Without tough reforms, writes Robert Pozen, we'll probably face an ugly repeat of recent history
Too Big to Save?
How to Fix the U.S. Financial System
By Robert Pozen
John Wiley & Sons; $29.95
Here's an offer: Invest a lot of money in a faltering project, and if things go well, you'll get your money back and maybe a little upside; but if it all goes south, you'll bear the entire loss. Not exactly the sort of terms to which anyone of sound mind would agree.
But this, says Robert Pozen, is exactly what the government signed on for in 2008—and more than just once—as the financial world swayed on the brink of collapse. In Too Big to Save? How to Fix the U.S. Financial System, Pozen, an eminent money manager and authority on financial regulation, rails against the waste and poor judgment that characterize many of the bailout deals of that year. His term for it is "one-way capitalism"—since only the banks were in line for real gains. And readers won't be able to mistake his disgust that the players who had taken the most foolish risks found themselves in the most advantageous spots.
Government officials who would never have put their own money into deals such as the Troubled Asset Relief Program or the massive, sequential rescue of AIG (AIG) had little difficulty placing taxpayer funds in jeopardy. Pozen thinks the government should have taken common stock in bailed-out firms so that it could fully participate in the upside.
While he applauds the government for having stepped up aggressively to avert a mass panic, he takes issue with its lack of forethought—and not only about those potential returns. The Treasury, the Federal Reserve, and the Federal Deposit Insurance Corp., he says, simply forgot about the issue of moral hazard. As a result, their interventions practically guarantee excessive risk-taking.
Unless some drastic steps are taken, Pozen sees the future as a very dangerous place. His list of recommendations—corralled in the last of the book's four sections and summarized in blocks of bold text (perhaps for busy politicians)—is long. And he pleads his case well, in a thorough but digestible fashion. He'd like to see FDIC coverage on bank deposits lowered to $100,000 from $250,000 to reduce risk to the agency and keep its protection focused on those who need it most. He favors creating a standard operating procedure for liquidating "systemically significant institutions," including mega-hedge funds, when they fail. One reform he opposes: the reinstatement of Glass-Steagall. Pozen says independent investment banks are more likely to stumble than integrated "universal banks."
Perhaps most interesting, original, and controversial are his recommendations for the governance of financial behemoths. The prevailing model of a large board—10 to 18 directors, few with experience in financial matters—just isn't working. As a result, Pozen says, compensation practices are out of whack, bonuses are outlandish, and control of risk-taking is virtually absent. He thinks these bloated boards should be replaced by a small number of "superdirectors" who have the time, experience, and financial incentives to act as effective watchdogs over complex institutions. A sound idea—and one CEOs would surely oppose.
Although mismanagement and moral hazard may be unavoidable, Pozen's prescriptions offer a navigable route to minimizing them. But since the ambitious reforms he calls for seem to be more than Congress can muster, reducing our national risk may be more than we can hope for.