One of the most vexing issues that have been considered during the ongoing financial regulatory reform debate has been systemic risk. In delving into systemic risk there have debates about regulators and powers, as well as new taxes and permanent TARP bailout authority. However, there are other sticky issues that need to be watched as well.

One of the concepts that has arisen and taken hold is the concept of “Too Big to Fail”. Under this theory, if a financial services firm gets to be too large, the federal government will have the preemptive power to break a firm up. Now the federal government already has anti-trust powers and these are normally geared at preventing a company from becoming a monopoly or having too much control of the market place. Under too big to fail, the federal government can arbitrarily decide if a firm is too large and break it up. While the Senate is still drafting bills for consideration, Rep. Paul Kanjorski successfully inserted preemptive breakup authority in the House financial regulatory reform bill that passed in December.

Additionally, the consideration of systemic risk and size can also lead to unintended consequences. For instance, many public companies have financing arms to assist in the purchase of the products that they produce. Therefore, many companies, whose business is the production and sale of goods, could get sucked into a systemic risk regime while other financial services firms may receive less scrutiny. The Chamber raised many of these concerns in letters that were sent to the House last fall.

The Property Casualty Insurers Association of America released a report yesterday on systemic risk: ‘Too Big to Fail’, Too Short-Sighted to Succeed. The study was written for PCIAA by NERA Economic Consulting.

The PCIAA-NERA study, not only gets into many of the same issues that the Chamber and others have raised about the potential application of systemic risk theories, it also elevates the specter of potential unintended consequences. The press release encapsulates it well by stating:

NERA’s study reached a number of conclusions that should give lawmakers pause before they create a systemic risk calculation based solely on a firm’s size. Among those findings:

• U.S. job losses and other economic inefficiencies;
• Consumer price increases for basic financial services; and
• Heightened systemic risk as a result of increased moral hazard.

These are concerns that should give pause and I would suggest a further reading of the report to obtain a more thorough understanding.

Systemic risk and resolution authority are issues that need to be addressed in order for financial regulatory reform to be truly credible. Whatever package is finally signed into law, we must be cognizant that it will create the economic rules of the road for the next generation. We don’t need a financial regulatory reform bill for its own sake. In order to provide America with the economic growth and job creation it needs, we need to make sure that we get the right answers to the right questions.

The stakes are that high.