Making Wall St. 'pay the tab' sounds nice until we try it

In that case, financial reform legislation unveiled this week would fall short of addressing how to wind up too-big-to-fail firms absent taxpayer bailouts or breaking them up.

The legislation calls for financial firms with more than US$10 billion in assets to share the cost of mopping up important firms that fail. The House Financial Services Committee, which unveiled the legislation along with the Treasury Department, came up with the US$10 billion cutoff to keep Main Street institutions, namely community banks, from getting stuck with the bill.

The big idea is to make Wall Street clean up its own messes. The threat of such payments, the thinking goes, will also prompt financial companies to impose discipline on peers.

These are laudable goals.

The practical problem is that the failure tab may be too steep for even the largest of the too-big-to-fail club such as JPMorgan Chase & Co. and Goldman Sachs Group Inc.

There are more than 100 financial companies that seem to meet the floor of US$10 billion in assets, according to Bloomberg data. They have about US$13 trillion in combined assets and total shareholders' equity of about US$1.35 trillion.

That's a big chunk of change. Yet consider that the government's commitment to American International Group Inc. stands at about US$182 billion, while propping up Fannie Mae and Freddie Mac may require US$200 billion.

While it's unlikely all that money will be lost, a cost of US$400 billion for just three institutions is a lot to shoulder, even for the firms in the 10-plus club. The amount is equal to about 30 percent of their combined equity. It is more than the equity of JPMorgan and Goldman combined.

It may also represent an even higher proportion of assets during the height of a crisis, when a too-big-to-fail firm is most likely to hit the wall. At the end of the third quarter in 2008, right after Lehman Brothers Holdings Inc. collapsed, the combined shareholders' equity of the 10-plus group was about US$1.04 billion, almost 25 percent below today's level.

So the commitments for AIG, Fannie and Freddie alone would be equal to almost 30 percent of the group's combined equity at that point in time.

Also, the equity base of institutions being tapped for the special charge would likely be even smaller if this bailout mechanism were triggered because one of their peers would have failed.

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