Who's really too big to fail?
Let some troubled financial firms fail, U.S. regulators tell Congress. Fannie Mae and Freddie Mac are exceptions.
America's top financial policymakers have a message about the government's role in times of turbulence: Bailouts not necessarily included.Skip to next paragraph
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"Allowed to fail." That's the way Treasury Secretary Henry Paulson, in a congressional hearing Thursday, said financial companies should generally be treated.
"Orderly liquidation," said Federal Reserve Chairman Ben Bernanke at the same hearing, outlining a possible response if a prominent securities firm faced bankruptcy.
Their words don't mean that the government is withdrawing from its backstop role in financial markets. In fact, the importance of that role was underscored this week as mortgage giants Fannie Mae and Freddie Mac saw their share prices plunge to levels not seen since the early 1990s. The two companies are so central to the home-loan industry that in a crisis regulators would have to step in.
Still, after cooperating to arrange the March rescue of securities dealer Bear Stearns, Mr. Paulson and Mr. Bernanke are reminding investors that government support has its limits.
Congress is considering how to reconfigure the nation's bank regulations after a year of turmoil and a decade of rapid change in financial markets.
Both the Treasury secretary and the Fed chairman say that such legislation is needed – including new regulatory powers to ensure the safety of the financial system on which Americans rely.
But in the hearing, they took care to stress that such moves will not be successful if investors and firms perceive themselves as shielded from often-harsh discipline of the marketplace.
"For market discipline to be effective, market participants must not expect that lending from the Fed, or any other government support, is readily available," Paulson said in his testimony. "For market discipline to effectively constrain risk, financial institutions must be allowed to fail."
The Bear Stearns intervention has raised the question of whether regulators now consider the largest investment banks – firms that originate securities like stocks and bonds – to be too big to fail. That is, the government will bail them out rather than risk a collapse that would affect the entire financial system.
Economists consider a few of the largest commercial banks to be too big to fail, although this is not enshrined as official policy.
Responding to a direct question on the four largest investment banks, Bernanke declined to call them too big to fail.