“All Serious Economists Agree”

The most remarkable statement I heard at the American Economics Association meeting over the past few days came from an astute observer – not an economist, but someone whose job involves talking daily to leading economists, politicians, and financial industry professionals.

He claims “all serious economists agree” that Too Big To Fail banks are a huge problem that must be addressed with some urgency. 

He also emphasized that politicians are completely unwilling to take on this issue.  On this point, I agree – but is there really such unanimity among economists?

I ran his statement by a number of top academics over the past day and – so far – it holds up.  But this may just reflect the kinds of people I meet.

Still, it is an interesting claim that stands until refuted – send or post details of serious people (in economics or elsewhere) who currently think Too Big To Fail Is Just Fine (other than people in government or big banks, of course). 

By Simon Johnson

92 responses to ““All Serious Economists Agree”

  1. Too Big Too Fail = Too Big To Exist

    Mainstreet gets it, so why shouldn’t economists.

    To “hold” that TBTFs should be propped up is to enable financial terrorism. Period.

    There are clearly other solutions, but the TBTFs have control of Obama, Congress, the Treasury, and the Federal Reserve.

  2. The problem with most economists is that they are not experts on national accounting, finance, and money & banking. They are specialists in micro and macro, which generally treat money (and debt) as a given. In short, they don’t understand the nature of the financial system and are not qualified to speak as experts on it. Who cares what these people have to say?

    When the Chairman of the FRS can say that “banks lend out reserves” (they don’t) or the president of the US can say that “the US is running out of money” (it can’t), and not be corrected immediately by his economic advisors, I wonder if the people in charge understand how the monetary and financial systems actually operate, rather than “in theory.”

    No wonder the Wall Street oligarchs are taking them for a ride. Or are they just feigning ignorance because they are complicit? I’m willing to give them the benefit of the doubt, but…..

  3. Simon, are you talking about Adam Davidson? That seems to be his catchphrase, used almost every time I hear him interview a public figure or economist. Sadly, it was one of the hallmarks of his shameful “interview” with Liz Warren (something to the effect that “all serious economists agree” that the decline of the middle class and the distress American families are living through was not the pressing issue).

    Anyway, what I wonder is who are the “non-serious” economists? More importantly, who decides who they are? I have a feeling I tend to line up with these less-than-serious economists on many issues, in fact, you might be among them with some of your “radical” propositions, not that I wouldn’t wear that as a badge of distinction these days.

  4. Agree – Allow interstate banking but bring back Glass-Steagal to eliminate the conflict of interest between retail banking, insurance and investment banking.

    This allows banks to reach scale in their businesses, but not be faced with the perverse incentive of selling a mortgage on one side of the house and selling against it on the other.

    Ensure all financial institutions maintain an X(15%)? interest in all products (e.g. mortgages, insurance policies) they sell.

  5. “The problem with most economists is that they are not experts on national accounting, finance, and money & banking. They are specialists in micro and macro, which generally treat money (and debt) as a given. In short, they don’t understand the nature of the financial system and are not qualified to speak as experts on it. Who cares what these people have to say?”

    Good point. But note that the argument ought to be taken one step further. Yes the economists are out in the ozone, but what do financial managers know about what makes a culture able to pay its own way, so long as that culture is not being robbed by a distant financial network?

    Our local cultures have been robbed of every support system we can be robbed of. The banking issues are way beyond whether the Big Six need to be dismantled.

    We need the community bankers we had in the 1970s who understood how a local culture built its wealth. Those banks could not expand their network of branches beyond the county lines. They had to succeed by helping the local culture to succeed.

    As a building contractor I knew the bank’s board of directors, who were also the loan committee, because they were the lumber dealer, the lawyer, the sheetrock contractor that I did business with building my houses. These neighbors didn’t need FICA scores to know who to lend to. And they lent the amount you needed when you needed it and much of the local lending was 60 and 90 day notes.

    The success of that system, in terms of creating tangible assets, was magnitudes more successful than the joke institutions that call themselves banks today. Frankly, local cultures would be better off today doing business with the Mafia than are by doing business with the institution we now call banks. What economists and bankers know today about how the bulk of wealth in the nation is created is a joke.

    Simon would do better taking some remedial history lessons from community elders.

  6. My brother is an academic economist, and he thinks that “big banks” aren’t necessarily the problem, since (he says) smaller banks also racked up too much debt in the bubble. When he said this, I didn’t exactly know how to respond, since I’d dumb as a nail — BUT I don’t seem to remember smaller banks being bailed out or anything, so I’d assume they aren’t exposed to the degree of moral hazard to which the bigger banks seem to be exposed and are thus a bigger problem than smaller banks. Anyway, I’d be interesting to hear what your response would be to his reasoning.

  7. Blago, a number of small banks have failed and will fail, and they were and are allowed to because they could and can be put into resolution without affecting the entire system. The idea behind ‘too big to fail” is that the TBTF’s are so interlocked with the system that if one goes, it would bring down the whole house of cards, as Lehman showed. The TBTF’s are also to big to nationalize or put into resolution because it would take an army of experts a year to unravel the mess. So the reasoning was not to rock the boat, bail them out and leave the same folks in charge that caused the crisis.

