US Senate Solves “Too Big to Fail” Dilemma – Dismantlement

Friday, May 7, 2010

Everyone hates the US Government’s two-option approach for dealing with supersized companies in trouble. Both choices (bailout and bankruptcy) have large, undesirable consequences, making for a dilemma.

On Wednesday the US Senate approved a solution: A third option that allows conversion of one “too big” institution into many manageable companies. This is great news.

The benefits of breaking up a company

Splitting up a mega-company’s operating units could offset the negatives from bankruptcy or bailout.

  1. It would allow managing the problems better by being able to focus on the individual components
  2. The total value (sum of the parts) would be potentially greater and achievable sooner because more buyers would be willing to purchase untainted, specialized operations (especially before the clients and employees head to other organizations). Also, no bankruptcy fire sales at low prices
  3. Any bailout funds would be granted for specific units and needs, thereby allowing for better control and understanding.

A key improvement: Minimize “moral hazard”

A bank executive once told me that the beauty of FDIC insurance was that the bank could push risk-taking to its limits without having to worry about putting the depositors at risk. This is an example of “moral hazard” – the taking of extra risks because there is insurance if things go wrong.

The notion of “too big to fail” has produced the bailout insurance policy. It hasn’t always worked (think Lehman) because bankruptcy is an option. But bailout has been the more likely choice.

The US Senate’s new, third option looks to avoid the insurance/moral hazard problem. Even if most of a company’s operating units survived, the dismantling and divestiture process would likely be accompanied by the removal of the former executive team and the board. This house cleaning, even though the executives were not accused of illegal actions, would provide a common sense type of “punishment” for those that put the institution at risk and created the problem.

There is one more point. The 95-3 vote emphatically underscores the US Senate’s strong belief that the bailout solution has been unsatisfactory. Any executive looking at that vote would interpret it as meaning the “too big to fail” insurance notion is dead.

So… As investors, we should be very pleased with the Senate’s action. It deals practically and effectively with the current dilemma. And this is the kind of legislation that can serve as a basis for sound corporate management.

Tags: , , ,

Leave a Reply

You must be logged in to post a comment.


John Tobey on Seeking Alpha

Seeking Alpha Certified

May 2010