The Past Speaks

“Bailout Risk, Far Beyond the Banks”

That’s title of an article by Gretchen Morgenson in the New York Times. She reports that global financial regulators are moving towards the creation of a list of “too big to fail” non-bank financial companies. Many taxpayers around the world will be alarmed by this news, given our recent experience with “too big to fail” banks. Such banks are bailed out by governments whenever their investments go sour because governments are reluctant to allow a mega-bank to go down. Everyone knows that the mega-banks can’t fail and that makes the equity of firms such as JPMorganChase especially attractive to investors. Such banks enjoy an implicit subsidy and find it easier to raise capital, so they will just grow larger and thus “too big to fail” becomes even more of a problem. Moreover, their managers’ knowledge that they are protected by the state changes their calculus about risky investments. It’s a classic case of moral hazard.

According to the NYT,

Last week, global financial regulators moved a step closer to extending the TBTF principle to non-bank financial institutions. A paper published by the Financial Stability Board and the International Organization of Securities Commissioners laid out how regulators planned to identify financial entities that are not banks or insurance companies but nonetheless are systemically significant and whose failure could pose a threat.

Among the paper’s main suggestions: Investment funds with more than $100 billion in assets should be designated as systemically important and subject to closer oversight. Many of these funds currently fall outside of a strict regulatory regime or are subject to only a light touch by financial overseers. Many — think hedge funds — are also shrouded in secrecy.

None of this is earth-shattering news. But no investment executive wants his company to land on a list of systemically important financial institutions. The increased scrutiny that this would bring is unwelcome to many in the powerful asset management industry.

I’m not convinced that “no investment executive” would want the implicit subsidy conveyed by being on this list of systemically important financial institutions. In fact, I think that the opposite is true.