The Rosner Amendment, or the last line of defense in a financial reform bill
By Mike Konczal
So part of the financial reform package is allowing regulators to wind down large financial firms in a way similar to the way they wind down commercial banks. One question is, "When do you wind these firms down?" Is it when all hope is lost and everyone is running for the door? No, ideally it should be before that, when the firm still has some value.
People have different opinions on what kind of trigger should be used for resolution authority: amount of assets, how risky the debt structure ("tenor") is to bank runs, credit default swap ratings on certain types of debt, etc. But who gets to decide where that line is? Should it be Congress, or should it be the regulators? For commercial banks, Congress wrote it into a 1991 law ("tangible equity in an amount -- (i) not less than 2 percent of total assets"). Some say that this works well, because it ties the regulators' hands and stops regulatory discretion and procrastination. Others say that having it in law is too binding on regulators, and many failing banks skip to a failed state too quickly.
Economics of Contempt asks me whether I think Congress should write the line for a failed systemically risky bank into the bill, and argues that that is a bad approach. I tend to agree. I'll have more on this here soon, but I view the risks as a combination of size of liabilities and cross-section of liabilities (how much of the debt is short-term). Regulators should have discretion on this.
But. But I don't trust them. I want some level of democratic accountability here without trying to pretend that the law will be smart enough to handle all kinds of problems. So what can we do?
I'm going to propose something I'll call the Rosner Amendment, since Josh Rosner wrote it down after I discussed my worry for real accountability in a "regulators make all the calls" bill. Rosner wrote the securitization chapter for our Make Markets Be Markets conference, and this is what he suggested to any financial reform bill (my bold):
I propose an amendment that requires legislatively required action be taken against any “too big to fail” institution which becomes undercapitalized, requires any governmental or government agency guarantees of its obligations or governmentally supported purchase of its assets outside of the normal course of activities, receives funds from the Federal Reserve’s window with terms of more than 60 days or draws against any industry funds raised for funding the risks of these institutions. Specifically, the Directors, Officers and senior management of any institution that draws on the industry funds or receives any relief should immediately lose his/her pay and future benefits and, as soon as safely feasible, replaced by regulators. As importantly, directors, officers and all senior managers of such troubled TBTF should be explicitly prohibited from becoming employed as Director, officer, senior manager or consultant at any regulated financial institution or an affiliated holding company or operating subsidiary for a period of five years.
The first part is basically saying, "Hey, here are all the bailout conditions." And after clear bailout conditions, here are clear rules for what happens if you are bailed out -- the managers need to not work in the financial industry for five years.
If you are someone who is not part of the top 1 percent, this makes perfect sense. If you are a school bus driver who drives his school bus into a volcano, guess what -- you can't be a school bus driver anymore. If you are a lawyer who goes insane during a court case and attacks the
judge, guess what -- you are now disbarred. And if you run a systemically important financial company into the ground putting taxpayers on the hook, guess what -- you can't run a systemically important financial company for five years.
Trust me, the managers of any of those failed community banks that the FDIC scoops up every Friday will have a lot of trouble getting another banking license. Why should the biggest 30 firms have any less trouble?
This will immediately take care of a huge amount of agency problems within large firms. Managers will have good incentives to distinguish between skill and risk in terms of traders' profits if their own jobs are on the line. Firms where embedded managers don't want to take the risks of being systemically risky will immediately start de-risking. It kills a lot of birds with a single stone.
And I'd sleep better at night, knowing that there was some sort of simple rule that demands accountability both from the regulators and from the financial sector. How about you?
Mike Konczal is a fellow with the Roosevelt Institute and the author of the Rortybomb blog.
Washington Post editor
April 1, 2010; 12:00 PM ET
Categories: Financial Crisis , Financial Regulation
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