October 27, 2009

The Opposite Of Capitalism

Here's the lead paragraph from the Associated Press:
President Barack Obama on Tuesday embraced a House bill that would give the government unprecedented power to seize bank holding companies and other large financial firms teetering on the brink of collapse and stick their competitors with the cost.
Whiskey.  Tango.  Foxtrot.

Since when does Ford have to pay for the failures of General Motors?  Well, actually, that would be since the UAW was given a functionally controlling interest in GM while still locking its employees into Ford's labor force.  So, bad example.  Ahem...  Since when does Google have to pay for the mistakes of Microsoft?  It doesn't.  In any kind of a sane world, should Microsoft make a significant mistake, Google gets to capitalize on it.  Why is the financial services sector any different than that?

Look, I can see the argument that more stringent regulation of financial services providers might be necessary given recent events.  Certainly I can understand, if not necessarily agree with, the political will to use the government's power to get financial services companies to behave in a more conservative fashion.  But this bill does not do that.  This bill means that if Bank of America makes a series of risky loans and fails, Wells Fargo and MBNA get to pick up the tab and pay for it -- not B of A's stockholders, which is who properly should bear that risk.

Note, of course, that we're not just talking about banks here.  When I use the term "financial services company" that can mean a bank but it can be any entity that offers financial products of any nature -- home mortgages, mutual funds, annuities, universal life insurance policies, derivative funds, and so on.  So yes, I'm looking at the brokerage houses, and the insurance companies, and the hedge funds here.

But the problem is that the regulations are going to be written by a "council" of the biggest of these financial product providers, under the leadership of the Federal Reserve -- and its activities in seizing and addressing failed financial product providers will be funded by the members of the council itself, not by the government.  Leaving aside the whole fox-guarding-the-henhouse nature of the manner in which the regulations would be drafted (this would be, quite frankly, par for the course) the problem is that when it comes time to put bite in it, we're talking about massive amounts of money and it has to come from somewhere.

When even Barney Frank admits that this creates a "perverse incentive," it's a bad idea.  No, this is not just a "bad idea."  It is an abyssmally bad idea.  We could send space probes out to search this vast galaxy of ours for worse ideas and it would take centuries before they returned any likely candidates.

The President says he likes the idea because it shifts the burden of rescuing a failed banking institution from the taxpayers to a "council" of other banks.  Whose conduct would be heavily-regulated by the government, which would force the other "council" members to pay for the rescue and rehab of their failed competitor, all under the guidance and supervision of the Federal Reserve.  Which I thought existed for the purpose of controlling the money supply and the interest rates at which the government lends and borrows money.

Bool-shit.  If Bank of America fails, then there are three good ways under existing law to handle that:
  1. The failed bank can be acquired by one of its competitors, at a fire-sale price.  The particulars of the merger must be approved by the Securities and Exchange Commission and more recently, by the Secretary of the Treasury.
  2. The failed bank can declare bankruptcy, and either seek a reorganization or a liquidation under the supervision of the Bankruptcy Court and a Bankruptcy Trustee.  This will result in the assets of the bank being liquidated and sold off to competitors, or being reorganized and rehabilitated.  The United States of America has automatic standing to intervene in the public interest in such a proceeding.
  3. The failed bank can be seized by the Federal Deposit Insurance Commission, which will result in it being placed in receivership, there to either be merged, liquidated, or rehabilitated -- sort of an involuntary bankruptcy.  Here and only here do taxpayer dollars come in to play, and that is done only to guarantee the safety of deposits.  (The receiver is paid out of the remaining assets of the failed bank.)

These ways of handling failed banks work fine.  There is plenty of room for governmental involvement and supervision in all of them so that the public can make sure that conservative, smart, and ultimately beneficial decisions get made about how all of these things happen.  Now, if the proposal were only to expand the scope of the FDIC or to create another government entity analagous to the FDIC for other kinds of financial services company, I would probably not be saying much of anything. But that's not what's on the table here.

So we've no need of a fourth way of dealing with this, in particular not a fourth way that involves the seizure of the assets of a company that avoided the mistakes of the failed competitor.  To further quote the AP:
Federal regulators already can dismantle banks. But the government was powerless last year at the height of the financial crisis when large bank holding companies and other non-bank institutions, such as insurance giant American International Group, started failing.
Who should pay to dismantle these firms had been considered among the toughest questions that Congress had to answer after last year's near-collapse of several firms that prompted hefty government bailouts.
Lawmakers know that voters are still angry from the bailouts and don't want to see taxpayer money on the line. At the same time, businesses say it is unfair to force them to invest their capital in advance to pay for the mistakes of others.
"It is unfair to force them to invest their capital in advance to pay for the mistakes of othes."  You don't say. 

Now, this terrifyingly bad idea isn't the end of America as we know it, so let's not panic just yet.  Here's why I say that.  If I were forced to pay a tax, that would be one thing.  This isn't a tax.  It's a taking.  That makes it a Fifth Amendment issue.  If I owned stock in, say, SunTrust Bank, and SunTrust was required to participate in this "council" and then use its assets to rehabilitate MBNA which was teetering on the brink of failure, I'd sue the government.  My property -- that is, the bank which I owned and its assets -- would be taken from me for some kind of a public benefit, and that means that the government has to compensate me for that.  I think I'd win on that seizure claim.

But just because the courts are there to protect against this sort of an abuse does not mean the idea should be endorsed.  It is a terrible idea and it should be resisted mightily.  It is one thing to say that segments of the free market that impact the public benefit need to be regulated.  Reasonable people can disagree about that.  It is something else to say that the market as a whole must be directly controlled by the government to correct the mistakes of one of its members.  That is what the President is talking about.  That is not capitalism, in which a competitor either profits by dint of its cleverness or fails by dint of its risky behavior.  This is the opposite of capitalism.  Let's get our Congresscritters to stop this idea in its tracks so we don't have to bother a court with it, why don't we?

And egad, something else just occurred to me.  If you thought it was expensive for the government to bail out failed banks using taxpayer money, just wait until it tries to do it for free.  A poignant thought on the day our national debt topped twelve trillion dollars.

UPDATE:  Banks within the FDIC system are required to pay money into the FDIC to help fund its depositor-protection activities, in what amounts to a mandated insurance policy. This is qualitatively and quantitatively different than FDIC member banks being required to pay in enough money to bail out their competitiors when they fail.


Left Coast Rebel said...

Great post, do you think this may find it's way to the Supreme Court?

Transplanted Lawyer said...

Yes, if:

1. The law actually passes, which is not a foregone conclusion, and

2. This "council" goes ahead and actually does what its threatened.

Libertarian Advocate said...

Truly exceptional post. I gotta put you up in my feed profile. Thanks, yet again!

Libertarian Advocate said...

whoops, meant my blogroll feed.