How Big Is Too Big?

As legislation on restructuring the banking industry moves forward, attention on Capitol Hill is increasingly drawn to the issue of bank size. Should our biggest banks be made smaller?

Senator Bernard Sanders, an independent from Vermont, introduced the “Too Big To Fail Is Too Big to Exist” bill in early November; this helped focus attention. Since then, in the legislative trenches where the detailed crafting takes place, Representative Paul E. Kanjorski — the Pennsylvania Democrat who is chairman of the Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises — proposed an amendment to the Financial Stability Improvement Act (currently before the House Financial Services Committee) that

would empower federal regulators to rein in and dismantle financial firms that are so large, inter-connected, or risky that their collapse would put at risk the entire American economic system, even if those firms currently appear to be well-capitalized and healthy.

In a major step forward, this passed the committee on Nov. 18.

The Kanjorski amendment recognizes that the systemic and societal danger posed by banks can be hard to recognize, and it proposes a number of potential objective criteria that could be used by the Financial Services Oversight Council (to be created by legislation in progress) to determine when banks need to be broken up, including the “scope, scale, exposure, leverage, interconnectedness of financial activities, as well as size of the financial company.”

The Kanjorski amendment does not impose a hard size cap on banks, but lawmakers in the House are discussing amendments that would do so.

There is, of course, a strong precedent for capping the size of an individual bank: The United States already has a long-standing rule that no bank can have more than 10 percent of total national retail deposits.

This limitation is not for antitrust reasons, as 10 percent is too low to have pricing power. Rather, its origins lie in early worries about what is now called “macroprudential regulation” or, more bluntly, “don’t put too many eggs in one basket.”  This cap was set at an arbitrary level — as part of the deal that relaxed most of the rules on interstate banking — and it worked well (until Bank of America received a waiver).

Probably the best way forward is to set a hard cap on bank liabilities as a percent of gross domestic product; this is the appropriate scale for thinking about potential bank failures and the cost they can impose on the economy.

Of course, there are technical details to work out — including how the new risk-adjustment rules will be enacted and the precise way that derivatives positions will be regarded in terms of affecting size. But such a hard cap would the benchmark around which all the specifics can be worked out.

What is the right number: 1 percent, 2 percent, or 5 percent of G.D.P.? No one can say for sure, but it needs to be a number so small that we all agree any politician who cares about our future would have no qualm letting it fail, and when doing so have confidence that our entire financial system is not at risk as it fails.

So to us, 2 percent of G.D.P. seems about right. This would mean every bank in our country would have no more than about $300 billion of liabilities.

A large American corporation would still be able to do all its transactions using several banks. They would even be better off — competition would ensure that margins are low and the banks give the corporates a good deal. This would help end the situation where banks take an ever-increasing share of profits from our successful nonfinancial corporations (as seen in the rising share of bank value added in G.D.P. in recent decades).

Indeed, the whole world would soon realize that our banks are more competitive and offer better pricing than others.

If, as might occur, the Europeans subsidized their big banks with cheap finance and implicit subsidies, we should let our nonfinancial corporates benefit and understand that our banks may become ever smaller. We can let Europeans subsidize banking because we all get better deals through their taxpayer subsidies, and then our corporates will have more profits to bring back to America.

Today our politicians and regulators lack credibility. They have bailed out too many banks and need to show they have truly regained the upper hand — by showing that they are installing such a hard size cap rule without exception.

The litmus test is simple.  Does Goldman Sachs continue to grow, and continue to be regarded as almost as good a risk as the United States government (Goldman’s Credit Default Swap spread is only 70 basis points above that of the United States today), because it has demonstrated it is too big to fail? Or, will the government impose a cap on the size of such institutions and require Goldman Sachs to find sensible ways to break itself into pieces – becoming small enough so that it will not be bailed out again next time?

We’ll see. Indeed, by the midterm elections, we will have an opportunity to decide. Is the Obama administration in favor of the status quo or, by November 2010 will they have sent a message that “too big to fail” has become “fail if you remain too big”?

By Peter Boone and Simon Johnson

This post appeared today on the’s Economix and is used here with permission.  If you would like to republish the entire post, please talk to the New York Times.

49 responses to “How Big Is Too Big?

