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?

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.

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

Thanks
Jeff

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.

bucky

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