Can the market help solve the market's problems?
Christopher Papagianis, a former special assistant for domestic policy to George W. Bush, has a smart critique of the Dodd bill's approach to executing systemically important, failed banks. His critique, essentially, is that it doesn't do enough to hurt creditors. It wipes out management and shareholders, but the folks who've loaned the bank money might still survive. That could lead them to prefer to invest with systemically important banks, making the too-big-to-fail problem even bigger. And we don't want that.
One way to handle this would be to attach the Miller-Moore amendment that passed in the House. If you're a creditor due to get your money back from a giant, failing, bank that doesn't have the money to pay you, you're losing 20 percent of your investment. Sorry, dude.
Papagianis goes in a different direction, arguing for an idea proposed by Chicago's Luigi Zingales and Harvard's Oliver Hart that would use credit-default swaps to measure risk. The CDS market did a much better job detecting stresses in banks than regulators did. So Zingales and Hart want to make the CDS market into a tripwire: If the CDS spread on a bank moved above 100 basis points (what that means isn't as important as the fact that it's a clear, objective number), regulators would have to enter the picture and begin stress-testing, and if that went poorly for the bank, converting debt to equity. (For a fuller explanation, head here.)
I like this idea. In fact, I argued for it in a recent Newsweek column, and I brought it up in my interview with Sen. Mark Warner. But as Mike Konczal points out in a critique of it, one of the preconditions is that credit defaults swaps move onto an exchange. I can back Mike up on that: When I spoke to Zingales about his idea, he said it required CDSs to be on exchanges. But Republicans have opposed putting the CDS market on an exchange. It's emerging as a major fault line in this debate.
So if Papagianis's take is going to emerge as the "smart conservative" position on resolution authority (and Reihan Salam is trying to make that happen), someone needs to persuade the Republican Party to get on board with its necessary preconditions.
Graph credit: CreditSlips.com.
April 15, 2010; 4:48 PM ET
Categories: Financial Regulation
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