Mark Thoma points us to
the House Republicans on the Financial Services Committee just voted to repeal “resolution authority.”
Let’s review the history. When the crisis hit, the government bailed out many financial firms — shadow banks as they are known. That’s not what it does when an ordinary bank fails. When ordinary banks fail, the government takes over the bank, puts the good assets in one pile, the bad assets in another, then repackages the good assets into a new bank that is sold back to the private sector as soon as possible.
This has many advantages, including the ability to replace managers of failed firms instead of rewarding them with a bailout. So why wasn’t this approach adopted during the financial crisis? The Treasury argues that it did not have the legal authority to take over large shadow banks — these banks fell outside of the existing regulatory umbrella (there is dispute on this point, some people claim the government regulators could have twisted existing regulation to allow this, but government regulators insist otherwise). Thus, government regulators believed there were only two (bad) choices. Let too big to fail banks fail and suffer the economic consequences, or to bail them out, including bailing out the owners and managers who had led the banks to disaster. If it had resolution authority — the ability to step in take over when banks fail — the rewards to management could have been avoided, and taxpayers could have been better protected in other ways, but limits on legal authority gave regulators only two bad options. Do nothing, or bail the banks out.