Obama's New Battle Cry of Financial Regs: Too Big To Fail! Too Big To Succeed!


Writing in the Wall Street Journal, Peter Wallison the American Enterprise Institute zeroes in on the crux of Obama's new financial-sector regs:

The administration's plan would create what are essentially government-sponsored enterprises like Fannie Mae and Freddie Mac in every sector of the financial economy—insurers, securities firms, finance companies, bank holding companies, and hedge funds—where these specially regulated firms are to be designated. The result will be devastating for competition. Larger firms will squeeze out smaller ones and aggressive small companies will have less opportunity to overcome the government-backed winners.

Moreover, the administration's proposal to provide a special bailout mechanism for large firms confirms the likelihood that these firms will never be closed down or liquidated. Citing the market turmoil that followed Lehman's collapse, the administration will argue that failures like this are "disorderly." But failure comes from risk-taking—the very source of our economy's strength—and it is ultimately risk-taking and its consequences that the administration's plan is intended to prevent.

Wallison uses the fates of Lehman Brothers and AIG to lay out the likely outcome of such a policy.

The turmoil following Lehman's failure occurred because market participants expected, after the rescue of Bear Stearns, that any larger firm would also be rescued. When Lehman wasn't, all market participants were required to recalibrate the risks of dealing with all others, causing a freeze-up in lending and hoarding of cash. Lehman's failure itself did not cause any substantial losses, and within two weeks of its bankruptcy filing Lehman's trustee sold its brokerage, investment banking, and investment management businesses to four different buyers.

Contrast this with AIG, the administration's paradigm, which was saved by the government because it was allegedly too big to fail. That firm is gradually wasting away under government control, with the taxpayers footing the bill….

The president has said on several occasions, including in yesterday's speech, that "I've always been a strong believer in the power of the free market." But his administration's prescriptions tell a different story. In AIG, GM, Chrysler, Fannie Mae and Freddie Mac we can see the future that the administration envisions for our economy—a sclerotic and unchanging structure of big companies working with, protected by, and relying on big government.

It's an important piece and one well worth studying (hat tip: Veronique de Rugy of Mercatus Center and The Corner).

Wallison gave a spell-binding talk on the "Roots of the Financial Crisis" at Reason Goes Hollywood, our 40th anniversary bash held last fall. Go here for downloadable versions, embed code, and more.

Click below to watch the 25-minute presentation.