Friday, November 14, 2008

Too big to fail

If there is one positive thing about this crisis is the significant expansion it has made to our vocabulary: An entire menu of credit-crunch jargon so widely employed and so instantly recognized that it’s bound to make it to the next edition of Merriam-Webster.

Take my favorite for example, “deleveraging.” At the depths of linguistic obscurity only a few months ago, the term has emerged as the most widely accepted response to any question that seems to matter these days.

“Why are emerging markets getting killed?” “Deleveraging”.

“Why is the dollar strengthening?” “Deleveraging.”

“How’re you doing?” “Deleveraging” (That’s my elevator-kosher alternative to what would have otherwise been “Pretty sh**ty!”).

Still, there seems to be one term whose meaning has yet to achieve consensus: “Too big to fail.”

First attempts to define it began back in March, post Bear Stearns bailout. At the time, lack of a precedent in recent history, together with the silence of Merriam-Webster on the issue, gave the Fed the excuse to adopt the “you’ll know it when you see it” approach. A couple weeks later, Ben tried to formalize the “definition” while testifying in Congress:

Too big to fail: An entity “participat[ing] extensively in a range of critical markets… [..] the sudden failure of [which] likely would lead to a chaotic unwinding of positions in those markets and could severely shake confidence. [A company whose] failure could also cast doubt on the financial positions of some of [its] thousands of counterparties and perhaps of companies with similar businesses… [and] would cause adverse effects [on] the real economy through its effects on asset values and credit availability.”

Not bad for a first attempt. But by the time of the crisis of Fannie and Freddie, it was clear to some that the term’s definition was in urgent need of expansion, with Hank taking the lead:

Too big to fail: An institution playing “a central role in our housing finance system” (thanks to our mindless policies in recent years); whose “debt is held by financial institutions around the world” (like, the Chinese, who must keep on buying our debt to help us finance our absurd levels of consumption); and whose “continued strength is important to maintaining confidence and stability in our financial system and our financial markets” (yes, we need Fannie and Freddie to buy all these junky mortgage securities out there that no one else is ready to buy).

With that expansion in place, one might have thought that by the time of the Lehmans’ crisis, Hank and Ben were confident they had it straight:

NOT too big to fail: “A major investment bank” whose troubles have been “well known for some time—evidenced, for example, by the high cost of insuring its debt in the market for credit default swaps” and whose potential failure investors and counterparties have had time to prepare for.


One day later, as AIG was going down, there was a feeling the definition had to be reworked:

Too big to fail: A large and complex financial institution the failure of which comes one day after the disorderly failure of another major financial institution and, as such, “would severely threaten global financial stability and, consequently, the performance of the U.S. economy.”

The critical part here is the “one day after.” And that’s because one day later, Morgan Stanley and Goldman Sachs come under pressure and are deemed “too big to fail" soon after. So that within a few more days, in the midst of panic, confusion and soul-searching, the term is redefined once more:

Too big to fail: Every broker-dealer… by definition! And as many distressed commercial banks as we can save!

So now we have the banks. But what about AIG? It’s an insurance company. Surely Hank must have had nightmares about this semantic inconsistency so, soon enough, he decided to expand the applicability of “too big to fail” to non-bank financial institutions (like insurers). This of course opened the door to non-bank-non-insurer financial institutions (à la GMAC).

“Is that an open door I see before me?” asks General Motors. “If financials are too big to fail, how about us, the US auto sector? The spokesperson of the American workforce?”

So now we have a linguistic battle between an outgoing and an incoming Administration and, with command of the English language not the current President’s strongest point, it’s Nancy Pelosi who steps in:

Too big to fail: One or more institutions the failure of which “would have a devastating impact on our economy, particularly on the men and women who work in that industry.”

Insightful stuff… I mean, who would have thought that (any) men and women at the risk of losing their jobs (thanks to their industry leaders and their lobbyists, who have been scr*&*ing up for years now) would be facing devastation?

But let’s go back to Merriam-Webster and the future of our language. This “men and women” qualifier is critical--effectively inviting all sorts of companies (with male and female workers) to knock on the door, be it Macy’s (“the world’s largest store”!), Starbucks (key for our morning sanity!) or the entire pulp and paper sector.

Did I say companies? Seems that even that’s not broad enough for our friend Hank. In what appear to be signs that, after months of sleepless nights, he’s kind of losing it, he announced on Tuesday that he is scrapping the original purpose of the Troubled Asset Relief Program (TARP), which was to buy (you guessed it) “troubled assets.”

Instead, he is planning to use the money to support, among other things, the securitization market: A market that for the past few years has permitted the excessive consumption and over-indebtedness of American households by repackaging their credit card debt, home equity loans, car loans, what-have-you and selling them to a broad pool of investors in the form of bonds—the very “toxic assets” that are now behind our credit crunch. Hank’s objective? Get the credit going again, and the American consumer spending.

Spending! You’ve heard right. In the end, it’s the American consumer who is just too big to fail.


c said...

if a company can be "too big to fail" or really "too big to let fail", then shouldn't they be prevented from getting that big. if we're going to let a company grow to the size that its failure can wreak havoc on "system" it just shouldn't be allowed to get that big.


Anonymous said...

Hank has unhelpfully told us that "too big to fail" should read "too interconnected to fail". The chirade of unravelling and settling credit derivatives in the wake of the Lehman collapse (and then the Icelandics) has since proved nobody knew the reality of counterparty risks until the horse had already bolted.

Regulators will now bite down on those markets - coined over-the-counter (OTC) or "opaque" in the self-assured financial jargon that is now our common currency. Those OTC markets lacked effective supervision from authorities that were content to remain as ignorant of the risks as the investors, or the banks' own CEOs. And now nobody has the moral highground to prohibit the lawmakers from doing as they wish.

Dave (another hack).