04/27/19 COMMENTARY: IF THIS SAFETY NET SNAPS, WHO PAYS?

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COMMENTARY: IF THIS SAFETY NET SNAPS, WHO PAYS?

The spectacle of bankers toasting the latest breathtaking megamerger under the crystal chandeliers of New York's Waldorf-Astoria Hotel is suddenly turning into a weekly ritual. But in the bland hallways of Washington's regulatory agencies, the mind-boggling speed at which banks, brokerages, and insurance giants are consolidating--and changing the face of finance--is cause for anxiety. ''This has taken us by surprise,'' says one stunned regulator.
The regulators have good reason to feel overwhelmed. Bureaucrats trained to monitor banks loan-by-loan may be unable to get their arms around new behemoths like Citigroup and the BankAmerica Corp.-NationsBank Corp. combo, which are racing toward the trillion-dollar barrier. ''The marketplace is moving so fast that the government is unable to keep up with it,'' says William M. Isaac, former chairman of the Federal Deposit Insurance Corp. ''Federal regulatory systems are 10 years out of touch.''
If the regulators are anxious, then taxpayers should be, too, because they'll be stuck with the tab if these supermarriages don't work out. To prevent costly bailouts, Washington must rethink how banks are regulated--by shifting more of the risk of failure to private investors, and encouraging the free market to police itself.
HEFT FACTOR. Granted, the U.S. financial industry is far healthier than a decade ago, when Congress shelled out $150 billion to buy out more than half the nation's thrifts. The ability of commercial banks to expand their branch systems nationwide leaves them less vulnerable to regional slumps and less dependent on one economic sector--like the oil-reliant Texas banks of yore. But given the sheer vastness of the new megabanks--Citigroup will have nearly $700 billion in assets--a single mega-failure could bankrupt the taxpayer-backed deposit insurance fund. At a mere $30 billion, it suddenly looks inadequate.
Despite Citigroup's newfound heft, the conglomerate holds just roughly $50 billion in U.S. deposits. Rampant speculation by aggressive bond traders at its Salomon Smith Barney subsidiary or faulty underwriting at the Travelers insurance division could cut deeply into Citigroup's capital structure. Federal regulators would feel obliged to prop up the parent institution under the hallowed ''too big to fail'' doctrine. ''With the safety net starting to extend beyond banking, the potential taxpayer exposure has grown,'' notes Arthur J. Rolnick, research director at the Federal Reserve Bank of Minneapolis.
If these new conglomerates are indeed considered too important to fail, then government should not continue to assume all the risk. Indeed, Congress should seriously think about shifting more oversight authority to the group that can best weed out the troubled institutions: the markets themselves. After all, the private sector--with its own capital at risk--should be far more diligent at monitoring behavior that threatens insolvency than bureaucrats who have little at stake.
Surprisingly, one of the leading proponents of market-based regulation is one of Washington's most important regulators, Fed Chairman Alan Greenspan. He believes that ''rapidly changing technology is rendering obsolescent much of the old bank examination regime,'' particularly when it comes to overseeing complex products such as derivatives.
Policymakers can start by ending the practice of making whole large depositors in failed banks. Rather, they should be made to suffer losses on one-third of any accounts that exceed the $100,000 FDIC limit. Corporations and other institutional investors would suddenly be more careful where they parked their cash--and stop supporting shaky banks that pay higher interest rates.
FAT FINES. Another idea floating around the Fed would allow banks to determine the proper capital reserves--presumably less than is now required--to back bank trading in bonds and other securities. The tradeoff: If a bank's trading losses exceeded a certain amount, the bank would be subjected to punitive fines. Brookings Institution economist Robert E. Litan favors requiring all banks to hold uninsured bonds as roughly 10% of capital reserves. This mandate would minimize taxpayer risk by creating a new group of watchdogs--the bondholders--who could provide ''early warning signals'' of brewing problems.
A more radical approach would be to replace the government-run system for insuring bank deposits with private insurance. Here's one way it could work: Private guaranty ''agents''--say, insurance brokers like Marsh & McLellan Cos.--would serve as the intermediaries between banks seeking private deposit insurance and a syndicate of guarantors, most likely other banks. With on-site inspectors probing the banks' financial health, these private agents would set the premiums paid by banks.
Admittedly, the private markets aren't perfect--witness the herd mentality that sweeps Wall Street periodically. But with capital darting across the globe at the speed of light, it is becoming increasingly difficult for any one country's regulators to keep pace. ''The world is going to have to move to private contractual guarantees,'' says Washington bank consultant Bert Ely. ''It's easier to bridge borders through the use of private contracts than with regulators.''
As the financial industry moves boldly to change the rules of the game, the regulators need to keep pace with innovative oversight. The bigger these new goliaths of finance get, the greater the consequences if they stumble.
By Dean Foust

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