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Too Big to Fail?  Not Anymore

New plan puts financial institutions on tight rope

Washington made a huge headline when it tackled the Basel Committee on Banking Supervision report that would require large banks to create contingency plans that would plan out their demise slowly in case they still not fare well. The committee knows for its capital adequacy standards released a press report that states “… Recognizing the wide diversity in national legal and resolution frameworks, the Committee’s report represents an internationally agreed set of recommendations for improving resolution. It recommends that national authorities seek convergence of national resolution tools and measures to promote the coordinated resolution of banks active in multiple jurisdictions. The report also recommends that systemically important cross-border banks and groups provide a plan to preserve the firm as a going concern, promote the resiliency of key functions, or facilitate a rapid resolution or wind-down should that prove necessary.”

And it seems everyone approves of it (but not the banks of course who’d do everything to squeeze out the public’s money). A great supporter of the plan, Lawrence H. Summers, the director of the National Economic Council says, “… It is wrong that taxpayers thousands of miles from Wall Street should be at risk because our financial system gives authorities no choice but to commit taxpayer money or to accept collapse and chaos. Without the prospect of failure, it is difficult to contemplate the application of market discipline. That is why we must develop a means to manage the failure of financial institutions. That is why we must insist that institutions go through the exercise of planning for their dissolution in the event of crisis before a crisis comes. Our financial system will not be fail-safe until it is safe for failure.”

I highly agree to what Summers thinks about the plan. From the beginning, I was in doubt as to how long the notion of “too big to fail” would last in the industry. There’s certainly no room for any bank that created loan programs that were too risky and who have greedily feasted on the public’s money. In fact, I wasn’t expecting the Basel Committee to prescribe such rules at this stage when most banks have successfully repaid their TARP money. I even thought the bailout issue is a thing of the past for these folks.

Harold Green, principal of the international housing research firm The Scollard Group, puts it best, “…The incentive to take unreasonable risks would be greatly reduced if the pay check of the people writing and approving the loan was based on the quality and performance of the loan. For instance, fees should be earned and paid out over the term based on performance. Compensation should be reduced if the loan defaulted or if it was terminated.” Care to listen Citigroup?

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