‘Too big to fail’ idea should end, FDIC chief says

The FDIC’s top officer said Friday that big financial institutions that take too many risks and become insolvent should be allowed to fail, with their shareholders and bond holders wiped out and top management getting the boot.

Sheila C. Bair, chairman of the Federal Deposit Insurance Corp., made the comments to the House of Representatives’ Financial Services Committee, which is considering changes to the nation’s financial services regulation system.

Her comments are similar to remarks in March by Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, Mo., which got wide attention for criticizing the “too big to fail” concept. That concept maintains that some financial companies are so intertwined with the economy that they must be bailed out.

Bair said if investors and executives think government will bail out such companies, a “vicious circle” of dangerous risk-taking results.

Large companies gain undue advantages over smaller competitors, she said, raising money at cheaper rates, growing more rapidly and taking even bigger risks. Investors become less cautious, ignoring signs of bad practices, Bair said.

“In some respects, investors, creditors and the firms themselves are making a bet that they are immune from the risks of failure and loss because they have become too big, believing that regulators will avoid taking action for fear of the repercussion on the broader market and economy,” Bair said.

Instead, she said, the government should set up an orderly system to resolve such problem firms, allowing their financial functions to continue while replacing management, eliminating shareholder value and taking other steps to restore them to order.

“In short, we need an end to ‘too big to fail,’” she said.

The proposed regulations are intended to prevent problems such as the financial crisis that began last fall with the failure of some large financial firms, prompting a series of multi-billion-dollar bailout measures by the federal government.

“We must get this right,” Bair told the committee. “In contrast to the current situation, this new regime would not focus on propping up the current firm and its management.”

Otherwise, she said, the nation will end up repeating the same costly bailouts of the past year.

One of the keys is to separate risky activities such as hedge funds from federally insured banks, she said, and to subject risky ventures to new financial rules.

Bair said past regulatory systems were not “sufficiently proactive” and instead allowed financial institutions to grow so large and complex that no regulator knew exactly what they were doing.

Too many activities were excluded from regulation by law, she said.

Such businesses should be required to have “financial buffers” to protect against the risks they take, plus restrictions on credit arrangements, she said.

She endorsed the Financial Services Oversight Council proposed by the Obama administration but said that version “lacks sufficient authority to effectively address systemic risks.”

Rather than being headed by the secretary of the Treasury, she said, its chairman should be appointed by the president subject to confirmation by the Senate.

Bair said Congress should change the laws that allow federal assistance before shareholders and creditors take losses and should set up a Financial Company Resolution Fund, possibly financed by levies on the financial companies, to cover losses from failures

Bair also said she supports forming the Consumer Financial Protection Agency to protect consumers from harmful financial products.

Contact the writer:

444-1080, steve.jordon@owh.com

« Money

Share