I will be speaking at an event on Capitol Hill on Tuesday, September 15. This is an anniversary of sorts for the financial crisis, and that is the topic for the event. I am planning a really hard-hitting talk. I am looking forward also to a talk by Russ Roberts.
I hope that reporters attend, for background if nothing else. As far as I know, the event is open to anyone, but advance registration is required.
One of the ideas that I might try to briefly outline is that we could use a paradigm shift in thinking about systemic safety. That is, instead of treating it solely as a regulatory problem, we should think of it as a business continuity problem. Rather than focus everything on trying to prevent failure, we should put effort into enabling our financial system to withstand failure. (Yes, I’m still beating my easy-to-fix rather than hard-to-break drum.)
Suppose that we had in place plans and processes to ensure that even with institutional bankruptcies, the ATM’s will operate correctly, credit card transactions will be processed, mortgage payments will be properly credited, and so on. That is, everyday financial transactions will not be disrupted. We do not necessarily need to guarantee continuity in every financial transaction. I would be inclined to omit credit default swaps and mortgage securities from the business continuity plan, for example. But where to draw the line is something to think about.
My point is that I would like to see regulators have sufficient business continuity procedures in place so that when a big financial institution gets in trouble, we have a viable and credible option for allowing it to fail. If we know that it can fail without breaking the ATM’s or other everyday financial processes that involve ordinary people directly, then we have a better chance of convincing market participants that failure is an option. If financial institutions believe that failure is an option, then they will take more prudent steps to manage their own risks, and they will be more inclined to control their exposure to institutions that are not behaving prudently.
I have at most a minute or two to touch on this idea, and I worry about whether people can grasp it that quickly. Your thoughts welcome.
READER COMMENTS
Patrick McCann
Sep 11 2009 at 5:12pm
Here’s a thought,
Suppose we consider the size of an institution to entail a certain amount of societal risk, solely for its behemoth nature creating perceived too big to fail situations. So firm size is a classic negative externality, and regulators could incentivize firms to pay a tax on those which reached a certain size, proportional to their size, which they could call an insurance premium and hold in some fund, which could supposedly fund corporate bailouts. The size of this insurance premium could be set through some interesting market mechanism or another. Also, bailouts would become predictable, if a firm somehow figured out a way not to participate, perhaps by headquartering itself in Bermuda, we would know it wouldn’t get a bailout. Those that became large enough to fall within the scope of this law would always get bailouts if they paid their premiums.
Billy
Sep 11 2009 at 6:21pm
Will Mercatus make this available online afterwards?
Gu Si Fang
Sep 11 2009 at 6:24pm
“I would like to see regulators have sufficient business continuity procedures in place so that when a big financial institution gets in trouble, we have a viable and credible option for allowing it to fail.”
That’s a great approach. I see it like an insolvent bank emergency kit / guideline. In any case, what has to be done will be done. Better get ready. The purpose is to allow depositors, creditors, shareholders and other counterparties to forecast reasonably well what would happen to them if their bank went broke (rather than wait for an uncertain decision). In such a situation, how to you distinguish an illiquid from an insolvent bank? You probably can’t, and so the kit should not depend upon successully making that distinction. When either one occurs, the emergency procedure kicks in. Debt-to-equity conversion is the main tool. It helps everybody evaluate what the remains are worth, but people should be prepared to see the price fluctuate… In the worst case where part of the deposit accounts had to be converted in this way, for instance, the amount of cash on the account would vary but it would still be possible to draw the remaining cash from an ATM.
Alex J.
Sep 12 2009 at 2:27pm
If you want to get the most out of a little, try to pack something counter-intuitive into a pithy metaphor or turn of phrase. I remember you had a blurb that got quoted from your congressional testimony.
Bill Drissel
Sep 12 2009 at 11:36pm
Dr K:
Please consider urging that regulators caused the meltdown as in your parable. Another point besides the three you made is that (at least in Europe) credit default swaps allowed banks to reduce their capital reqts even further.
Regards,
Bill Drissel
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