Hair of the Dog that Bit Us: The Insufficiency of New and Improved Capital Requirements

Government safety nets give protected institutions an implicit subsidy and intensify incentives for value-maximizing boards and managers to risk the ruin of their firm. Standard accounting statements do not record the value of this subsidy, and forcing subsidized institutions to show more accounting capital will do little to curb their enhanced appetite for tail risk. This paper proposes accounting and ethical standards that would reclassify the legal safety net support a firm receives, and record the value of taxpayer support as an equity investment. The purpose is to recognize statutorily that a safety net is a contract that promises to deliver loss-absorbing equity capital to firms at times when no other equity investor will. The explicit recognition of the public's stakeholder interest in economically, politically, and administratively difficult-to-unwind firms is a first and necessary step toward assigning to their managers enforceable fiduciary duties of loyalty, competence, and care toward taxpayers. These duties are meant to parallel those that managers owe to shareholders, including the right to share in the firm's profits and to receive information relevant for assessing their investment. The second step in this process is to change managerial behavior: to implement and enforce a series of requirements and penalties that can lead managers to measure and record on the balance sheet of each subsidized firm — as a special class of equity financing — the capitalized value of the safety net subsidies it receives from its taxpayer put. Incentives to report and service this value accurately in corporate documents, and in government reports making use of them, should be enhanced by installing civil sanctions, such as a call on the personal wealth of managers and officials who can be shown to have engaged in actions intended to corrupt the reporting process, and by defining a class of particularly vexing acts of safety net arbitrage as criminal theft.