The usual comment whenever the failure of large financial institutions is discussed is "it’s too big to fail". There has been an assumption that the really big lenders are immune from failure, as Uncle Sam would never allow that to happen. That’s what makes Treasure Secretary Henry Paulson’s comments this morning so interesting:
He said the perception should be avoided that an institution is "too interconnected to fail or too big to fail" and added that "we must improve the tools at our disposal for facilitating the orderly failure of a large, complex, financial institution."
More specifically:
Knowing that Fed support is readily available could cause institutions to willingly take on too much risk, as they did in the run-up to the subprime mortgage crisis, he said.
"For market discipline to constrain risk effectively, financial institutions must be allowed to fail."
The discussion was sparked by problems in the investment banking world, but note Paulson said "financial institutions" not "investment banks".
What does this mean for the GSEs- specifically Fannie Mae and Freddie Mac?
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twist -
You are bringing up a good point here. You will recall that retired (and sorely missed) St. Louis Fed President Bill “The Butcher” Poole has been sounding alarm bells on this for many years. Just after 9/11 he started worrying at the concept of too big to fail. At this point he is tacitly implicating the GSEs in his worries by placing them right after his TBTF discussion.
Poole had sharpened his thoughts on this by the time he gave this late 2004 speech in Prague, when he addressed the GSE issue head-on.
Some readers may recall my Doomish “movie review” of “Debt in the Afternoon” (2005), starring the American Enterprise Institute’s Peter Wallison. In that recorded seminar, AEI’s banking gurus examine in depth the need they see to put Fannie and/or Freddie into bankruptcy if things get too hairy. At present, as Bill the Butcher pointed out, there is no legal way the GSEs can go into bankruptcy (it’s an issue in the reform legislation moving frantically through congress ahead of the election — and catastrophe).
Henry Paulson is about the only one who has any merit in this mess, I tend to agree with what has to see more often than any of the MOMO’s on wall street or in the white house.
As a regular reader of Slashdot.com, I believe you need to add the tag “Sudden breakout of common sense”
Poirot-
I would be worry that the tag would get rather dusty between posts!