About two or three times we’ve heard Ben Bernanke announce what amounts to a revolution in US financial policy–the guarantee that no matter how unhealthy a major financial firm might be, it will not be allowed to fail. Importantly, this decision has never been approved by legislation, executive order or a judicial decision. Instead, it seems to have been made outside the constitutional structure.
Last night on 60 Minutes Ben Bernanke made one of the clearest statements yet about this policy.
(PELLEY) Are you committing in this interview, that you are not going
to let any of these banks fail? That no matter what their balance
sheet actually looks like, they are not going to fail?
(BERNANKE) They are not going to fail. But what we can do, should it
be necessary, is– is try to wind it down in a safe way.
One of the striking things about this new policy is the utter lack of public deliberation about it. We don’t know exactly how the policy was formulated or who might have approved it. We also don’t know exactly what this means. Should we assume that all loans or any counter-party risk has been transferred to the government of the US? Is only equity at risk with financial firms? Have we fully considered what this will mean for asset allocation and capital structure?
It’s a marked reversal of our former policy, which explicitly allowed for financial failures. Shouldn’t there have been some discussion period for such a policy revolution?
Keep in mind that this new policy’s closest precedent was the implicit guarantee of the obligations of Fannie Mae and Freddie Mac. As we’ve shown, that was a policy that was useless at best and probably unduly costly. In the end, it just shifted forward the costs of the program onto future taxpayers. There’s no such thing as a free guarantee. Eventually, it winds up being paid for. Shouldn’t we have a public debate about the potential costs of Bernanke’s unlimited guarantee?