Paul Volcker is clearly too old and too independent minded to feel any need to avoid criticising the White House and the Treasury, although he has a role in Barack Obama’s administration as chairman of the Economic Recovery Advisory Board.
Mr Volcker has been agitating for some time about what he regards as an inadequate approach to dealing with large financial institutions that combine commercial and investment banking arms. He has called for some form of reinstatement of the Glass-Steagall Act.
In his evidence to Congress this morning, he zeroed in on the problem that a range of big institutions, now including investment banks such as Goldman Sachs and Morgan Stanley, as well as traditional commercial banks and hybrids such as JP Morgan Chase, are being designated as “systemically important”.
The clear implication of such designation, whether officially acknowledged or not, will be that such institutions, in whole or in part, will be sheltered by access to a federal safely net in time of crisis; they will be broadly understood to be ‘too big to fail’ . . .
In fair financial weather, the important institutions will feel competitively hobbled by stricter standards. In times of potential crisis, it would be the institution left out of the ‘too big to fail’ club that will fear disadvantage.
Compare that with the evidence of Tim Geithner, the Treasury Secretary, yesterday:
Identification of a firm as a Tier 1 financial holding company will not convey a government subsidy – it will be no guarantee of extraordinary governmental assistance in the event of financial distress. To the contrary, it will be a guarantee of substantially stricter supervision and regulation by the government – an intensity of government oversight that will serve as a strong disincentive for forms to become too big, complex, leveraged and interconnected.
On the whole, I agree with Mr Volcker and cannot help but think Mr Geithner is indulging in wishful thinking. As my column this morning noted, such institutions gain higher ratings and a lower cost of funding, as well as the comfort of a “heads I win, tails the taxpayer loses” implied government backstop.
In return for that, they merely have to suffer (or continue to outwit) their regulators. That will be irritating but it sounds like a good bargain to me.
The problem here, as Mr Volcker identifies, is that last year’s extraordinary events have made explicit what governments wanted to avoid disclosing – that large financial institutions will be propped up in times of trouble.
The only way to convince the market otherwise, and to reduce the obvious advantages of becoming a Tier 1 financial firm, is to let at least one of them collapse next time. That was what the Treasury tried to do with Lehman Brothers but could not hold the line.
Until then, being ‘too big to fail’ is going to be too attractive for most big institutions to resist. I would be surprised if any of them choose, as Mr Geithner suggests, to shrink themselves.
