Fed's Fisher Wants To Break Up Big Financial Firms

Fed's Fisher Wants To Break Up Big Firms
MAR 3 2010, 11:08 AM ET

Dallas Federal Reserve Bank President Richard Fisher said today that he would advocate a plan to break up large firms that pose a systemic risk to the economy. While many policymakers in Washington believe that regulation needs to ensure that firms can fail, far fewer are willing to break them up to accomplish that end. Since there's still some possibility that the Fed will end up the systemic risk regulator, it matters if its leaders come out in support of breaking up too big to fail firms. Unfortunately, Fisher joins only a small minority of leaders at the Fed who support splitting up such firms.

Here's what Fisher said, via the Wall Street Journal:

"Given the danger these institutions pose to spreading debilitating viruses throughout the financial world, my preference is for a more prophylactic approach: an international accord to break up these institutions into ones of more manageable size--more manageable for both the executives of these institutions and their regulatory supervisors," Fisher said, adding that he'd also support unilateral action by the U.S. on this matter.

"I think the disagreeable but sound thing to do regarding institutions that are TBTF is to dismantle them over time into institutions that can be prudently managed and regulated across borders," he said. "And this should be done before the next financial crisis, because it surely cannot be done in the middle of a crisis."

Fisher admits that he's the exception, as most at the Fed think breaking up firms is too extreme a measure. But he isn't alone. Kansas City Fed President Tom Hoenig has also come out in support of breaking up dangerously large firms in the past. So the chorus is still quiet, but growing.

If the rest of the leadership at the Fed came out in support of breaking up firms deemed too big to fail, then I would have a far easier time supporting its getting the role of systemic risk regulator. If its directive is to make sure firms don't grow too large, break them up if they already are and prevent mergers when systemically risky firms might be created, then I would be less worried about its other conflicts of interest. Of course, Congress would also have to give the Fed its blessing to have that power.

Could this happen? The House version of financial regulation that passed does contain some language providing break up authority. The Senate's original version did too. But it's unclear at this time whether whatever bill that the Senate finally comes up with will still contain this authority. Given the challenge Banking Committee Chairman Christopher Dodd (D-CT) faces in getting anything controversial in there, I kind of doubt we'll see break up authority included.

And that's a problem. Even though larger firms could create failure plans to detail how they would be wound down by a resolution authority if they ran into trouble, there's no guarantee these plans would actually work. It sounds great in theory, but only in theory. Until the economy enters another financial crisis, it's impossible to know if these failure plans will really hold up when the economic landscape looks very different.

Breaking up systemically risky firms is the most direct way to address the too big to fail problem. It would be messy, but it's also the only way we can have some certainty that firms can collapse without taking the entire economy down with them. It's nice to see another Fed president join the cause, but unless others follow, it might not much matter.