How Obama's overhaul of the Fed will devastate competition

According to the administration white paper circulated prior to the president’s speech, the Federal Reserve would be authorized to create a special regulatory regime — including requirements for capital, leverage and liquidity — for any firm “whose combination of size, leverage, and interconnectedness could pose a threat to financial stability if it failed.” In addition, if a large financial firm is failing, the Treasury is to be given the power — in lieu of bankruptcy — to appoint a conservator or receiver to “stabilize” it.

Designating particular financial firms for this kind of special regulatory treatment clearly signals to the markets that these institutions are too big to fail. It will reduce the perceived risk of lending to them, enabling them to raise funds at lower cost than their smaller competitors.

In other words, the administration’s plan would create what are essentially government-sponsored enterprises like Fannie Mae and Freddie Mac in every sector of the financial economy — insurers, securities firms, finance companies, bank holding companies, and hedge funds — where these specially regulated firms are to be designated. The result will be devastating for competition. Larger firms will squeeze out smaller ones and aggressive small companies will have less opportunity to overcome the government-backed winners.