"Too big to fail" questioned by FDIC chairwoman

At a speech in Orlando, Florida, the chairwoman of the Federal Deposit Insurance Corporation (FDIC), Sheila Bair, spoke out against the U.S. implicit policy of “too big to fail.”  This unwritten policy states that certain financial institutions, even if horribly mismanaged, cannot be allowed to fail because of the possible ramifications on the U.S. banking system.  Bair’s comments came at a conference for small and medium-sized financial institutions and were likely designed to highlight loopholes in Senator Christopher Dodd’s financial industry overhaul legislation.  The loopholes would allow for “too big to fail” bailouts via the Federal Reserve Board’s emergency authority.

Bair stressed that any use of the Fed’s emergency powers would have to meet a very high bar.  She suggested that Dodd’s proposed oversight council be required to have made a “systemic risk” evaluation before approving any bailout monies in the future.  In other words, Bair is saying that if the bank screwed up of its own volition then it should not be granted funds under the Fed’s emergency authority.  Amen!

Analysis: I like that FDIC Chairwoman Sheila Bair has spoken out against the implicit “too big to fail” attitude of the U.S. Congress and the U.S. regulatory system.  As I have repeatedly said on this blog, capitalism only works if the experience of monetary returns are accompanied by the commensurate experience of monetary risks and loss.  Otherwise, a overly risk-taking culture is created within the critical-for-capitalism’s-health financing system.

Thankfully a spokesperson for Senator Dodd has said that the loophole in question has been removed.

Importance grade: 10; I have said since day 1 of this blog 18 months ago that the institutions, ideas and people that led us down the road to bloat and ruin had to change if we hoped to avoid similar problems in the future.  That a major financial regulator has spoken up about one of the most critical components of any proposed financial industry overhaul legislation is critically important.  At least one regulator is not toking from the hookah pipe.  Amen!

Jason