Sirota: 'Too big to fail' means too big to be private

Or, as Nassim Taleb said, if it might have to be bailed out tomorrow, nationalize it today.  As Sirota explains, there is free-market thinking behind this prescription.  It's about keeping a clean separation between what is government's, and what is the private sector's, without all this quasi-national bailout baloney and airs of "protecting capitalism" with no-strings government financing.

If It's 'Too Big To Fail,' Then It's Too Big To Be Private

By David Sirota

March 3, 2009

 

I appeared yesterday at the top of Neil Cavuto's Fox News show to discuss the potential for financial industry nationalization. You can watch the clip here. I tried to use the opportunity to float a fairly simple - and old-fashioned - concept: If something is "too big to fail," then it's too big to be in private hands.

The term "too big to fail" is a euphemism for any institution that is so important to the entire nation's most basic well being, that society cannot let that institution fail. This is why one of the foundational principles of civilized society has always been nationalization - ie. government control - of the institutions that are "too big to fail": institutions like the military, whose failure would mean a basic loss of national security; law enforcement, whose failure would mean a basic loss of civil order; and infrastructure construction, whose failure would mean the crumbling of commerce. The government, as the most powerful representative of society as a whole, runs these institutions/services because they are too important to be allowed to fail.

 

Unfortunately, the hard-right and center-right ideologues who ran the government for the last 30 years gutted the basic laws and enforcement mechanisms (financial regulations, anti-trust prosecutions, etc.) that prevented a myriad of financial institutions from becoming "too big to fail."

 

The American Insurance Group is the best example of this - a company that, as the New York Times notes, essentially based its business on a risky scheme to sell insurance to other corporations against colossal housing market failure. This allowed huge banks and investment houses to effectively offload their own absurdly risky housing investments by "insuring" those investments against loss with AIG - a shuffling of paper and deep-frying of books that let those banks leverage themselves even more, sans regulation. When the housing bubble burst and the banks called in their insurance, AIG was asked to pay up, and it couldn't, because it never expected to have to back up its insurance policies. But because AIG was so big - because it had so singularly cornered the market on such insurance and had essentially become the insurer of last resort - it couldn't eventually pay up, its failure would result in a cataclysmic ripple effect of defaults.

 

So now everyone is focused on the short-term question: Should we temporarily nationalize AIG and the biggest banks, or should we keep forcing taxpayers to get all the downsides of nationalization (ie. throwing money at the companies) without any of the upsides (i.e. ownership of the companies, power to throw out management, etc.)? Obviously, I'd say the former, but I'd go a step further: When it comes to an AIG - a company that is effectively ensuring the rest of the economy against loss - we shouldn't temporarily nationalize it, we should permanently nationalize it, or at least its core functions.

 

As I wrote in an earlier post, we shouldn't be afraid of permanent nationalization, because it is - thankfully - already all around us. Indeed, in some sectors of the economy, we have embraced nationalization thanks to an era where our government at least considered the possibility that if a function or service or entity is too big to fail, it is too big to be private.

 

That era's government believed a minimum retirement benefit and health insurance for the elderly is a "too big to fail" kind of function - too important to be subjected to the whims of the private marketplace. So we now have government-run Social Security and Medicare. That era's government also created the Pension Benefit Guaranty Corporation, which nationalized the catastrophic insurance of pension plans. It forces corporations to pay premiums that underwrite a fund that pays out the pensions of companies that go bankrupt. The government deemed that function - catastrophic pension insurance - as a "too big to fail" kind of function, understanding that if the service was in private for-profit hands, there would be a risk of that private venture overleveraging itself, and then failing when it needed to pay out retirement benefits to millions of Americans.

 

Now, clearly, it's time to resurrect the principle that if something is too big to fail, it's too big to be private. We can resurrect that principle both through far tougher regulation that prevents individual private institutions from ever becoming so singularly important to our nation,* and by nationalizing the few core functions and services that are probably best left to the government as insurer of last resort. In the former category, that means much stronger financial regulation, and in the latter category it means some kind of nationalization of basic market insurance (and, I might add, health insurance).

 

If ever there was a time that the country was ready for this kind of back-to-what-made-us-great argument, that time is now.

 

* A key point here is the word singular: There is some safety in diversification and numbers - for instance, if a crucial function of the economy is handled by multiple businesses, then the failure of one of those businesses should (theoretically) pose much less danger to the overall economy than if that business was so singularly or monopolistically crucial as in the case of AIG.