Too Bernanke To Fail?

There is no practical solution to "too big to fail," and no alternative to the Fed's ability to print money to ease potentially destabilizing financial panics.

• By HOLMAN W. JENKINS, JR.

Last week's show trial of Ben Bernanke, like all show trials, was less about convicting a man than about upholding a view of reality. An unspoken concordat authorized both parties to take refuge in their tropes. Republicans labored to portray Mr. Bernanke as a high-handed government bureaucrat, dictating terms to a private sector CEO.

Democrats wafted along on their preferred trope, the scheming businessman (Bank of America's Ken Lewis) extorting a bailout from the Federal Reserve.

Edolphus Towns, chairman of the House Oversight Committee, did his bit to frame the choice of bogus narratives, saying BofA's controversial Merrill Lynch acquisition was a shotgun wedding and all that remains is to find out who was "holding the shotgun."

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Fed Chairman Ben Bernanke

The effort of congressmen to uphold the distinction between the public and private sectors is noble, and doomed to fail in this case. Last week's hearing reflected unmedicated unease over two facts legislators recognize but resist acknowledging: There is no practical solution to "too big to fail," and no alternative to the Fed's ability to print money to ease potentially destabilizing financial panics.

Governments long ago authorized banks to operate with capital and reserve requirements inadequate to cover serious panics, with the understanding that government would step in. "We have chosen capital standards that by any stretch of the imagination cannot protect against all potential adverse loss outcomes," Alan Greenspan explained in a talk at the American Enterprise Institute this month. "Implicit in this exercise" is the occasional bailout of the financial system.

Roll back the tape: Bank of America was "too big to fail." Merrill Lynch was "too big to fail." Together they were "too big to fail." There was no way, ipso facto, Mr. Lewis would have sought to put the two companies together last September without the Fed's OK, and no way he would have failed to go to the Fed in December when he decided belatedly that Merrill's soon-to-be-revealed losses might endanger market confidence in BofA.

One strand is the argument, tested by some on the Hill, that Mr. Lewis owed a "duty" to inform his shareholders of the pending Merrill losses so they could vote against the deal. The Fed allegedly stopped him. But shareholders in "too big to fail" institutions are partners with the government too -- a partnership in which inevitably government takes the senior role when its safety net is in play.

Nothing proposed by the Obama administration or likely to find a footing in Congress will dissuade the capital markets from creating companies that, in a panic, politicians will judge too dangerous or costly to let fold. There will be no repeal of deposit insurance. There will be no repeal of limited liability for financial institutions, which would radically alter the ownership incentive to take leveraged bets.

This isn't the end of the world. "Too big to fail" has been the de facto law of the land since at least the late 1970s, and didn't impede the longest run of prosperity in U.S. history. But let's not make matters worse.

The Fed already is the "system regulator," and too often already has allowed protecting the value of the dollar (its first duty) to become subordinated to trying to soften the blow for financial firms of episodes of failed risk taking. The Obama plan for a SuperFed would take us farther down the wrong road.

Likewise, formalizing the status of some institutions as "systemically important" would only create, as Peter Wallison of the American Enterprise Institute argues, Fannies and Freddies galore. A new "resolution regime" might be useful but not if it places more AIGs in government hands. Better would be a rule that automatically imposes stiff debt-for-equity haircuts on bondholders if a firm needs long-term government financing to survive.

And Mr. Bernanke? His moment of twisting in the wind has created, surprisingly, an opportunity for Mr. Obama, who, after a suitable pause, can now reappoint the Republican-appointed Fed chief and make him a bit more of an Obama man.

Larry Summers, who is believed to want the job, is problematic on two counts: The White House might be accused of trying to install a political operative to support Mr. Obama's re-election; yet the ambitious and unclubbable Mr. Summers might actually prove a headache for the White House if he decided he should run the economy single-handedly.

Better the devil you know (and like personally). There's even an opening for a steroid replay of the Clinton-Greenspan bargain of the early 1990s: Mr. Obama gets a grip on spending; Mr. Bernanke keeps interest rates low. Just maybe we get out of today's mess without wrecking the dollar or snuffing the economy with killer taxes.