Some Banks Are Too Big To Fail

As the Congressional Oversight Panel examined the history of the near-collapse of Citigroup (C) and its plans to stay out of trouble, a Treasury official made it clear that the department believes that no bank is too big to fail no matter what the circumstances.

Herbert Allison, who is in charge of the $700 billion TARP program, told the group that “There is no too-big-to-fail guarantee on the part of the U.S. government.” Elizabeth Warren, who chairs the five-member Congressional Oversight Panel, begged to differ. She said that there was a public perception that any large bank in really dire straights would be bailed out for the sake of the financial system.

The Adminstration hopes to get around the “to big to fail” issue with the Volcker rule. This would separate the deposit taking operations of banks from the operations which take risks through proprietary trading that can be very profitable but which can also pull a bank under if trades don’t work out. That happened to hundreds of hedge funds last year.

Both sides of the argument fail to acknowledge the reaction that the public and business world would have if an institution like Citigroup went under. No matter what the government would say about the “firewall” built between any large financial firm and the rest of the financial system, the collapse of one of American’s huge banks would cause a panic and probably freeze the credit system again. Individuals and companies would lose their faith in the system, even if that was only temporary. But, even a short-lived loss of confidence in the American credit network would do irreparable damage to the government’s ability to handle the nation’s affairs in general and oversee critical companies like Citigroup  in specific.

A failure of a major banks might seem to be an isolated incident of the proper controls were in place, but convincing the public of that is nearly impossible.

Douglas A. McIntyre.