http://www.nybooks.com/articles/archives/2010/dec/09/economy-why-they-failed/
December 9, 2010 New York Review of Books
The Economy: Why They Failed John Cassidy
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Former Fed chairman Paul Volcker's laudable idea, which the White House adopted at the start of 2010, was that nondepository institutions shouldn't be allowed to shelter under the government safety net, and, legally, at least, they won't be able to. The US government now has the power, during a crisis, to take them over and close them down. (At the time of the collapse of Bear Stearns and Lehman Brothers, this authority was lacking.)
However, it is one thing to empower the Treasury and the Federal Deposit Insurance Corporation to fire senior bankers, wipe out stockholders, and impose losses on creditors. It is quite another thing for the authorities to exercise these powers. If Goldman, say, was to run into serious trouble shortly after giving up its banking license, it is hard to believe that the Treasury and Fed would shut it down and let the dominoes fall where they may. If markets were plummeting and creditors, depositors, and other counterparties were rushing to liquidate their positions, the authorities would come under enormous pressure to prop up the firm, or find a healthier rival to take it over. Then we would be back to September 2008.
Despite the best intentions of Volcker and others, the big six banks and an undetermined number of other financial firms are almost certainly still too big to fail. Taxpayer rescues of systemically important institutions can't be legislated away: the real issue is what can be done to reduce the likelihood that such measures will be needed. Apart from regulating individual lines of business that involve big risks, a tricky enterprise in the best of times, the options are either to greatly reduce the leverage that banks can take on or to break them up, so the failure of any one of them would no longer pose an insurmountable risk to the system.
Neither of these ideas is exactly revolutionary. Practically everybody agrees that excessive leverage played a key role in the crisis, and the idea of splitting up the largest banks has won the support not just of progressive economists but of the British Conservative Party, which formed a coalition government in May 2010; of Mervyn King, the governor of the Bank of England; and even of Alan Greenspan, the former Fed chairman. If the banks are "too big to fail, they're too big," Greenspan said in October 2009, and he went on to say, "In 1911, we broke up Standard Oil. So what happened? The individual parts became more valuable than the whole. Maybe that's what we need to do."
But far from insisting on drastic reductions in leverage and smaller banks, the Obama administration connived against measures designed to bring these changes about. Senator Susan Collins, of Maine, and Senator Blanche Lincoln, of Arkansas, both proposed amendments to the Dodd-Frank bill that would have forced the biggest banks to hold substantially more capital -- and real capital, not hybrid securities that are more like debt. After the Senate passed the Collins and Lincoln amendments, the White House and Treasury pushed Congress to drop them from the final legislation. A move to break up the biggest banks, such as Wells Fargo and Bank of America, which was sponsored by Senator Ted Kaufman, of Delaware, and Senator Sherrod Brown, of Ohio, didn't even get that far. The Democratic leadership in the Senate joined with Republicans to kill the amendment, which was voted down 61-33. "If we'd been for it, it probably would have passed," a senior Treasury official told New York magazine. "But we weren't, so it didn't."
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Michael