  1. I do not have the exact numbers handy, but it is pretty clear that both major Canadian banks and major Australian banks have liabilities far in excess of 2% of GDP of those countries (in 2008 Canadian GDP was $1.5T and Australian GDP was $1.0T). Yet the financial systems of both of these countries performed very well during this downturn. One clear reason behind this is the very different style of government regulation in these countries – much more assertive and less deferential to the industry and “the market forces”.
    It seems that Simon and Peter assume (quite justifiably)that the nature of the US financial regulation will not change, which is probably why they suggest putting hard limits on the bank size.
    Choice of a 2% threshold also seem reasonable – when Continental Illinois failed in 1981 its assets were 1.5% of the then US GDP.
    At the same time, one has to realize that $300 Bil is a rather low threshold. GE liabilities are almost $700 Bil. Insurance companies like Metlife and Pru have more assets than $300 Bil.
    I would have preferred to have the hard limit set higher, say, at 4% of GDP ($600 Bil), but to have capital requirements increasing with the asset (or liabilities) size.
    More importantly, these limits should not let the financial regulators off the hook. We truly need a change in the culture of our financial regulators. What is it that the Canadians and Australians know and do that the American’s don’t?

  2. increasing cap requirements could effectively
    de profitize agglomerations
    but not stop risk syndicates of systemically comparable risk baring capacity

    size is a matter of connectedness and herdness
    where risk is concerned
    where a ceo clique is concerned
    using the 10% rake off rule of thumb
    size really really really matters
    so executive comp regs seems more smart strikish to me
    who will put these masatdons together if you take out both the new pinnacle rewards
    and of course the A&M transaction fees need to be taxed prohibitively
    like short term gains perhaps to cut churn and flip flop

  3. if firms had markets to sell all their benefits
    like tax credits etc things one firm gains by absording another
    what ought to be ejectable out to be ejectable
    cut the purely formal mergers that have gains without substance

    obviously scope effects are less likely to be efficiency moves then scale effects

  4. “What is it that the Canadians and Australians know and do that the American’s don’t?”

    How large a bank’s sphincter has to be for their foot to fit in, would be my guess.

  5. No mention that Kanjorski’s amendment would allow any TBTF avoid PCA by bringing action in a US district court in order to rescind the PCA? Prompt could then be stretched out for years as zombie banks manipulate the federal court system. Part of the Kanjorski amenment:

    (h) JUDICIAL REVIEW.—For any plan required under this section, a financial company subject to stricter prudential standards may, not later than 30 days after receipt of the Council’s notice under subsection (e)(5), bring an action in the United States district court for the judicial district in which the home office of such company is located, or in the United States District Court for the District of Columbia, for an order requiring that the requirement for a mitigatory action be rescinded. Judicial review under this section shall be limited to the imposition of a mitigatory action. In reviewing the Council’s imposition of a mitigatory action, the court shall rescind or dismiss only those mitigatory actions it finds to be imposed in an arbitrary and capricious manner.

    At a congressional hearing last week, Simon supported the idea of allowing Treasury/Geithner to keep the remainder of TARP money. I’m begining to question Simon’s motives, agenda. I’m curious what the Peterson institute’s desire is as to regulating TBTF’s, the ability to apply PCA and Geithner maintaining a slush fund for Wall St.I’m also curious as to Simon’s compensation from the Peterson institute.

  6. Yes, I brought this link

    on the same subject. According to that and a few other things I read the Kanjorski amendment is another anti-reform scam meant to pretend it’s tackling the structural issue but really to render the banks even more unaccountable and deranged.

    But Trojan horses aside, the basic point is correct: We need hard caps on size, as one of the necessary measures. (But not the only one.)

  7. However small, if the banks all conspire, and are all allowed to invest in the same non productive derivatives, they will still divert capital away from the real economy to imaginary profits justifying indecent and damaging bonuses, while starving the real economy.

    The notion of integration in the mathematical sense has to be introduced. This is a known problem with carcinogens. To limit each given carcinogen below a threshold is not enough. By piling up carcinogens under the threshold, one can get large carcinogenicity. Thus Germany has introduced an overall integrated carcinogenicity limit. France, and the EU will soon follow suit (under scientific pressure).

