Byron Dorgan joins Bernie Sanders: “Abolish ‘too big to fail.’ If you’re too big to fail, you’re too big.”
By James Kwak
Would be nice if he actually co-sponsored Sanders’s bill, or if he would even just mention it in an interview…
I admit I’m biased, but notice Dorgan is a midwestern Democrat. Those people in “fly-over country” aren’t as dumb/ignorant as people think. It’s reason to steal a grin if no one is looking, and pray a third joins the team soon. I’m thinking it wouldn’t be too difficult to get Al Franken to sign-on. Anyone in Minnesota up for calling their Senator???
I’m on it
Al Franken’s Minnesota Office phone 651-221-1016
Al Franken’s Washington DC phone (Ask for Franken)
I hope someone adds a penalty for failing to comply onto the bill.
So they were offended at Him. But Jesus said to them, “A prophet is not without honor except in his own country and in his own house.”
I don’t get it.
Case A: A huge bank (call it J.P. Goldman-Stearns-Bank) underestimates the risk in a new popular type of derivative security and loses billions. Since their collapse would pose a systemic risk to the financial system, the government has to step in, at huge cost to taxpayers.
Case B: A thousand small local banks underestimate the risk in a new popular type of derivative security and lose billions. Since their collapse would pose a systemic risk to the financial system, the government has to step in, at huge cost to taxpayers.
Why, exactly, do we prefer Case B to Case A?
Why, exactly, do we think Case B is less likely than Case A?
1) Smaller banks will have more difficulty capturing their regulators and controlling our legislature (and executive).
2) Smaller banks have simpler balance sheets. That makes them easier to audit for regulators and for investors. It makes it harder for them to hide outsized risks in “off-balance-sheet instruments”.
3) Most importantly, as Rockfish points out below, is that TBTF institutions have artificially low borrowing costs. Creditors and counterparties know that they will always be made whole, so they have no reason to care if the firm is taking outsized risks. This is a distortion of the market that increases systemic risk. If we made sure that no particular firm was TBTF, lenders and counterparties would be far more likely to impose the discipline that they should have been imposing all along.
I don’t think anyone’s really comparing Case A to Case B, mostly because a thousand small local banks couldn’t trade nearly as much of the derivative in question, so in your particular comparison, Case B can’t exist, which answers your second question.
Perhaps what you meant was 10 medium size banks instead, so let’s go with that. The idea is that if JPGS were, J, P, G & S instead, they wouldn’t all be exposed to the derivative in the same way, so any one of them (or maybe 2) could go under without jeopardizing the entire economy, and even if the government needed to step in, it wouldn’t need to pledge nearly as much money.
That being said, I think that if you take an existing JPGS and split it up, the interconnectedness between them would considerably higher (necessarily) than the currently criticized web of connections between banks, so their default correlation would be very high, defeating the whole purpose of the split.
While the idea is noble, I think it would be very hard to split it up and get significant benefit from a systematic risk perspective. As is, it’s not like the government only had to support 1 or 2 large banks throughout the current crisis. Between the various programs, help was doled out to a fairly large number of institutions.
I think the TBTF moniker is totally sidestepping this issue. If you break up banks and no one bank is TBTF, when you take correlation into account, you will still find small sets of banks which, considered together, are TBTF.
There are certainly plenty of other issues, such as the implicit government guarantee at no cost to the institutions involved, etc., but I think TBTF is a bit of a red herring.
At the end of the day, I think I agree with you.
Well, if you take a large enough group of any size banks you’ll eventually reach critical mass. That’s kind of like saying the whole banking system is TBTF, which we can probably agree on.
Isn’t the broader goal here to remove the implicit government guarantee from these institutions? Since you can’t just say “no guarantee” about JPGS bank because nobody will believe, you can only try to get the entity down to the size where people believe you could let them fail. As Simon has suggested, one way to do this is make it increasingly onerous to be that big.
Another idea is to make these banks pay substantial insurance premiums to the govt for the privilege. Large enought to create a fund that would be able to bail them out. If I smoke I pay higher premiums, if I have speeding tickets I pay more, if I drive a Ferrari I pay more. Why not banks that are higher risks?
The chance of Sanders’ bill ever becoming the law of the land is precisely 0. If it’s too big to fail, it is the law of the land.
Gosh, and here I was convinced that Bernie was the lone legislator willing to spit into the wind. Next thing you know, Bernanke will also support the idea (NOT!!!).
This song is dedicated to Senator Bernie Sanders of the Great State of Vermont and his congressional Bill against systemically threatening banks: