2009-11-20 Too Big to Fail: An Insufficient and Excessive $200 Billion Con

7/31/2019 2009-11-20 Too Big to Fail: An Insufficient and Excessive $200 Billion Con

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November, 2009

Joshua Rosner

646/652-6207 [email protected]

Please refer to important disclosures at the end of this report.

Too Big to Fail: An Insufficient and Excessive $200 Billion Con

The current regulatory reform approach being sold to the American public may be thebiggest con captured regulators and lobbyists have yet to attempt to perpetrate. They aretrying to pass legislation that avoids having to address that we should not accept: Livingin a world where firms are allowed to be too big to fail or big enough to control ourpolitical process. Instead they trying to convince us they can create an industry fundedfund to handle failing TBTF firms. This is dishonest, absurd and illogical:

1- If a firm is too interconnected to be wound down in an orderly way and couldtherefore cost counterparties to fail then the total risk is the cost of the aggregateexposures of all correlated and interconnected firms and would equal a significantpart of the entire system. TBTF=TBTInsure!

2- Before we even said there were TBTF institutions we committed $187bb to AIG,and $400bb to the GSEs on top of the $3tt in guarantees and support offered bythe T and Fed. Certainly not all will be lost but 20-50% will.

3- $200 bb is not enough and yet it is an absurdly large number because nobodycould pay it. It is an uninsurable risk. With only about $1 trillion in TCE at thebanks and insurers how can they even collect this large amount of $200bb, even if insufficient. They will also tax fund managers.

4- $200bb becomes dead money not providing any returns, how do those assessedoffset the loss of the economic use of that money? Taking larger risks.

5- In truth, the fund concept is really just a tax on investors to fund the bailout of these TBTF banks? Who do they intend to assess? Banks? Advisors? Funds? If they assess the largest funds isnt that really just a tax on the investors in thosefunds? Shouldnt a prudent investor or pension consultant demand their money betaken out of that firm and sent to a smaller, not TTF and not assessed firm?

6- Rather than accept that TBTF firms ROEs were solely strong because of leveragewe will foolishly extract $200bb from the entire industry and make our entirefinancial services industry uneconomic and globally uncompetitive? We shouldbreak up the TBTF firms and risk global banking deals either being syndicated bysmaller firms or going to another sovereign's risky firms.

7- Even if it worked that only one firm went bust at a time and they were notinterconnected let us assume a firm fails to the tune of $150bb a year after raising$200bb. Will we then go back to everyone and ask them to replenish it? Will theyhave the money to?

8- A fund will create a "race to zero" - disincentives to prudent risk management.Specifically, if the best managed TBTF firms know they will have to pay asignificant amount of capital into a fund to insure and support their worst


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managed peers they will surely see economic benefit in reducing risk controls andtherefore improving their returns.

9- Remember the GSEs received AAA ratings and a market distorting lower cost of capital because they were seen as government obligations. When push came toshove, even though the Fed, Treasury, Barney Frank and others regularly deniedthey were guaranteed government obligations, the rating agencies proved to havebeen correct. Should we codify this view for more institutions?

10- According to the SIGTarp AIG report, even before we codified the notion of aclass of TBTF institutions we accepted them as government guaranteed: "FRBNYwas further concerned as it was throughout the AIG rescue about the reactionof the rating agencies. While threatening not to support AIG might have beenuseful for purposes of forcing concessions by the counterparties, it could alsohave been viewed by the credit rating agencies as an indication that the FRBNYand the U.S. government was not standing fully behind AIG, which could havehad a negative impact on AIGs credit rating" and "In addition, FRBNY wasconcerned that its use of a threat of an AIG default might introduce doubt into themarketplace about the resolve of the U.S. government in following through on itscommitments in support of financial stability." expanding this to a list of largefirms should have negative implications for our sovereign risk rating.

11- The current house bill, as amended, requires the Treasury Secretary to beinformed and consent to the break-up of a firm over $10 billion in assets andrequires the President to decide on the breakup of firms with over $100 billion inassets. This makes the decision, to break up these firms and commit taxpayers toultimate risk and losses, a political process driven by the executive branch. This isa fundamental conflict with basic concepts of our government and is an abdicationof responsibility by our elected legislators.

12- Maybe the correct response is: If you want to be a global bank you need to be aplain old fashioned boring bank (holding plain old treasuries and funded bydeposits). Let the smaller and non-systemically important firms be the innovatorsand take more risks, they can only hurt themselves.

13- If there is a problem with bankruptcy then fix the bankruptcy code.14- Create disincentives to being on the "too big to fail" or "tier one financial"

company list. There should be an amendment that requires legislatively requiredaction be taken against any too big to fail institution which becomesundercapitalized, requires any governmental or government agency guarantees of its obligations or governmentally supported purchase of its assets outside of thenormal course of activities, receives funds from the Federal Reserves windowwith terms of more than 60 days or draws against any industry funds raised forfunding the risks of these institutions. Specifically, the Directors, Officers andsenior management of any institution that draws on the industry funds or receivesany relief should immediately lose his/her pay and future benefits and, as soon assafely feasible, replaced by regulators. As importantly, directors, officers and allsenior managers of such troubled TBTF should be explicitly prohibited from


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becoming employed as Director, officer, senior manager or consultant at anyregulated financial institution or an affiliated holding company or operatingsubsidiary for a period of five years.

15- By getting out of the TBTF game, we will have a more robust and economicallycompetitive economy where no players have a governmentally conferredadvantage or subsidy. Such a leveled playing field will begin the process of regaining credible markets and attracting stable foreign capital. Let other nationspursue misguided policies of protecting uneconomic and anticompetitivebusinesses. Such an approach will allow our taxpayers to avoid having to be partof the next banking bailout crisis.

16- Those who argue against a more proactive reduction in risk and size of TBTFinstitutions will, as they always do, say: Doing so would create an unleveledinternational playing field for our institutions relative to their internationalcompetitors. Level playing fields are a worthy goal; this is not a relevantargument. Instead, this tired line must be resoundingly dismissed on severalcounts:

Those countries with the largest banks as a percentage of GDP (Iceland, Ireland,Switzerland) demonstrated that a concentration of banking power can causesignificant sovereign risk and tilt global economic playing fields away from you.

The likely breakups of ING, Lloyds and KBC suggest that it is we who seek tosupport an unleveled playing field where we subsidize our TBTF banks whileother nations recognize the policy failures of moral hazard. If we continue downthis path we will likely be at risk of violating international fair trade regimes.

When the unleveled playing field argument is cited, why dont communitybankers demand to know why it is ok to disadvantage the 8000+ communitybanks relative to our largest banks, all in the name of protecting big banks fromgovernmentally- subsidized international competition?

There is no longer any evidence that, beyond a cost of capital advantage thatcomes with implied government support, there are sustainable and tangibleeconomies of scale arising from being the largest. The financial supermarketconcept has been proven a failure.

We must demand that our legislators no longer allow unelected officials at theindependent Federal Reserve to sign international accords created by the TBTFbanks through supra-national bodies like the Basel Committee.

Are we to believe that if we did not have such large and globally dominant firms,US borrowers might be paying more that the 29% interest that several of theTBTF firms are now charging on their card accounts?

Perhaps we should think about what advantage our population has gained as aresult of our financial institutions being such a large part of our economy or beingglobally dominant.

Since when did we accept a national strategy of following rather than leading?When we do what is right, others follow. As example, consider the bank secrecy


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2009-11-20 Too Big to Fail: An Insufficient and Excessive $200 Billion Con

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