Too Big to Fail: Let’s Make it Law

This article first appeared on Minyanville.

Bankruptcy is just such a pain in the ass. Who needs it?

In an attempt to institutionalize the concept that certain “systemically important” firms are too big to fail, Treasury Secretary Timothy Geithner and Federal Reserve Chairman Ben Bernanke are petitioning Congress for expanded federal powers to seize and dispose of certain non-bank financial institutions if they get into trouble.

The 2 top US regulators argue that important lessons have been learned in the wake of the disastrous federal takeover of American International Group (AIG). Bankruptcy laws, they say, don’t adequately protect public interests when fallout from the collapse of a big financial firm would do substantial damage to the system at large.

Geithner and Bernanke agree the power should rest within the federal government, but don’t see eye-to-eye on who that regulator of last resort should be. Bernanke suggests the responsibility could be handed over to the FDIC, already a specialist in dealing with failed banks. Geithner, on the other hand, thinks his Treasury department should handle such messy events.

Barney Frank, House Financial Services Chairman and always one to offer up valuable solutions to important problems, said this morning “We need to give somebody, somewhere in the federal government the power” to put failing non-banks “out of their misery,” according to the Wall Street Journal. Thank you Mr. Frank - the specificity of your suggestion is truly remarkable.

Ever since Bear Stearns collapsed just over a year ago, snatched up by JPMorgan Chase (JPM) for a song, courtesy of a $29 billion federal backstop, the Fed and Treasury have become skilled in the dark arts of ad-hockery to protect the battered American financial system. Scantily disclosed and hugely complex bailouts, rescues and guarantees have become the norm as officials scramble to prevent the collapse of certain key institutions.

As the world’s financial system has become more interconnected, big banks and other financial firms have grown increasingly dependent one on another for survival. Derivatives and round-the-clock trading have rendered the likes of Morgan Stanley (MS), Goldman Sachs (GS) and formerly AIG, as essential to the well-being of the global economy as big banks like Citigroup (C) and HSBC (HBC).

Meanwhile, outside the world of high finance, companies operating in the rest of the economy still live in what's left of the free market. Failure, a natural part of the capitalist system, means declaring bankruptcy and closing up shop. The system for disposing of failed firms may not be perfect, but allows for a healthy, needed cleansing of firms that didn't make it.

Allowing the government to control this process lends itself to immense political influences, likely dragging out rescues years longer than necessary. And as we're now seeing with AIG, once bureaucrats get involved in managing a business, contracts and other legal obligations become mere suggestions.

As Washington salivates at its ongoing power grab, taking increasing control over our economy, the free market dies - bit by painful bit.