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Ohio State University, Moritz College of Law




We find ourselves in an economic crisis, the severity of which few persons living today have witnessed. Fear, the natural accompaniment of such crises, arises from our uncertainty about the depth and duration of the crisis. The consensus is that a restoration of confidence is fundamental to a recovery. From the eye of the storm, it is difficult to assess the effectiveness of attempts at quelling its ravages. Yet, we may have little choice but to begin making those assessments as the architecture of the new order is being designed now.

The origins of the current crisis are well recorded. 2 Topping the list of causal factors were a U.S. obsession with housing creation, unnaturally low interest rates, deregulation of financial and capital markets, a blind eye by policymakers to correlation risks to the economy, financial engineering, accounting doctrine, and, of course, the standby for all economic emergencies, greed. One factor that pulled together elements of all of these was the presence of several large and complex financial institutions, each of whose disorderly liquidation would have a disastrous effect on the financial system and on the real economy. The threat posed by these institutions to the public interest caused them to be grouped under the misleading heading "too big to fail" (TBTF). The title is misleading on the one hand, because it implies that institutions are readily identified as falling into this category, and, on the other hand, by the false signal that size alone matters when, in fact, other characteristics of a firm (complexity, leverage, interconnectedness) may be what creates the foreboding that spillover effects from a firm's demise will threaten the economy.

In its response to the current crisis, the federal government has been adding to the legacy of the inchoate TBTF policy of the U.S., and the picture has not been pretty and hardly inspiring of much needed confidence. The bailouts have been so arbitrary, so vague of purpose, and so poorly communicated that it is little wonder that neither consumers nor markets have been encouraged. The deficiency of policymakers' response to the current crisis has been well chronicled, and the purpose of this paper is not to add to that body of work. Rather, the attempt here is to set forth a new way forward for dealing with the systemically significant or, as grudgingly referred to below, TBTF firms. It will be pointed out that the current reactive policy of "constructive ambiguity" may well be ambiguous but is hardly constructive. In its place is suggested a more forward-looking approach that, before the crisis hits, defines and identifies institutions whose uninsured creditors will be protected. That protection comes at a cost, however, in the form of informational intimacy with the firms' constituents and with their regulators. Most significantly, what is called for is a transfer of the funding advantage such firms enjoy back from whence it came-the general treasury and the taxpayers.

This new approach, viewed from one perspective, is a radical departure from a century of U.S. democratic capitalism. From another perspective, however, it is a logical next step beyond those already taken by policymakers in response to the current economic crisis. It draws upon the historical lesson that government support of private institutions comes with a price, whether that support is explicit or implicit. If we are to tolerate the continued operation of legal entities whose very size and complexity pose a risk to the general economic welfare, then the market will identify those firms with some precision and their competitive advantage, already considerable due to their scale, will be magnified by the perceived backing by the government of their uninsured creditors.

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