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Geithner Doubts He Can Identify Systemically Risky Banks

January 14, 2011 - by Donny Shaw

The Dodd-Frank financial regulatory reform bill that the Democrats passed last year didn’t take an aggressive approach to fixing the too-big-and-interconnected-to-fail problem that necessitated the bank bailouts. The Senate rejected an amendment to the bill that would have broke up the biggest banks and, instead, created a “Systemic Risk Council” to determine which banks are too big and interconnected and make them follow tougher capital and leveraging requirements. It’s supposed to keep the giant finance companies on a tight leash and avoid the shocks to the financial markets that would be caused by restricting the growth of a Goldman Sachs or Bank of America.

But it’s not guaranteed to work, and I’d say the latest comments from Tim Geithner, who is going to chair the council, do not inspire much confidence:

Tim Geithner has questioned the feasibility of identifying financial institutions as “systemically important” in advance of a crisis, just as the regulatory council the Treasury secretary chairs is supposed to start doing precisely that.

A report by a US government watchdog into the rescue of Citigroup quotes Mr Geithner as saying: “What size and mix of business do you classify as systemic? … It depends too much on the state of the world at the time. You won’t be able to make a judgment about what’s systemic and what’s not until you know the nature of the shock.”


Some officials are known to harbour doubts about the system but Mr Geithner’s public comments questioning the feasibility come at an awkward time.

“In the future, we may have to do exceptional things again if we face a shock that large,” Mr Geithner told the office of the special inspector-general. “You just don’t know what’s systemic and what’s not until you know the nature of the shock. It depends on the state of the world – how deep the recession is. We have better tools now, thanks to Dodd-Frank. But you have to know the nature of the shock.”

People familiar with the discussion said Mr Geithner was pointing out why it was important for regulators to retain discretion over the designation and that it was unwise to prescribe hard objective measures because that would allow institutions to wriggle out of the designation.

This sounds to me like an excuse to not do your job. If you’re serious about keeping a handle on systemic risk, you’d err on the side of caution and make as inclusive a list as possible so you don’t accidentally let firms through to take advantage of their lower capital and leverage requirement and get too interconnected. Instead it sounds like Geithner is inclined to keep a short list and wait until things get messy before making judgements, because, you know, that’s when the best decisions are made. Right.

This kind of waffling when it comes to actually taking decisive regulatory action is exactly why proponents of limiting bank size think hard-and-fast rules are the way to go. We’re probably not going to see another big effort to reform regulations of the financial sector, let alone a revamp of the basic structure, for quite some time, so, for now, let’s remember that we have humans in charge of implementing the Dodd-Frank bill and that they need encouragement from the public from time to time to not be lazy.

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