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A Different Take On Too-Big-To-Fail

Publication Date: 
February 23, 2010
Source: 
RIA Biz
Author: 
Sara Hansard

Professor Emeritus Kenneth Scott is quoted on the possibility of subjecting large financial institutions to bankruptcy proceedings:

Elizabeth’s note: Issues surrounding failures of big financial institutions are important to financial advisors on a number of levels. Never mind the broader economic and investing implications of their actions, mega-banks and their brethren are also the competitors of advisors, the employers of advisors and the source of most breakaways. After all banks now own all the wirehouses. With banks so inextricably tied to the advisory universe, it is important to consider the right course of action when they screw up — which they inevitably do. Sara Hansard has opened a window on this matter with her article. Neither saving AIG’s skin with a government bailout nor letting Lehman Brothers go down the tubes feels right to many people. This article advances our understanding of the issue.

While investment banks or broker-dealers may not like it, large financial institutions should have to go through bankruptcy proceedings like other companies, rather than a resolution system such as the one banks currently fall under, a group of free market academics and an investment advisory firm said Monday.

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A policy built around an adapted bankruptcy law would probably face stiff resistance from the financial services industry, the group acknowledged. “From their standpoint it might not look as good,” as a resolution process, said Stanford Law School professor Kenneth Scott. “The whole point would be to make failures tolerable for that kind of a large institution, so that there would not be the high probability that there is now that there would be a government-funded, taxpayer-funded bailout.”

Providing taxpayer funding to back up large financial institutions as the government has done over the past couple of years reduces risk for people who deal with the financial firms that receive the backing, and it reduces the cost of credit extended to the firm, Scott acknowledged.

But those advantages result in “heads I win, tails the taxpayer loses,” for financial institutions, Scott said. “That’s something that we want to get away from. And would all of the firms involved applaud that? I don’t think necessarily.”