Remember AIG? The American taxpayer has sunk $150 billion into the failed insurance giant and backed another $300 billion of corporate risk because it was “too big to fail.” Because the entire global system was connected to AIG, its collapse would have been the financial equivalent of a Deep Impact-asteroid strike. Now the AP reports that Obama wants to cut off any future need for the phrase “too big to fail”:Under the administration’s proposal, companies such as Citi, Goldman Sachs and others in a broad top tier engaged in complex transactions would face stricter scrutiny and have to hold more assets and more cash as cushions against a downturn.They also would have to anticipate their own demise, drafting detailed descriptions of how they could be dismantled quickly without causing damaging repercussions. Think of it as planning their own funerals — and burials.
So far, most public response to the news has focused on the first part, and with reason. The repeal of Glass-Steagall in 1999 led to so much consolidation in the financial industry that a few companies making bad decisions nearly brought down the entire global monetary system. But it is the second part that interests me the most.
For AIG was not a “bank,” and therefore was subject to none of the regulations a “bank” would face. Thus, no legal mechanism existed to manage a bankruptcy; and since the FDIC already struggles to meet the needs of failing banks (seven more failed over the weekend, bringing the number to 52 so far this year), there was no governmental agency prepared to take the insurance giant into receivership even if the regulation had existed.
NPR’s This American Life did a great show in March about how the FDIC deals with failed banks. The agency enters the bank on Friday afternoon, brings more people than the bank has employees, and spends the entire weekend going through its books. By Monday morning, the FDIC has to reassure depositors their money is safe and assemble a complete picture of assets and liabilities.
In contrast, AIG had tens of thousands of employees handling all of its accounts at offices spread across the world. The Federal Deposit Insurance Corporation simply doesn’t have enough people to handle that scenario, nor does it have the international authority.
So what was the government to do?
A bank — or an entity acting just like a bank but pretending to be an insurance company instead — cannot collapse on its own without immense collateral damage: first a run on the bank, followed by runs on other banks connected to the first bank, followed by runs on banks connected to those banks. The last time that scenario happened, we called it the Great Depression.
The alternative was — and remains — to throw money at AIG until the bleeding stops, if it ever stops. Which is why the second provision of Obama’s regulatory proposal is even more important than the first.
There is no way to avoid having systemic risk, or very big banks, in a globalized economy. You can make efforts to retard their growth; you may require them to hold more assets and capital as a buffer against risk. But until there is a way to take over and dismantle them when they fail, all the regulations in the world won’t prevent another massive bailout.
