Breaking up money-pit behemoths is necessary

blondboinsd · #1 03-22-2009, 09:51 PM

Thoughts?

Over the past two weeks, Americans have been increasingly outraged about the $165 million in bonuses that financial giant AIG paid its executives, many of whom helped create the financial debacle that has pushed the world economy to the brink of depression.

The public is right to be irate. AIG's argument that these bonuses are somehow sacrosanct because they are contractual obligations comes at a time when autoworkers, state workers and even journalists have had their pay and benefits slashed despite previous contracts or assurances.

But the truly outrageous part of this affair is not the bonuses. Instead, it is the fact that we taxpayers have spent an estimated $170 billion – roughly a thousand times as much as those bonuses – to keep this ailing behemoth alive, as part of the $1 trillion or so that we've spent bailing out Wall Street.

We have spent this money because top regulators and politicians have determined that AIG, Citigroup and a coterie of other Wall Street financial firms are “too big to fail” – or 2B2F in Twitter-speak – meaning they are so big that if they collapsed, it could lead to financial Armageddon.

AIG alone has a portfolio of derivatives nominally valued at $1.7 trillion, including hundreds of billions of dollars in risky mortgage-backed securities. And that's after some intense slimming. When the bailout began last year, AIG's derivatives totaled $2.7 trillion, roughly the equivalent of the gross domestic product of the United Kingdom, the fifth-largest economy in the world.

Imagine the financial earthquake that would happen if England declared bankruptcy and you've got a good picture of what would have happened if AIG suddenly went belly up. Even now, its derivatives are nominally worth more than the economies of Canada, Brazil or Russia, as measured by the World Bank.

How did AIG, Citigroup and the other derivatives-swollen monsters on Wall Street get so big?

These companies have long ranked among the world's biggest financial firms, but they grew to truly gigantic size over the past decade thanks to a spate of deregulation and a dearth of law enforcement by the federal government.

Over the past 20 years, the government stripped away many of the regulations that once bound the financial sector. In 1999, the Financial Services Modernization Act swept aside firewalls between banks, insurers, securities firms and investment banks. In 2000, the Commodity Futures Modernization Act shielded derivatives from federal regulation.

These acts eroded New Deal regulations that had been designed to prevent banks from engaging in the kinds of activities that had led to the Great Depression. But the deregulators had no fear that a similar financial debacle would occur again.

“This was a bipartisan fiasco,” said Timothy Canova, professor of international economic law at Chapman University in Orange.

Much of the deregulation was spearheaded by Republicans on Capitol Hill, led by then-Sen. Phil Gramm of Texas, who chaired the Senate's Banking Committee, with the active support of President Bill Clinton. Congressional Democrats were initially nearly unanimous in their opposition to the deregulation, though most eventually came around, thanks to White House cajoling.

The result was that banks like Citigroup grew to monstrous size through mergers and acquisitions (the 1999 modernization act was passed to retroactively legalize the merger between Citicorp and the Travelers Group), and other financial institutions, such as AIG, fattened their portfolios with questionable derivatives, many of which are now worthless.

So how should we handle such behemoths? Here are my thoughts:

First, prepare to pull the plug on AIG and any other financial giant that requires billions of federal dollars to survive. Providing a pipeline of government aid to these institutions is like providing life support to the bio-engineered tyrannosaurs from “Jurassic Park.” They never should have been allowed to exist in the first place, at least not in their current bloated form, and we're doing ourselves no favor to keep them alive.

“AIG deserves to be put out of its misery,” said Eli Lehrer, senior fellow at the Competitive Enterprise Institute in Washington, D.C. “The money hole that it has become is an outrage for the country and an enormous burden for the taxpayers. It should not be able to exist as it is.”

Second, before we pull the plug, make sure we can handle the fall. These entities are only 2B2F if there's no net to catch them.

During the savings-and-loan crisis of the 1980s, as hundreds of financial institutions went belly up, the government set up a new agency, the Resolution Trust Corp., to dispose of their assets. The RTC had its flaws – there were constant charges of cronyism – but it also succeeded in ensuring the relatively smooth disposition of nearly $400 billion in assets. A revamped RTC could be structured to take care of the 2B2F institutions.

“Putting AIG into some kind of conservatorship is probably the answer,” said James Hamilton, economist at San Diego State University. “There should definitely a dramatic event to show that this is a new era, with new management and new obligations. That has to be the strategy, instead of hold our breath, put more money in and hope things will work out. That's the strategy that we've been operating under for the past year and a half, and I don't think it's a winning one.”

Third, carve up the 2B2F entities so that they're never 2B2F again. Although many of us look back at Franklin Roosevelt as an example of how to handle our current financial woes, perhaps we should consider emulating a different Roosevelt: his trust-busting cousin Teddy.

Teddy, after all, got his face carved into Mount Rushmore after using newly crafted antitrust laws to break up some of America's largest corporations, notably Standard Oil. Teddy Roosevelt proved that no entity was 2B2F – or at least not too big to break up.

A government-spearheaded breakup of the biggest firms, including AIG, Citigroup and Bank of America, could prevent companies from becoming 2B2F in the future.

“The idea of 'too big to fail' is really killing us,” said Dan Seiver, economist with San Diego State University. “We should make sure that nothing is too big to fail in the future.”

As we split up these institutions, we should also consider reinstituting a modernized version of the Glass-Steagall Act, the New Deal banking law that was largely shredded by the 1999 modernization act. Glass-Steagall may have been too restrictive for 21st-century banking, but our current regulations are far too permissive.

Once again, it could be time to take a look back at Teddy Roosevelt. As a one-time boxer, he had a fighter's mentality when it came to governing: “Don't hit at all if it is honorably possible to avoid hitting,” he once said. “But never hit soft.”

So far, the Obama administration has been hitting soft. It's time to go for a knockout blow.

JCL · #2 03-22-2009, 10:59 PM

Thanks for posting this. I don't disagree with the theme. I also like how the article moves beyond partisanship, and recognizes that both parties have been part of creating the mess.