    So, by analogy, what should be limited is the overall risk to the system, and that should evaluated by checking how much risk is in the global system. An obvious way out is to regulate derivatives by limiting leverage, certifying each and every single derivative, and distinguishing commercial operators from speculators (who should be more limited in leverage).

    Patrice Ayme

  8. excellent points

    now try to calibrate those systemic risk measures
    into an algorithm that passes congress and the potus veto

  9. seems to me if we had fairly good systemic risk measures
    we could replace capital margins with insurance

    cep clique’s are the ultimate leverage guys right
    they can have zero equity if board allowed

    equity leverage isn’t the problem its intertemporal hypoliability

    after all widely dispursed equity is just the first compartment to get slashed when the titanic hits an ice berg
    the later compartments have no magic barrier
    beyond position
    i think all ownership in a joint stock outfit oughta be considered creditorship
    and subject to those protections

    face it the cceo clique is the incentive sensitive alement here
    once equity exposure can be spread made liquid and
    why consider it motivational any more then junior debt ???

  10. It is the activities of the banks that create systemic risk. Making the banks smaller while allowing them to engineer derivative bets will not solve the problem. At best, it will move the risk to the shadow banking system, insurance companies, pension funds, corporations. Derivative trading produces the lion’s share of bank profits. Those profits must create losses elsewhere, because trading is zero sum.

  11. i>One clear reason behind this is the very different style of government regulation in these countries – much more assertive and less deferential to the industry and “the market forces”.
    I don’t think that is true. Were Canadian banks blocked from investing in pools of no money down mortgages? I don’t think so. They did not invest in the new easy money because they are Canadian culturally – i.e. financially conservative and suspicious of easy money. There are plenty of US institutions in a similar situation – local and regional banks and big institutions like Charles Schwab who just gave me refi.

    There was no reason to do these bailouts of companies too big to fail. There was and is plenty of capital around that could get us out of this mess by buying up the assets of the “too big to fails” in bankruptcy.

  12. One clear reason behind this is the very different style of government regulation in these countries – much more assertive and less deferential to the industry and “the market forces”.
    I don’t think that is true. Were Canadian banks blocked from investing in pools of no money down mortgages? I don’t think so. They did not invest in the new easy money because they are Canadian culturally – i.e. financially conservative and suspicious of easy money. There are plenty of US institutions in a similar situation – local and regional banks and big institutions like Charles Schwab who just gave me refi.

    There was no reason to do these bailouts of companies too big to fail. There was and is plenty of capital around that could get us out of this mess by buying up the assets of the “too big to fails” in bankruptcy.

    Sorry I messed up the tags in my first attempt. I would delete it but I don’t see how to do this…

  13. A lot of financial institutions are too big. We should consider the most toxic ones (institutions that prove to be threats to economic stability), and dissolve them. These entities are too big, and in all senses are crushing competitiveness in the markets. I don’t see why this has to be such a debate. Teddy Roosevelt did well by breaking up Standard Oil around the turn of the 20th century, and the oil markets thrived, because not one single entity controlled every single aspect of a market, and this fostered competition, which led to technological progress, job creation, and just simply a better financial situation. Large corporate entities get dissolved because something that large is too economically ideal, and financial ideologies are bad for the markets.

  14. I think setting a hard number or percent is not the best approach. What Sanders essentially says is: make out a list of institutions that you’d feel obligated to bail out of a default… if an institution is on that list, it is too big.
    Conversely, The Fed/Treasury/Congress could make a list of institutions that it explicitly guarantees it will NOT bail out… be on it or die.

  15. Happy Thanksgiving Everybody!!!!!

  16. A definitive size cap is a good start. But it’s ONLY that, a start. We also need to make credit default swaps illegal and go after the shadow banking. I hope all the people out there are aware of the extreme dangers of shadow banking. We need to hold leaders like Barney Frank and Chris Dodd accountable in making and passing laws to regulate the uncapitalized dice rolling that caused a great deal of the recent crisis. If they don’t pass air tight laws on this YOU the taxpayer will be stuck AGAIN with giving corporate welfare to the banks. There have been some signs recently that Barney Frank is not serious on this issue and only doing a phony tap dance for the public.

    Here is an article/interview by Mike Konczal over at the Atlantic magazine explaining “shadow banking”. I don’t agree with everything Perry Mehrling says in the article, but it could help you understand shadow banking better.

