As advocates for shareholder rights, we strive to make sure our members are heard on important matters that affect all of our portfolios. That's why the White House asked for feedback from the Motley Fool community and agreed to answer your questions. Here is the fourth installment of our interview with Austan Goolsbee, chief economist for the President's Economic Recovery Advisory Board.
Search on the phrase "Too Big to Fail," and you'll get 28,000 references to the now-ubiquitous term for behemoth businesses that the government cannot allow to fail because the broader economy is tethered to the same cement galoshes. (See also: "Bailout," "moral hazard," "Freddie Mac (NYSE: FRE ) ," "Fannie Mae (NYSE: FNM ) ," "Bear Stearns," "AIG (NYSE: AIG ) ," "Citigroup (NYSE: C ) ," et al.)
"Too Big to Fail" was a hot topic in the call for questions for David Gardner's and my meeting with the White House to discuss the administration's push for financial-industry regulation reform. Here are some examples.
- Coconnor55 wrote: "'Too big to fail' and unregulated markets need to be addressed. All markets need to be transparent and public -- no shadow markets."
- blaueskobalt invoked the name of the former IMF chief economist: "Simon Johnson recommended progressive capital requirements for banks as a way to incentivize them to become smaller so that 'too big to fail' was no longer a reality with the biggest banks. Are you considering this policy? If not, why not?"
- TyrantBone said: "I would support having the agencies consolidated as long as the innovation was still allowed. Can't we force banks to take less leverage when 'bigger than life' financial products are gaining steam? Maybe not harm innovation, but limit abuse."
- Edfinn1 suggested: "No one is too big to fail, or smarter than the market. If institutions have cross-collateralized fancy new instruments, or designed new instruments too complicated to be explained and underwritten in a reasonable way, it's a fraud, a Ponzi or fattening. … To think anyone is too big to fail removes all discipline from the market, and rewards the insiders, management and entrenched few concentrated shareholders who cause huge losses to the market and the country. … Stop the regulatory shopping that allows an AIG or Enron to opt for regulation by the most captive, least able agency. Break up any entity that is 'too big to fail,' and restore discipline to the market."
Here's what Austan Goolsbee, chief economist for the President's Economic Recovery Advisory Board, had to say about big business failures and how the administration plans to handle future bailout situations.
The White House's plan to prevent future bailouts
The administration has a regulatory reform proposal (links to PDF document) that outlines how it plans to decouple insolvent businesses from the broader economy and prevent future late-night phone calls from distressed companies seeking bail.
The plan requires that "all financial firms that pose a significant risk to the financial system at large are subjected to strong consolidated supervision and regulation." A newly created eight-member Financial Services Oversight Council, chaired by the secretary of the Treasury, is responsible for that oversight. Gone is the SEC program that had been on investment-bank babysitting duty.
Under the proposal, the Federal Reserve will conduct regular stress tests of companies that meet the council's criteria for being "too big to fail." It will also look at capital standards for banks and bank-holding companies, and it will force federal oversight on non-bank financial firms, such as industrial banks credit-card banks, by turning them into traditional bank holding companies. Also on the council's agenda: figuring out what to do with Fannie Mae and Freddie Mac.
In a nutshell, the word to Wall Street is this: Break the rules and we'll wind down your business, break it up into pieces, fire management, or shut you down completely.
Size isn't everything
Being big doesn't necessarily make a bank bad. The real damage was done when gigantic institutions waded into complex financial products like credit default swaps. Bank executives saw big dollars and a way to skirt the rules by trading in a virtually unregulated security.
Fool members have suggested reinstating laws governing the separation between banking and non-banking business to provide a buffer between risky business practices and the economy at large. See yesterday's installment of this series, "Would Glass-Steagall Have Saved Us?," for the administration's response.
This is our time to speak up
The Fool is a hotbed of engaged and informed citizen-investors. And this is merely the beginning of our involvement. We'll be covering and commenting on this proposal and other bills the entire time, and we're committed to keeping our conversation with the administration going and representing you, our community of Fools. Enter your comments below about financial-regulation reform and what changes you, as an individual investor, want the administration to make.
Tomorrow on Fool.com, we talk with Goolsbee about the possibility that regulation will stifle innovation.
Fool.com columnist Dayana Yochim invests only in financial vehicles that can be described on the back of a single cocktail napkin. She owns no interest in any company mentioned in this article. The Motley Fool is investors writing for investors.