Who Will Carry the Water?
By Thomas Cooley, Paganelli-Bull Professor of Business and International Trade, and Kermit Schoenholtz, Professor of Management Practice and Director of the Center for Global Economy and Business
In a full-fledged systemic crisis, involving a shortfall of capital in the financial sector as a whole, the instrument holder would be selling rainy-day insurance to the entire financial system.
In spite of this progress and the Dodd-Frank law notwithstanding, the specter of 'too big to fail' still haunts the financial landscape. It is hard to imagine that a future U.S. Treasury Secretary would risk another Lehman crisis by imposing large losses on a behemoth's creditors, let alone sacrificing several financial giants in a systemic crisis. Such doubts tilt the financial playing field in favor of big intermediaries, which receive a subsidy in the form of lower funding costs (and higher credit ratings) due to this perceived insurance.
Cross-border entanglements make it difficult to resolve a G-SIFI without a crisis. When Lehman failed, it had nearly three thousand legal entities in fifty countries. Such cross-border operations trigger complex interactions between the bankruptcy procedures of multiple countries, encouraging a self-defeating grab race for assets by regulators and counterparties alike. Large, unnecessary -- and potentially crisis-triggering -- losses are likely to result.
Read full article as published in The Huffington Post