The Obama administration and the Federal Reserve Board have begun a full-court press to get Congress to expand the federal government's power to be able to seize nonbank financial institutions — insurance companies, hedge funds, investment banks, private equity firms — that run into trouble. This is such a bad idea that it's hard to know where to begin.
The ostensible model for such power is the Federal Deposit Insurance Corp., which insures individual bank deposits. The FDIC takes over banks in trouble quite regularly, generally throwing out their top management, cleaning out bad items in their portfolios, restructuring and eventually either dissolving them or selling them to some other bank.
The FDIC's experience, however, is mostly with small banks. When there was a widespread problem with savings and loans in the 1980s (a problem whose roots could be found in government policies, which too few people remember), the government created a temporary organization, the Resolution Trust Corp., to handle the financial workouts. This new power Obama seeks would be to handle companies that pose a "systemic" risk or, in other words, those deemed "too big to fail." The government has little experience with such a task, and based on its record with AIG, not much relevant skill.
Specific proposals for expanded power to seize and reorganize financial firms are still in the planning stages, but most of them involve expanding the power of the Federal Reserve Board. Yet there's a growing consensus that the Federal Reserve's policy of heedlessly expanding the money supply from about 2002-06 was an important contributor, if not the key factor, in creating the financial crisis. When an agency uses its power in ways that create a crisis with global implications, is it really smart to give it more power? It would seem more sensible to cut its power and authority.
Expanding government's power so it could physically take over such companies rather than allowing them to be subject to market discipline would undoubtedly be used to keep companies barely in business, gasping for breath, when their mistakes and excesses should have dictated that they go out of business. It would prop up failures and discourage innovation and reallocation of capital and other resources to companies that can do a better job. It would inevitably be used to make decisions about who would survive and who would fail based on political influence rather than economic performance.
In short, this is a terrible idea.