Your Morning Roubini

In the WSJ this morning, Nouriel Roubini and Matthew Richardson once again make the case for Plan N, given their belief that the stress tests are useless (emphasis mine)

...it is highly likely that some of these large banks will be insolvent, given the various estimates of aggregate losses. The government has got to come up with a plan to deal with these institutions that does not involve a bottomless pit of taxpayer money. This means it will have the unenviable tasks of managing the systemic risk resulting from the failure of these institutions and then managing it in receivership. But it will also mean transferring risk from taxpayers to creditors. This is fair: Metaphorically speaking, these are the guys who served alcohol to the banks just before they took off down the highway.

And we shouldn't hear one more time from a government official, "if only we had the authority to act . . ."

We were sympathetic to this argument on March 16, 2008 when Bear Stearns ran aground; much less sympathetic on Sept. 15 and 16, 2008 when Lehman and A.I.G. collapsed; and now downright irritated seven months later. Is there anything more important in solving the financial crisis than creating a law (an "insolvency regime law") that empowers the government to handle complex financial institutions in receivership? Congress should pass such legislation -- as requested by the administration -- on a fast-track basis.

The mere threat of this law could be a powerful catalyst in aligning incentives. As the potential costs of receivership are quite high, it would obviously be optimal if the bank's liabilities could be restructured outside of bankruptcy. Until recently, this would have been considered near impossible. However, in 2008 there was a surge in distressed exchanges of debt for equity or preferred equity.

Still, the recent negotiations with Chrysler's creditors suggest large obstacles. The size and complexity of large banks' capital structures make debt-for-equity exchanges an even taller task, particularly because creditors will want to hold out for a full bailout along the lines they have been receiving.

The government should be able to dangle an insolvency law as an incentive to cooperate. This will result in a $1 trillion game of chicken. But given the size of the stakes, and the alternative of the taxpayers continuing to foot the bill, it's the best way forward.

Just so. So far, this very legislation that we need -- legislation for receivership powers that FDIC chair Sheila Bair had asked for six weeks ago and something she said the FDIC needed to have back last June -- has all but been forgotten. The stress tests and the Obama declaration that Too Big To Fail means just that has pretty much scuttled any Plan N implementation.

Which is a shame. As long as the government lacks the power to beat Too Big To Fail, the banks will continue to extort the American taxpayer to the tune of trillions. Given the fact that the banking industry continues to own Congress however, the odds of this happening will continue to be slim to none.