Cleaning Up the Crisis

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It’s clear by now that a failure of regulation on multiple fronts helped to fuel the financial crisis. What’s more, according to Bob Pozen -- chairman of MFS Investment Management and author of the book Too Big to Save? How to Fix the U.S. Financial System -- government has also failed, in certain instances, to clean up the fallout from the crisis.

Pozen says the government went overboard in bailing out so many companies, as well as guaranteeing the debt of “everything in sight.” It was a mistake, Pozen charges, to give 600 banks so much money. He argues that the only reason so many banks received funds was that “people got panicked, and [government] just gave it out.” He points to American Express (NYSE: AXP) as an example: “It’s a good credit card company, but if it had gone bankrupt, would it have wreaked havoc on the rest of the system? Would lots of other institutions [have] gone down? Probably not.”

Pozen does note that these are not all-or-nothing situations. For example, in the case of Morgan Stanley (NYSE: MS) and its liquidity problems, he says it made sense for the government to permit the company to become a bank holding company, thus ensuring it could obtain more stable deposits by accessing the Fed’s window. “But we didn’t have to give them $10 or $20 billion in capital,” he says. “We could have solved the problem of liquidity by addressing that directly.”

We went overboard
Besides bailing out 600 firms, the government also guaranteed the debt of banks, thrifts, and their holding companies, Pozen notes. “It’s legitimate that we should have guaranteed some debt of, say, banks and thrifts that really had difficult problems issuing debt,” he says. “But for instance, John Deere (NYSE: DE). Do you consider that a financial institution? They (John Deere) owned an S&L, so since they were an S&L holding company, we guaranteed a few billion of their debt.” He also cites Target (NYSE: TGT), which owned an S&L, and General Electric (NYSE: GE) as big users of the government’s debt-guarantee program.

Pozen also questions banks like JP Morgan (NYSE: JPM) and Goldman Sachs (NYSE: GS), which paid back the preferred stock/federal money, but were still permitted to keep the guaranteed federal debt. “The question is, where do we draw the line?” he asks. “We’ve got to have a much more articulate and disciplined process.”

Rectifying the system
As part of creating that more disciplined process, Pozen says there are only two instances when large firms should be bailed out. The first is if the firm is central to the nation’s system of payments (the processing of checks, wires, and cash). The second is if the firm’s failure would lead to the failure of many other financial institutions throughout the world. Applying those criteria, Pozen says the appropriate number of bailout recipients is “probably in the 20 to 30 range, not in the 500 to 600 range.”

Another part of articulating a more disciplined process, Pozen says, would be to rectify the guaranteeing of bondholders. Through many of these bank bailouts (i.e., that of Bear Stearns), we bailed out the most sophisticated bondholders in the world; Pozen argues that we should stop guaranteeing new bank debt and let the current guarantees expire.

Additionally, Pozen would like to see a statute preventing the bailout of a financial institution unless the Treasury Secretary provides a written rationale for it. Pozen says the decision by the Treasury Secretary to bail out an institution should require approval from the Fed and the FDIC chairman, followed by a U.S. Government Accountability Office review after the fact. “At least we will understand why we did it and then see if it really made sense,” he says. “I think this would put some real discipline into the process.”

Listen to the entire Bob Pozen conversation here.