Transactions: May 4, 2009

You probably don't know this, with your head plunged into the swirling uncertainties of the financial crisis, but the world is a simple place. Trees bloom, flowers flower and the sun gleams like raindrops on a plastic yellow raincoat. Simple things, straightforward things, are, ipso facto, good; tangled, gloomy, neurotically knotty things are, by extension, bad. Complexity is the devil's playground. Show me a derivative instrument with more than two moving parts and I will show you a satanic garden tool. My mantra is: Make it simple, Paco. Let us move to credit card-free rural environs, pitch a tent, build a hut, pet the fish and befriend the badgers. Simple is transparent, obvious, comprehensible by ordinary folks who Twitter. Complex is an invitation to cronyism, conspiracy, greed.

Believe it or not, this brings us to the concept of too-big-to-fail. For anyone who's been awake for, say, a decade, the current celebrity status of too-big-to-fail is remarkable. Too-big-to-fail testifies before Congress; blogs, tweets and spars with Jon Stewart; and, under the initials TBTF, markets a line of luggage and sports shirts. The term had a brief moment of notoriety in 1984, when Continental Illinois, a big Chicago bank with scant consumer deposits and lots of corporate loans, suffered a hot money run after losing its shirt through an affiliated oil-and-gas bank in an Oklahoma City strip mall. The government bailed it out. Although the feds got paid back, and Bank of America eventually acquired Continental, regulators, in their hushed regulatory dens, anguished over more big banks failing, thus heaping more humiliation upon them when they had to explain this to Congress. This must never happen again! Indeed, while many streamlets fed the roaring bank consolidation of the '90s, one of them was the regulatory desire never to have to save a TBTF institution again. There were two parts of this problem, however: You could worry about banks getting too big, or you could fret about uncompetitive or inadequately diversified banks, which tend to collapse in stiff breezes. Like quantum physics, you can't fix one problem without screwing up the other. So regulators opted for size and diversification and planned their retirements.

Now TBTF is back. We have abandoned the notion that big is stable and competitive because, well, it turned out to be a crock. The simple answer currently circulating as part of conventional wisdom's traveling Chautauqua show is that all we need to do is break up big banks and everything works out. Indeed, as an extension of that simple remedy, we are mulling a "systemic regulator," which may be the Federal Reserve or may be a new agency, that will monitor financial institutions and order up various invasive surgical procedures if they grow too big and too risky, from cutting leverage to adding capital to breaking 'em up. Now, while this sounds good, there are some, alas, knotty details; indeed the kind of annoyances we've experienced already (see Ken Lewis on disclosure). How do we define TBTF or, in up-to-date lingo, a systemic-risk institution? Do we measure it by capital, deposits, assets, leverage, ATM machines? (We did so well on capital.) Do we draw the same line for all banks? And what if it's not a bank at all, but a hedge fund or a hedge-buyout-investment bank? How do we handle growth? Say a hedge fund rockets from obscurity to gargantuan in three years. Do we order it to give funds back, which is like ripping its heart out, or reduce leverage, which involves mere suffocation? How much disclosure is necessary? What is the legal framework for intervention? (For all the talk of using antitrust, those murky rules don't necessary jibe with TBTF.) Will these institutions be competitive with giant foreign banks? Will they be fat targets for slick foreign acquirers?

And that's the easy stuff. The hard stuff involves governance. If we assume there is no single equation for systemic risk or TBTF -- that's a reasonable assumption given the multiple factors involved -- then it comes down to human judgment. Oh no, not them! Who, pray tell, will set the parameters, make the decisions, oversee what is really a mighty lever over the financial economy? The ultimate authority will be Congress, which makes me feel better. But the problem here, besides Congress, lies in that immense power to determine profit and loss, expansion and contraction. The fact is, the power to break up a large institution is exactly like the power to prick a swelling financial bubble. It exists, but its very effectiveness means it will rarely, if ever, be used, until, of course, everyone, including Congress, cottons onto the problem, in which case the hut has burned down. Such power in a democracy is never, shall we say, simple. Sorry, Paco.