Same as the old boss
- The Who
Over the next few weeks, the Strawman Blogger is going to try to bury the hatchet when it comes to healthcare reform. The headlines have moved on, and the Strawman Blogger doesn't want to get left behind. Frankly, we need the page hits.
Instead, we're going to transition back into the world of finance. No more individual mandate in this blog; the SMB is all about leverage limits and the crisis in Greece. Get with the times, people.
To kick it all off, we're going to talk about the thing that's on everyone's mind: Too-big-to-fail. These are the bailout banks, the institutions large enough that, when the financial crisis rolled around, the government stepped in to keep them afloat. No one likes them very much, but they're here to stay.
So today we'll talk about the common solutions for the too-big-to-fail problem. We'll discuss their merits and we'll tell you what needs to be done.
Solutions you can use. That's what were about at the SMB.
The Contenders
There are quite a few suggestions to the too-big-too-fail problem, but they mostly fall into three discrete themes. Let's jump right in:
The first theme, as the old quote goes, is that too-big-too-fail is too big to exist. Got a big bank? Break 'em up. Either redraw the old line between investment banks and commercial deposit-takers or find another way to take them to pieces. But they gotta go.
We have sympathy for this position.
The second theme - championed by the likes of Paul Krugman - is that too big to fail isn't the problem. Or at least, not the problem worth focusing on. Krugman in particular has commented that a widespread series of small bank failures would pose the same risk to the financial system as the collapse of one or two large institutions. In his mind, it's the resolution powers of the FDIC that protect us from this risk. When a small bank collapses, the FDIC steps in to mop up the mess. Deposits are protected, assets are stripped and sold.
There is no similar protection for large institutions that have significant operations in the shadow banking sector, relying heavily on short-term borrowing. As these uninsured operations fall outside the purview of the FDIC, there is no mechanism that allows for an orderly collapse.
In this school of thought, something similar to the FDIC is needed for the shadow too-big-to-fail banks. If a capable resolution authority is able to dismantle big firms, protect their deposits, and impoverish their shareholders, the problem goes away. The too-big-to-fail fails.
Thirdly and lastly, there's the package of financial reforms preferred by the administration and congress. They don't do much more than nod in the direction of the too big to fail phenomena. Instead, they believe that a better regulatory structure - in particular, investing the Federal Reserve with oversight of important financial firms, bringing over-the-counter financial products like derivatives onto traded exchanges, and (maybe) creating a consumer protection board will prevent those nefarious and negligent practices that so nearly destroyed the world economy.
That's it. Better regulators? Consider us under-fucking-whelmed. In case you haven't noticed, our current crop of barely competent, functionally handicapped, practically illiterate regulators managed to miss the biggest financial crisis in the last eighty years until it was steamrollering over their fucking legs. It is unclear how they can be trusted to catch the next one.
Not that they would bother to look in the first place. Most regulators are too busy maneuvering for cushy exit jobs in the same companies they're supposed to be policing. Enforcing cuts in your future employer's leverage ratio is unlikely to endear you to Human Resources. It's called regulatory capture: See examples here and here. And here.
But honestly? All of that doesn't even matter. Here's the dirty little secret of the Great Recession: They didn't see it coming. There was no small army of brave regulators railroaded by the power of the Street. There was no corrupt cabal of crooked public servants, turning a blind eye to excess in return for their thirty pieces of silver. No one was outgunned or corrupt. They were just stupid. They drank the Kool-Aid, same as everyone else, and they thought the good times would last and last.
So the next time a financial crisis rolls around, new rules won't help. Caution is temporary. Stupidity is forever.
Our Estimable Opinion
So where does that leave us? Should we break up the big banks, create a resolution authority, or just cross our fingers and hope for the best?
Far be it for us to disagree with a Nobel Laureate, but we think Krugman has it wrong. Or at least, he's right in the wrong way. See, we weren't entirely fair to Congress in the description above. Chris Dodd's bill does include a resolution authority, and it forces big firms to pay into an insurance fund for that purpose. Congress has even bandied about the idea of strict leverage limits. The truth is muddled between our extremes. We lied to you. We're very sorry.
But we did it for a reason. There's a problem with resolving a big, failed firm. No one's ever done it before. Big firms fails during big crisis, and a big crisis is an unlikely time to grow a pair of testicles. We're unconvinced that, faced with a climate like that of September '08, the Federal Reserve would take a cool look around, let out a whistle, and take the axe to a bank like Citigroup. That requires a supreme level of cold badass. Cold badass is not what public servants are known for.
So we take a resolution authority with a grain of salt, for the same reasons we don't believe in better regulation. They both take someone smart, capable, and ballsy in the drivers seat. That combination doesn't come around too often.
Our Estimable Solutions
Break them up. So Krugman disagrees with us. Who cares? Cordon off investment banks from commercial deposit takers, impose strict leverage limits, impose capital ceilings, and then hell, regulate whatever's left if it makes you feel better.
We think this for two reasons. First, the collapse of many small firms can endanger the financial sector, but that's ok. The collapse of a broad number of small firms tends to happen because of a market failure, and market failures may just be unpreventable.
The failure of single-institutions, on the other hand, can be an isolated phenomenon. Long-Term Capital Management didn't fail because the broader economy stopped functioning. It just made a spectacularly ill-timed arbitrage and watched the world play hell with its spreads while its capital drained away. But because it was large enough, and interconnected enough, LCTM was saved anyway.
We don't actually mind saving banks during a market failure. We do mind having to clean up the mess of the rich kids during the not-so-bad times. Too-big-to-exist clears this up nicely.
And lastly, we'll level with you. Why do we really want to break up Wall Street and the big banks? Because we can. Because it's not clear that Wall Street isn't just full of rent-seekers who add nothing to productive society. Because it's not clear that Wall Street today is any more efficient at allocating capital than they were forty years ago. Because there are no real efficiencies of scale for a bank that holds ten percent of America's deposited assets, and a hell of a lot of drawbacks. Because together they drain talent from areas of American industry that could actually use it. Because. We. Bloody. Well. Can.
Maybe, as Krugman says, there will be market failures and global panics and financial catastrophes long after the big banks are dead and buried. Why not? There were before. But given a choice between a world of panics with big banks and panics without, we'll opt for the latter. We'd rather spend our money on people we like.
