About That "Resolution Authority"

Two contrasting articles in this week's Wall Street Journal editions beautifully illustrate the wide gap in perception concerning a concept known as a "resolution authority." I wrote this piece earlier this month on the topic.

Former Fed Vice-Chairman Allan Blinder wrote an editorial on Tuesday in which he all but assigned God-like power and omniscience to such an entity. He wrote,

"Here we do need a legislative fix- one that gives regulators a third way, between bankruptcy and bailout, that would either euthanize these institutions peacefully or resuscitate them under new management. That's what "resolution authority" is all about."

The next day, in his editorial revisiting the 2008 TARP, entitled "Rethinking the Bailout," Holman Jenkins, Jr., wrote,

"Another popular fix-it, a resolution regime for big banks, might help in time of calm, but big banks seldom fail in times of calm, and such a regime is no substitute for rolling out an indiscriminate safety net in times of panic. Quite the contrary: If it threatened bank creditors with real losses (as it properly should), invoking resolution authority would only feed the panic.

In a panic, remember, the problem isn't really bank size or interconnectedness- it's behavior, a fear that the public is one headline away from trying to yank its money out of the financial system....But let's face it: The real danger came from incentives that Washington scattered far and wide to much smaller, harder-to-see players that came back to haunt us all, including the biggest banks."

I'm solidly with Jenkins on the resolution authority issue.

Perhaps it's because Blinder was a Fed official for so long. Or a Princeton ivory tower professor. But he seems to simply ignore bankruptcy as if it's an inconvenient detail. Never mind that it was so important as to be included in the Constitution.

Instead, Blinder simply takes on faith that some new entity would be capable of doing what others have not.

Trouble is, it comes down to the people. And the Fed, FDIC and OCC all failed in their oversight roles during the real estate runup and subsequent meltdown. God knows the Fed vastly overstepped its authority, and the FDIC certainly tried its hardest, too.

No, we don't need another entity to invent something that already exists. By that I mean we have bankruptcy, and we have the FDIC to take over insolvent banks.

What Blinder, apparently not well-grounded in the real world, fails to appreciate is the inability for regulatory entities to easily identify the about-to-fail institutions. I wrote this in the prior, linked post,

"As I listened to Volcker and Corker, I heard, instead, a sort of semi-languid tone suggesting that someone from Washington would board a plane to visit the troubled firm and see what was going on.

In the real world, there's just not that much time. The unremarked upon reactions of trading counterparties to ailing and failing institutions is what seems to be unacknowledged by legislators and regulators.

There's a fine line between government seizure, without basis, of an about-to-fail institution, and the closure of an insolvent one. But if the government sends clear signals that no financial institutions that fails will, beyond deposit insurance, be assisted in any way, you can rest assured that counterparties will look after their own risks.

The Constitution specifies bankruptcy for failed firms. For some reason, regulators no longer wish to use that option."

Jenkins understands this. Blinder does not.

Stopping one financial institution's failure from creating a systemic panic is a laudable goal. But as long was we rely on regulatory agencies staffed by human beings to do so, such a process won't function reliably.

It's far more effective and efficient to clearly warn private institutions that they are obligated to look after their own counterparty risks with each other. That nothing will be done by government short of perhaps provide a bankruptcy court with financial services expertise and an understanding of the need for prompt adjudication of claims.

We don't need another regulatory entity or authority. We just have to use the ones we have more effectively.