– May 16, 2017

An economics scholar, Dan Thornton, sees a constitutional amendment as the only way to stop the U.S. government from engaging in “too big to fail” bailouts, but the idea appears too noble to pass.

Big-government types won’t go for it for myriad reasons—accountability, for one. Central bankers like opaque dealings with commercial bank executives that enable them to pose as rescuers from crises while providing career insurance for elite bankers.

A constitutional amendment would return conservatism to banking, reducing Third World–style lending and other imprudent notions, says Dan Thornton, head of Missouri-based D.L. Thornton Economics LLC and supporter of the amendment idea.

“Financial firms will be incentivized to use well-known risk management techniques to limit exposure to any one financial institution or firm,” Thornton wrote in his Common Sense Economics Perspective newsletter.

Dodd-Frank, enacted two years after the last major crisis, contains the Orderly Liquidation Authority provision, which former Federal Reserve Chairman Paul Volcker and others see as preventing taxpayer bailouts of troubled financial houses. The OLA will not stop bailouts of big firms amid panicked investors and blaring news headlines, while small firms will be easily overlooked, Thornton says.

“The idea that failure of systemically important firms would have disastrous consequences is too ingrained in political decision-making,” Thornton wrote in his piece titled “Here’s the Only Way to End Too Big to Fail.” “This happens in spite of the fact that no one can say exactly what constitutes a systemically important firm much beyond the fact that it’s big. There is only one sure way to end ‘too big to fail’: a constitutional amendment.”

Hank Paulson, Treasury secretary during the 2008 crisis, revealed the thinking that Thornton says has become gospel.

In his 2010 book “On the Brink: Inside the Race to Stop the Collapse of the Global Financial System,” Paulson wrote in the afterword:

Today the Top 10 financial institutions in the U.S. hold close to 60 percent of financial assets, up from 10 percent in 1990. This dramatic concentration coupled with the much greater interconnectedness, means that the failure of any of a few large institutions can take down a big part of the system, and, in domino fashion, topple the rest. The concept of “too big to fail” has moved from the academic literature to reality and must be addressed.

Ben Bernanke, Fed chairman during the crisis, points in his book “The Courage to Act: A Memoir of a Crisis and Its Aftermath” to rescued Bear Stearns’ being “too interconnected to fail.”

Another prominent investment bank, Lehman Brothers, was allowed to succumb to the crisis for other reasons. That the government shuttled Lehman to bankruptcy is what sent heads spinning on Wall Street, said James Thomson, chair of the finance department at the University of Akron in Ohio. Thomson called the move a “policy shock.”

Addressing the crux of Paulson’s “domino” outlook, Thornton said, “Of course, there is no specific evidence that it will or that it should.… Interestingly, this was one of the principle [sic] reasons for the Vietnam War — the domino theory of communism. Fear makes people do things that they would not otherwise do.”

While the regulators had the TV spotlight, market arrangements were quietly doing much to cool the crisis, as Professor Edward Stringham argued in his book “Private Governance: Creating Order in Economic and Social Life.”

Thornton realizes his idea is a long shot. Of the only 27 amendments to the Constitution, the last one became effective 25 years ago and was originally contained in the Bill of Rights (the first 10 amendments to the Constitution), which became effective in 1791.

Any amendment must be approved by two-thirds of the votes in the Senate and House of Representatives then ratified by three-quarters of the 50 state legislatures. Amendments must be seen as above politics, said Kermit Roosevelt, law professor at the University of Pennsylvania Law School in Philadelphia.

“In our two-party system, this means that any amendment with a partisan effect will be defeated — and most amendments do have such an effect,” said Roosevelt, whose publications include the 2010 book titled “Conflict of Laws.” “So in practical terms, the possibility of meaningful amendments is very small.”

The mindset of the officials is essentially the same as Wall Street executives. Paulson was a Goldman Sachs CEO before being picked to head the Treasury. The current Treasury secretary, Steven Mnuchin, was a Goldman Sachs partner and also managed a hedge fund.

In their reactions to the newsletter, most colleagues see the amendment as the only way to stop “too big to fail,” but some are “uncomfortable” with a constitutional amendment for reasons not entire clear to Thornton, Thornton said.

“I suspect that they really don’t believe, as I do, that ‘too big to fail’ is both unnecessary and harmful,” Thornton said. “Others believe that ‘too big to fail’ can be dealt with by placing the right set of restrictions on banks and/or other financial institutions.”

James Mosher


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