    Remember how your state’s U.S. Representatives and U.S. Senators voted on these issues when you vote November 2010 and beyond.

  17. A really nice article, particularly the part about Liquidity not being a “free good”.

    The conclusions seem a bit hopeful, however…

    “That’s why we need a credit insurer of last resort, to put a floor on the value of the best collateral in the system. I say the new Bagehot Rule should be: Insure freely but at a high premium.”

    Indeed, the government currently _is_ the insurer of last resort. If the premium is too low, then this simply makes TBTF official. If the premium is too high, then how exactly does differ in effect from other recommendations like increasing capital requirements? Both are an implicit tax on leverage.

    So how, exactly, does that premium get set? And does it differ by quality of collateral? And who determines that quality? (Surely not the ratings agencies…)

    I’d be curious to hear some details from Rorty.

  18. I have a question about “quality of collateral” with regard to the underlying mortgages. Please do not construe this as a defense of ratings agencies, but how much of the AAA ratings of the tranches were related to the “implied government guarantees” of the home finance GSEs? I read somewhere that, together, Fannie and Freddie guaranteed half (in the $trillions)of all outstanding mortgages. It is also my understanding that, in addition to guaranteeing mortgages, Fannie also created mortgage-backed securities. In fact, Fannie started the securitization ball rolling to promote liquidity and others followed. Now that these GSEs are in conservatorship and still doing business, are the guarantees explicit? Doesn’t this assumption muddy the rating waters at least where mortgage debt(not the only securitized debt) is concerned?

  19. Absolutely , a really nice article. Shadow banking is a revival of the Trust Company idea that caused so much trouble a century ago. Trust companies had no reserve asset holding of specie and currency requirement while banks had a heavy reserve asset holding requirement. Like 15 %. The banks had 15 % of the deposits of all types held in a non interest generating asset while Trust Companies did not.

    What were the reserve assets requirements fifty years ago when money market funds had less than 5 % of the market? Quite high at 10 %.

    What was the result? Regulators were pressured by banks to decrease reserve asset requirements so that banks could offer yields commensurate with money market funds. The regulators went for the lowest common denominator to increase yields where the money market risk was far higher while retaining a lot of the depositor protection.

    Money market funds must be treated the same as banks or banks must drop FDIC protection. So what happened to the banks FDIC costs the last few years…. FDIC fees were waived. The cost was eliminated to the banks while keeping the perceived risk abatement structure in place for depositors.

    Money Market Trust Company must become a bank as Trust Companies were forced to become a century ago.

    I have a friend that owns a small bank in competition with a Credit Union. He bristles at the “unfairness”.

    Same old story keeps repeating itself. So now we are back to the same type of political agitation as followed the banking panic of 1907. That hackneyed old blue ribbon political word ” Reform” becomes the empty utterance of the day.

  20. It is very interesting that mere organization free concepts like interest and credit swaps would be thought of as an adjunct banking system. A contract now substitutes for an organization. The conceptual change is even more disconcerting when the mere contract is so new it has never been tested for staying power and indeed has failed at it’s first test of surviving adversity.

    Have we gone out so far on a limb of the financial system that the weight splits the trunk, thus requiring the removal of the tree?

  21. Richard Hoogesteger

    I like this post and I think reducing the size of banks will help somewhat. However I think the crux of the problem really is setting appropriate reserve requirements for banks, whatever their size, which have a government guarantee, whether by law or in fact, for their depositors or their counter-parties or anyone else. Modern financial instruments, like derivatives, often are opaque enough so that it is unclear what the reserve requirements ought to be. If this is true about a financial instrument then government insured financial institutions MUST be forbidden from investing in that instrument.

    Adequate reserve requirements is the only way out of this mess. If AIG had an implicit government guarantee then they should have been much more tightly regulated.

  22. None of that can work with big banks, because the second banks get big enough they

    1. BUY deregulation;

    2. BUY non-enforcement of what regulations there are;

    3. BUY TBTF protection.

    You could probably work out a passable equation for this progress from “capitalism” to rent-seeking.

    The same problems can exist among smaller banks if they’re allowed to become “too interconnected to fail”, so breaking up size is necessary but not sufficient. We also need rigorous restrictions on derivatives.

    But smashing size is the basic requirement which enables all the others. Otherwise all the others would be lobbied away again the same way they were the last time.

  23. The problems in the US home mortgage market were not caused by banks buying deregulation. They were cause by federal regulations which want increase home ownership but did this forcing banks to make loans with little or no down payment. It was regulation, not deregulation, which led to the mortgage melt-down.

  24. repeating this canard hardly improves its validity


    the concentration of opaque risk holdings
    within hyper leveraged institutions was not a necessary consequence of risky mortgage origination

    in fact it’s still not clear the borrower risk was the problem if credit limits had been set lower
    and ponzi valuations prohibited

  25. So risky mortgage origination did not drive the ponzi valuations? Gimme a break.

  26. Bad mortgages were a relatively small problem; securitizations of bad mortgages and synthetic CDOs of mortgage securities introduced a leverage factor estimated at 100 times. You have to understand that virtually all the bank profits (and banker bonuses) were attributable to a half dozen years of these CDOs and the imbedded correlation risk which none of the rating agencies understood. This is what created the meltdown, and it is why all the ‘assets’ acquired by the Fed are probably worthless.

    You can try to understand this or stick with Glen Beck.

  27. How can securitization of bad mortgages and synthetic CDOs of mortgage securities be a bigger problem for the whole economy than the Bad mortgages themselves? Take a bad mortgage and split into the risky part and the safe part. Post meltdown the safe part still has value. Houses in Las Vegas, Arizona and Florida do not have negative values.

  28. This resolution, if enacted, which I doubt, but that’s just me, would go a ways to correct the complete imbalance in profitability between economic sectors. But, I also believe that unless Glass-Steagall is reinstated, and the Fed either removes all of its present guarantee programs, or pegs it’s interest rates to member banks to a higher rate for those who are too large, so as to discourage them gambling because the cost of their money is so low.

    The last thing that must be done is to have all shareholders agree (say 70%) on payment for all high salary executives and those who earn bonuses, and, of course, bonuses should be held back at least two years for performance to enable a determination if profitability was truly earned.

    There’s lots more, and we’ll see what the Congress does, but I have serious doubts, regardless of the level of negative public opinion.

  29. “removes all of its present guarantee programs,”
    these safe guards amount to socializations
    they worked for fdic why not more broadly
    the key is some serious risl premiums
    on both individual holding and total portfolio profile
    the attempt to reduce leverage is an attempt to
    control risk by controling profitability
    it adds nothing to the consequences of default
    to the lender or investor
    why not tag the investment or loan up front one by one
    with a mandatory insurance premimum
    AIG stuff but thru a federal insurance outfit
    believe me even if institutions were allowed to operate outside this insured sector
    their cost of funds would spontaneously move
    the action more and more to inside the insured sector

  30. if uncle had the aig roll in this
    with some clear exchange sunshine on the action taken
    then yes maybe uncle allows too low premiums like with the total boondoggle pension insurance fund
    but no panic no freeze up no crisis
    the sudden siezure syndrome is abolshed immediately
    as with demand deposits after fidic so should all oblogations “calm down”
    no runs no panics
    scandals ??
    of course
    but the credit sea would roll on always as
    tranquil as before

  31. Anyone read the Mort Zuckerman opinion piece in US News?

    He starts giving all of the justifications as to why TBTF institutions will result in economic devestation and then intellectually reverses course to justify why TBTF’s shouldn’t be broken up. Hey Mort, why don’t you stop tap dancing on the edge and pick a side. It’s amazing how weak his arguments are about why the US shouldn’t break up the TBTF’s. It seems most main stream writers are either too worried about upsetting the TBTF executives/financial elite or too scared of looking out of step with rest of the crowd to honestly analyze the pro’s and con’s of splitting up TBTF institutions.

    Simon – please keep pressing the government on this issue. I think your arguments are gaining momentum.

  32. I have this strange feeling Mort Zuckerman probably took whatever he had leftover from his Madoff losses and invested it in Dubai. But that’s just a feeling.

  33. Some people think Mort Zuckerman has a ghostwriter for his columns. If you ever watch Mort on PBS he talks like the male version of Sarah Palin. He had millions of dollars invested with Bernie Madoff. You know Madoff—the guy who told people they were making 15%+ annually and never executed a single stock trade. So you can surmise how much financial advice you want to take from Mort Zuckerman on that that.

  34. in reviewing sj’s may article in that petrified forest knows as the atlantic monthly
    i think i get doc johnson’s real drift:
    knock out the power clique
    recirculate power
    even if in time it recondenses
    even if it recondenses over seas
    the “corporates” made in america
    that now make their wares globally
    shouldn’t care where their bank is located

    i’m not persuaded by his pseudo poluist measures
    his trust busting
    and not a little bolstered in this dubious intransigence
    by doc johnson’s own
    admissions of inefficiency
    and likely hood of migration over seas
    the hi fi laputa is truly global it motors where it will
    wall street could just as easily merge with the city and both relocate in zurich or geneva
    surrounding itself with a fortress europe

    all of this is fantasy
    the global system would still face the occasional crisis of epic proportions
    the sudden nose dive of credit and trade

    one notes size doesn’t matter in a complex pattern of dominos network connections can bring down a sysytem as well as the wild risk kinks in a few big players

    the line is a large network of uninsured units
    will systemically aquire less risk then a network with a few strategic big units that are backed by a limitless credit mill ie
    the good old imperial currenct mine de jour

    prove that thesis and prove in invisible set of links below the radar might not re emerge that produces similra risk levels …
    etc etc

    i say go up to unification instead
    a national depositiry system like the post office
    combined with market rate uncle liability insurance

    oh why bother

    like a child crying in the wilderness

  35. Orthogonal Vision

    Rather than a single cutoff value that defines TBTF, why not a sliding scale of taxation and regulation so that larger entities have a disincentive to grow beyond their means. This would extend all the way to the point where if someone is regarded as TBTF, they should be regulated as a utility with strict limitations on their activities and ROI. This would force successful companies to create new entities rather than just getting bigger and eliminate future concerns from TBTF.

  36. exactly
    make it an at the margin decision

    one problem a prohibition is transparent an amateur could see its enforcement
    a disincentive schedule could be intentionally inadequate
    like most reg violation penalties..err
    for the big corporates
    not the petty street criminals

  37. What is the status of the legislation for regulating the credit rating agency’s (ie, moody’s)? Is that a dead issue? Or another issue that is in the background, that will be hashed out later?

  38. beware “to be hashed out later”‘s

  39. I may be wrong here, but haven’t we lost sight of what the real problem is? Didn’t the problem start when deregulation reared its ugly head and banks merged with investment houses and insurance companies began dealing in credit swaps? Why don’t we re-enact legislation separating banks, investment houses and insurance companies? Maybe this is too simple a solution, but it seems to me that it solves the problems that triggered the current crisis, having major Wall Street insitutions who had their fingers in too many pies to allow them to fail and take the whole financial system with them.

  40. ray
    that is essentially what conventional wisdom calls for
    simple argument
    that seemed to work
    look at 46- 68 when the new deal era regs rode high

    my problem
    how did that doc jeykle of a system
    evolve into this present hyde of a system

    in other words how in broad daylight were the citizens syep by step set up and finaly
    traduced by acts of their own elected government

    and how does one account for this change
    in the zeit geist without acknowleging implicity
    it will likely all cycle past us again
    even if a restoration of a system of sanity restraints gets reapplied to our leading financial institrutions

    i’ll not be coy

    nationalize em and keep it that way

  41. JUDICIAL REVIEW—“the court shall rescind or dismiss only those mitigatory actions it finds to be imposed in an arbitrary and capricious manner.” I thought the judicial system was an independent branch of government under the U. S. Constitution. How is it that the Congress can limit the actions of the Federal courts? Am I naive?

  42. I’m not knowledgeable enough to break down the details but it works vise versa. There’s a lawyer (I think his last name is Wise) who comments here sometimes, maybe he can tell you. But it does work both ways in special cases.

  43. Effective solutions to problems exposed by the financial collapse will never be wholly cured. Remediation that is effective will , of necessity, be required to be very comprehensive.

    Absolutely, banks and any other type of financial institution must be prevented from reaching too big to fail. Beyond that, the financial regulation system must keep all types of organizational structures on an even playing field. That means a form of required asset reserves for all types of deposit takers including investment vehicles that might be a substitute for banking institutions. Credit default swaps are insurance and those in the business must be required to hold reserves the same as any other insured interest arrangements. We will never see global uniformity of these kinds of remediation so preventative measures to avoid evasion mus be in place. A simple one is an excise tax on the recipient of retail premiums if the insured risk counterparty is exempted from US rules. The same device might be used in other areas of risk to prevent avoidance. Retail banking should again be separated at the holding company level from investment banking. And on and on the list might grow.

    The other side of the coin here is that regulatory agencies will eventually fall back into bastions of muddling bureaucracy. But we already have that on all sides of the finance system anyway with the penchant for unloading risk and trying to retain the risk premium revenue at the same time. These kinds of activities will never be eliminated. Instead, leadership will have to deal with the moribund and aggressive grifting as a function of effective leadership.

    Will Congress be able to accomplish what it has rarely been able to accomplish with respect to financial reform? At some point Congress will understand that if they do not solve the problem their polity itself will disintegrate on them. At some point they get cracking or else.

  44. Hi,
    I enjoyed reading this article and your blog. I also write a few articles on the current Australian fianancial news on my blog . I would be humbled if you could do a link exchange with my blog. My blog is at . Do let me know and I can send the code for the link exchange . I am available on email at jeromejf at .


  45. This whole post is a canard. There is no such thing as too big to fail. The assets of any failed bank are sold in bankruptcy and all the creditors who could be paid would be. The liabilities of the bank could be 1 trillion, but the actual loss would be a small percentage of that ASSUMING the actors in the system force the bankruptcy of the bank once they are insolvent. Pretending is what has caused us to see 50% losses in FDIC takeovers.

  46. Sure, any institution can fail, no matter how big or small. The question should be, when does an institution get so big that its failure causes catastrophic damage to our (or the worlds) economy?

    It’s true that assests of any bank would be sold at auction, if there were anyone left to pick up the pieces. What if several “too big” banking institutions were to fail within days of each other, causing a rippling affect and taking hundreds of smaller institutions with them? At the same time, what if the failure of so many banking institutions should lead to a catastrophic failure of thousands of other institutions, both large and small, that depend on the banking industry for daily survival?

  47. “Too big to fail” has acquired a general meaning all it’s own since August 2008. There is a perception among those with investments in the banking system that there is a point where size does in fact imperil an investment they make in the system. A time to bail out.

    Why should the assets be sold in bankruptcy? Why not an old fashioned reorganization in bankruptcy? The creditors live with their choice of assets they desired to partake in? As an example, the affiliated group stays intact for simplicity here only and all the creditors lose a portion of their deposits and loans and receive common stock in exchange. They pick the new board of directors who picks the new officers. Naturally, the depositors would be sequestered as to velocity of withdrawls.

    Regulation requires a framework from which to work. “Too big to fail ” is a framework from which to design a set of rules that mitigate excess as a form of prior restraint. Prior restraint does fail too. So, on balance institutional complexity forces prior restraint.

    Given the complexity of the financial system and the obvious fact of systemic decline resulting from marginal economic returns , the political system must address the issue to attempt to reverse those declining marginal returns. What are declining marginal returns in a financial system? Well, they are obviously the point where the financial system generates loans that fail in sufficient amounts as to imperil lending in a credit based system.

    The object is to politically set up devices to prevent credit losses in a banking system that imperil the system. Is this possible? If it is not possible, the system has run out of time and must reduce itself to a simpler more parochial character.
    Does limiting size based on assets accomplish this? Probably somewhat. Limiting size is a backhanded way of forcing simplicity. Would this work? That depends on the flexibility built into the new regulatory system.

    Joseph Tainter in the summary of his ” The collapse of Complex Societies” certainly thinks so. Page 198. And I am keeping it short.

    ” Complex societies,it must be emphasized again,are recent in human history. Collapse then is not a fall to some primordial chaos,but a return to the normal human condition of lower complexity…… To the extent that collapse is due to declining marginal returns on investment in complexity, it is an economizing process.”

    What we do know as a result of the last several years is that the complexity inherent in size and organization of the credit system is that it is no longer marginally capable of generating sufficient loans that get paid back. The complexity exceeds marginal returns. Size is an important factor in the systemic credit system failure we are seeing. It is hardly the only contributing feature.

  48. Great post; heavy questions.