An Examination of Systemic Risk
Tuesday, June 16, 2009SUSIE GHARIB: The Obama administration tonight is putting the final touches on its blueprint for new regulations for the U.S. financial system. The reforms will be released tomorrow. At the center of the plan are new tools and new rules to prevent what's called systemic risk, widespread risks that threaten the entire financial system. So why is this so important and why should we care? Darren Gersh explains.
DARREN GERSH, NIGHTLY BUSINESS REPORT CORRESPONDENT: Here is one way to think about systemic risk -- if you can bring down a building without destroying the neighborhood, the risk is not systemic. The challenge for regulators is figuring out before they collapse, which institutions could take down big chunks of the financial system. And that's not as easy as it sounds, says Lily Fu Claffee, a former top Treasury lawyer.
LILY FU CLAFFEE, PARTNER, JONES DAY: Because there are organizations that are not large, but if they cease to exist, if we stuck dynamite in their front door and blew it up, it would have systemic ramifications.
GERSH: The understanding of systemic risk has been stress-tested in this credit crisis. Bear Stearns was considered too big to fail and was rescued, but after Lehman Brothers was allowed to fail, regulators expanded systemic risk to include firms that are interconnected with many other firms. Some of the confusion is intentional, because regulators have been deliberately vague about what they consider a systemic risk. Brookings scholar Douglas Elliott says there's a good reason for that.
DOUGLAS ELLIOTT, FELLOW, BROOKINGS: There's been an allegation, which I doubt could ever be proved, that banks that are big, but not quite big enough to be a systemic risk might actually want to be bigger, because if they are systemically important, the taxpayer will pretty much have to rescue them. And if people know that, they are going to be more comfortable dealing with that bank.
GERSH: The Obama administration has already signaled it considers size and connections key components of systemic risk. But being more specific won't be easy.
CLAFFEE: You've heard folks in Congress warn that their could be over- regulation based on a definition that's too broad and you can also define it too narrowly.
GERSH: The definition matters here. Banks, insurance companies and even some hedge funds that are now found to pose a systemic risk will face more regulation.
ELLIOTT: They are clearly going to have tougher requirements. They are going to have to hold more capital. There may be types of business they are not allowed to do. There will be disadvantages and I guess the hope is that the disadvantages will roughly balance out the advantages.
GERSH: This may sound like a wonky policy debate, but it's not. Regulators have got to get this right if they're going to protect all of us from another crisis that could send stocks, home prices and the economy reeling. Darren Gersh, NIGHTLY BUSINESS REPORT, Washington.
