The Troubled Asset Relief Program watchdog agency says the government will have to struggle to keep "implicit guarantees" from distorting the financial services markets even after TARP shuts down.
The Congressional Oversight Panel, an entity that Congress created to oversee TARP and the efforts made to support American International Group Inc., New York, earlier released a report on the reasons that the current financial crisis occurred.
In the new report, Elizabeth Warren, the panel leader, and other panel members focus on exist strategies, and strategies for reducing the need for future government-run bailout programs for financial services giants.
The panelists end up concluding that exit and prevention strategies must be transparent, and that the government must focus on keeping people from assuming that it will bail out big financial institutions, but not the big financial institutions' smaller competitors.
"To the degree that lenders and borrowers believe that such an implicit guarantee remains in effect, moral hazard will continue to distort the market in the future, even after TARP programs wind down," members of the panel write in their report. "As Treasury contemplates an exit strategy for the TARP and similar financial stability efforts, addressing the implicit guarantee of government support is critical."
One way to reduce moral hazard is to establish credible procedures for liquidating or reorganizing failing businesses, the panel members write.
One is to create the kind of "resolution authority" that Congress is now considering; a second is to let troubled financial institutions take their lumps and go through Chapter 11 reorganizations; and a third would be to require use of "living wills," or contingency plans for winding down the operations of companies that are too big to fail and run into trouble.
"Advocates argue that the existence of such plans would avoid the shockwaves that the disorderly collapse of Lehman Brothers caused and AIG threatened, but it is possible that the very act of creating such plans might bring unexpected risks to the attention of management in time for them to be addressed," the panel members write. "However, even commentators generally in favor of this concept note that living wills are an incomplete tool without ensuring separation among an institution's component parts. This separation can take place along activity lines, where systemically critical functions must have ring-fencing capable of protecting them during the unwinding pursuant to the living will. In effect, if there are ways to permit such businesses to fail, then they are no longer too big to fail."
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