How NOT to Deal with Too Big to Fail

Over at the Baseline Scenario, Simon Johnson once again makes a good banking reform suggestion coupled with a bad WTO-related strategy:

the consensus is moving towards the view that state-supported banking (i.e., operating through implicit guarantees on Too Big To Fail banks) constitutes an unfair form of protectionism.  Financial services in this guise do not currently fall within the remit of the World Trade Organization, but it would be a simple matter to extend its mandate in this direction. In any reasonable judicial-type process, involving relatively transparent weighing of the evidence [proponents of big banks] would be most unlikely to prevail.

We blogged on some of Simon's over-reverence for the WTO a while back. In fact, the WTO does have rules on financial services, they do require financial deregulation, and specifically, they make it more difficult - not easier - to solve the too big to fail problem.

To wit: the WTO's General Agreement on Trade in Services Article XVI(2):

In sectors where market-access commitments are undertaken, the measures which a Member shall not maintain or adopt either on the basis of a regional subdivision or on the basis of its entire territory, unless otherwise specified in its Schedule, are defined as:

(a)        limitations on the number of service suppliers whether in the form of numerical quotas, monopolies, exclusive service suppliers or the requirements of an economic needs test;

(b)        limitations on the total value of service transactions or assets in the form of numerical quotas or the requirement of an economic needs test;

(c)        limitations on the total number of service operations or on the total quantity of service output expressed in terms of designated numerical units in the form of quotas or the requirement of an economic needs test;(9)

(d)        limitations on the total number of natural persons that may be employed in a particular service sector or that a service supplier may employ and who are necessary for, and directly related to, the supply of a specific service in the form of numerical quotas or the requirement of an economic needs test;

(e)        measures which restrict or require specific types of legal entity or joint venture through which a service supplier may supply a service;...

Financial services is a sector that countries can commit under the GATS, and over 100 countries did so for this market access obligation - including the US and EU. You can see what deregulators would like this provision:

1. It prohibits even non-discriminatory size caps (i.e. it's deregulation, not just liberalization);
2. It limits the ability of countries to specify that investment services can't be provided by a commercial bank, or make other requirements that certain services have to be provided by non-profits;
3. It contemplates five different ways that governments might try to limit size, and prohibits all of them - even at the subfederal level of government.
4. Then, there are other GATS-related rules, like GATS Article VI and the Understanding on Commitments in Financial Services that pose additional deregulation obligations on nondiscriminatory policies.

Even without these specific rules, the WTO dispute settlement system's 15 year track record of ruling against over 90 percent of challenged public interest laws should give pause to any reformer looking to utilize it to serve the public interest. It's interest is in maximizing trade flows, not preserving sound regulation.