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Should resolving large financial firms be a political decision?

By Anonymous

I'm not sure I buy this argument from Yves Smith:

Treasury has asked for open-ended authority to resolve large financial institutions, which is pretty much a blank check. That?s a breathtaking power grab by the Executive and should not be acceptable in a democracy. It wasn?t surprising that post the TARP that Congress would be completely unwilling to go there. Any decision to wind up a large bank is going to require Congressional authorization; the amounts at stake are too large for this not to be a political decision.

Leaving aside that Treasury is not, in fact, asking for open-ended authority to resolve large, complex financial institutions (LCFIs), I disagree that resolving a LCFI should necessarily be a political decision. I've seen variants of this argument elsewhere, and when I first read Yves' post, I didn't think twice about her argument, because it kind of sounds like it should be correct. But the more I thought about it, the less I agreed with it.

Yes, the amounts at stake are large, but why does democratic legitimacy require Congressional authorization at the very last minute (and on a case-by-case basis)? What would be undemocratic about enacting ? through the proper democratic channels (i.e., a bill passed by Congress and signed by the President) ? a framework for resolving LCFIs ahead-of-time, which delegates the decision on whether/when/how to resolve a LCFI to federal agencies?

I think we can all agree that Congress, as an institution, isn't exactly set up to make the quick, consequential, and technocratic decisions that a successful resolution of a LCFI requires. Exhibit A: the TARP vote fiasco. The extreme uncertainty caused by that situation was bad for everybody, regardless of what side you were on in the TARP debate. Personally, I'd rather not relive that nightmare.

There's nothing wrong with Congress acknowledging its own limitations, and making a conscious decision to delegate the authority to resolve LCFIs to better-equipped federal agencies. That's what we've done with the FDIC's resolution authority, for example, and the numbers can get astronomical there too. JPMorgan's commercial bank, which would be resolved by the FDIC, has over $1.6 trillion in assets. BofA's commercial bank has over $1.4 trillion in assets. But I don't see anyone demanding that the FDIC give up any of its resolution authority. (My guess is that that's because most of the critics of Treasury's proposal are big fans of the FDIC's anti-Wall Street rhetoric, and trust that the FDIC will make the "right" decisions. That's not directed at Yves; it's just my general sense.)

In Treasury's proposal (pdf), the decision on whether/when to resolve a LCFI would be made by the Treasury Secretary, in consultation with the President, and only after receiving a formal recommendation from the Fed's Board of Governors and the FDIC (or in rare situations, the SEC). It's important to note that all the agency officials who would be involved in this decision ? the Treasury Secretary, 7 Fed Governors, 5 FDIC Board members, and 5 SEC Commissioners ? are confirmed by the Senate. I'm on record saying that this "systemic risk" determination should be made when an institution is initially deemed a Tier 1 financial holding company, rather than frantically at the last minute, when the officials' main concern is getting the announcement out before Asian markets open. (Because everyone knows that if the announcement isn't made before 8 p.m. on Sunday, it doesn't count. Just ask Hank Paulson.) For our purposes though, it doesn't really matter when the decision is made by federal agency officials; my point is simply that there's nothing about the decision to resolve LCFIs that requires the direct involvement of Congress.

Full post as published by Economics of Contempt on November 07, 2009 (boomark / email).