Congress can't fail to address "too-big-to-fail" problem.
IS BORING BEST?
"We had steady long-term growth that focused on productive industries like manufacturing and new knowledge industries when we had a financial system that was boring and well-regulated. Financial innovation has not led to a stable, prudent system that works for either people or business."
Prof. Prentiss Cox, University of Minnesota
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The financial crisis and resulting recession were clarion calls for stepped-up financial regulation. Accordingly, President Obama has proposed to Congress wide-ranging measures that would greatly impact Wall Street and Main Street.
But it will take the congressional end of Pennsylvania Avenue to tackle the plan's biggest shortfall: not adequately addressing "too-big-to-fail" -- the idea that financial firms such as AIG are too interdependently intertwined and thus need to be bailed out by taxpayers because their failures could bring down the entire financial system.
It's not that the president's proposal doesn't try. One element of the plan would grant new powers to the Federal Reserve Bank to regulate "systemically important" financial institutions, and to increase the capital reserves required beyond current standards. But those steps might not be enough.
Gary Stern, president of the Federal Reserve Bank of Minneapolis, recently told Congress: "I do not think that intensification of traditional supervision and regulation of large financial firms will effectively address the too-big-to-fail problem."
University of Minnesota Prof. Christopher Phelan, who is a consultant to the Minneapolis Fed, agrees. "They believe that just by getting those regulations right they can make sure this just doesn't happen again," Phelan said. The Obama plan "doesn't solve the essential moral hazard problem." One option would be to require firms to more specifically detail and guarantee how they would meet their financial obligations in the face of business failure -- without taxpayer aid.
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