of-wall-street/>)
-
but rolling back our biggest and most dangerous banks certainly is
necessary. And there is simply no evidence that banks on today's modern
scale convey any benefits to society.

Massive banks cannot be controlled, at least not in the US context; we are
not Canada<http://baselinescenario.com/2010/03/25/the-canadian-banking-fallacy/>.
"Smart regulation" in this context is an oxymoron. Our regulators have been
captured by the ideology of finance for 20 years; the big banks industry are
not about to let them out on parole now.

For a long while, the Obama administration insisted that size caps for banks
were not on the table. Then, in January, the president himself announced
the Volcker Rules - which include a size cap for
banks.<http://www.tnr.com/article/politics/shooting-banks>
We've argued this cap should be even tighter - big banks can get smaller in
an orderly fashion and regulators can help - but still any cap would be a
step in the right direction.

Yet there is no size cap in Senator Dodd's bill.

Given that this White House has shown it can achieve considerable things,
when it applies itself, why not pursue the Volcker Rules in full?

The White House is clearly not afraid of the business lobby - Deputy
Secretary Neal Wolin took on the Chamber of
Commerce<http://www.treasury.gov/press/releases/tg606.htm> this
week regarding the Consumer Protection Agency for Financial Products; his
tone was strong and his arguments were telling.

Yet the White House, Senator Dodd, and perhaps even Barney Frank are all
stuck on one issue - they can't contemplate making our biggest banks smaller
(or even limiting their size).

It's as if a very clever political poisoned pill has been put into place.
If you act against the big banks they will .... What exactly? Threaten to
prolong the recession? Help your opponents get elected? Run ads against
everything you believe in?

Whatever the reason, write it down and think about it. How do you feel
about a small set of big financial firms having this kind of power? How is
that good for the rest of the business community, let alone regular citizens
and our democracy?

This administration is perfectly capable of taking on the big banks. All
that is missing is a little clarity of thought and a fair amount of
political courage. Or they can just call up Senator Kaufman.
--
Eric D. Schwerin
Rosemont Seneca Partners
(202) 333-1880
[email protected]