Twenty-First Century Trust-Busting

Halfway through Michael Lewis and David Einhorn’s NYTimes Op-Ed (btw, when did those two hook up?) the reader begins to wonder why part of the longer-term solution to Citi’s problems isn’t a government break-up. Then, as if on cue, the boys drop the bomb themselves:

THERE are other things the Treasury might do when a major financial firm assumed to be “too big to fail” comes knocking, asking for free money. Here’s one: Let it fail.

Not as chaotically as Lehman Brothers was allowed to fail. If a failing firm is deemed “too big” for that honor, then it should be explicitly nationalized, both to limit its effect on other firms and to protect the guts of the system. Its shareholders should be wiped out, and its management replaced. Its valuable parts should be sold off as functioning businesses to the highest bidders — perhaps to some bank that was not swept up in the credit bubble. The rest should be liquidated, in calm markets. [Emphasis added] Do this and, for everyone except the firms that invented the mess, the pain will likely subside.

This is more plausible than it may sound. Sweden, of all places, did it successfully in 1992. And remember, the Federal Reserve and the Treasury have already accepted, on behalf of the taxpayer, just about all of the downside risk of owning the bigger financial firms. The Treasury and the Federal Reserve would both no doubt argue that if you don’t prop up these banks you risk an enormous credit contraction — if they aren’t in business who will be left to lend money? But something like the reverse seems more true: propping up failed banks and extending them huge amounts of credit has made business more difficult for the people and companies that had nothing to do with creating the mess. Perfectly solvent companies are being squeezed out of business by their creditors precisely because they are not in the Treasury’s fold. With so much lending effectively federally guaranteed, lenders are fleeing anything that is not.

You can argue about the wisdom or practicality of this strategy but it does bring to mind a certain symmetry with the turn of the last century when industrial and transportation firms were deemed too large to allow free and fair competition within the economy. Of course, that would require a government with more confidence that it has a legitimate role to play in the economy.

The last time breaking up a supposedly anti-competitive firm came on the national agenda, the Bush administration decided to let the ball drop. You can argue that the dynamic nature of technology solved the problem of Microsoft’s predatory practices. But then we’ll never know if Gates and Ballmer would be in a better position today if they had been split up by government decree.

What will the Obama administration’s approach be?


How to Repair a Broken Financial World?
New York Times; January 4, 2009

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