  8. Does this mean that jerkwad Charles Calomiris is not a serious economist????

  9. Being among those who demonstrably spoke out the loudest and the earliest against the “too big to fail”, when most cowardly kept mum just in case the “too big to fail” were too big to fail, I believe that I have earned the right to opine in the matter; and I opine that the priority is not getting rid of the too big to fail but to get rid of the causes why some banks can become too big to fail; and which is nothing but the way regulators favor with their regulations the banking business that is normally more associated with the big banks. Place the same capital requirements on all type of bank business and if the too big to fail survive then there might be some reasons why they should survive.

  10. Laurie Iseman

    Dan makes an excellent point. When bankers lived in the communities that they served, they had a vested interest in helping those communities to succeed. Separate the commercial banks from the investment banks and then you’ll see the communities banks come back to life, enabling the citizens to thrive once again. When the communities banks are funding the housing market, and local businesses again, we might just have a chance of turning things around. Keep the money on Wall St and we’re all doomed. Commercial banks and investment banks have two distinctly different purposes. Economist should understand stand that, but that doesn’t seem to be the case.

  11. It will become very clear, very soon, those too big to fail (banks), are all broke.

  12. Laurie Iseman

    Had a few typos…should be community banks ;-)

  13. Ha! btraven, love the name. He was such an interesting guy, quite a romantic figure in a way. Has there been a biography of him yet?

  14. I am baffled the general lack of urgency in addressing too big to fail in Congress. Unless we are prepared for the taxpayer’s to recapitalize financial institutions every ten years or so, we need to take the concept of TBTF seriously. Of course, Congress is very unlikely to act because of millions of dollars of campaign money that is at stake.

  15. “Tragedy is when I cut my finger. Comedy is when you walk into an open sewer and die.”
    – mel brooks

  16. Okay, here’s a new clarion call for Simon Johnson, Mr. Kwak et al.:

    There should be demonstrations in the streets, strikes, petitions in support of two major policies:

    1) absolutely no end to the Federal extensions to state unemployment programs. They should continue indefinitely or until such time as the unemployment gets below a target rate, say 5%. Short of that, they should continue without change.

    2) Some kind of extension to the Recovery Act that will cover the “looming” shortfalls in state budgets. The savage budget cuts that states are preparing for 2010, must not be allowed to happen.

    Okay, so maybe there won’t be non-violent strikes, demonstrations and petitions in support of these two policies.
    But how about an angry post or two from Mr. Johnson on baselinescenario.com?

    The U.S. and the world have stepped back 100 yards from the the abyss of a second Great Depression. If aggregate demand is not maintained, we will step very rapidly back and perhaps enter that abyss.
    The world cannot and should not bear the terrible and completely unnecessary suffering of countless millions that would result from economic collapse. This is still a very great danger!

    Mr. Johnson, Mr. Kwak et al. your country needs you now!
    You know what to do!

  17. Too-big-to-fail is not the problem!
    Was LTCM too big to fail? It had how many employees, 500 at the most? Yet it almost brought down the world economy in 1998(?).
    This is a pseudo-problem, it does not address the need to restore Glass-Stegall, to ban the use of financial instruments that no one understands!
    These kinds of discussions are complete distractions form the real issues.

  18. Bill Gilwood

    “and leave the same folks in charge that caused the crisis.”

    Why? Why couldn’t the government have taken a more active role in the banks given the amount it poured into them? Why not replace the “folks incharge”? Leaving the “same folks in charge” means these “folks” can use the banks they’re “in charge” of as conduits to run taxpayer money (TARP,TALF, etc.) into their own pockets. Leaving the “same folks in charge that caused the crisis” means they’ll just repeat the similar behavior again.

  19. Bill Gilwood

    Yes, our elected officials would rather take a payoff from the highest bidder than do the job they were elected to do.

  20. Bill Gilwood

    True, but the politicians are to corrupt to act, and the media is an owned mouthpiece on a short leash.

  21. “All serious economists agree…” – I heard this statement a lot during the beginning of 2009 concerning the bailouts and TARP. At the same time, my economics professor, and 249 other famous, highly esteemed economists from all over the US, wrote a letter to the President expressing the exact opposite opinion from the one that was being touted as agreed upon unanimously. Secretary of Treasury Geithner uses this “all serious economists agree” liberally, as do so many of them when they are pushing one strategy or another to screw the American people.

  22. Banks, small and large have been failing since banking began. That’s not the issue. We now have a system where the TBTF’s have been nationalized by implication, but we, the people (owners) don’t get to share the profits. As to the small banks, that’s why the FDIC exists. Can you imagine the FDIC bailing out the bigs or their depositors? Anyway, I think that any economist who does not agree must not understand what is happening, or has been paid to disagree. If we don’t rebalance our economy, the doom loop will simply continue until we look like Somalia!!

  23. Calomiris is one scary dude for someone who professes expertise in macroeconomics. He is simply a right wing schlump, and I suggest that his chair at Columbia must be supported by at least one of our major financial oligarchs. Interesting to note that Henry Kaufman, for whom Calomaris chair is named, was a director at Lehman and worked for Soloman. It seems only logical that Chuck should say what he does. He’s just keeping the tradition, isn’t he?

  24. Agree. They are just doing the bidding of their patrons, not the voters.

  25. “The U.S. and the world have stepped back 100 yards from the the abyss of a second Great Depression.”

    We came a lot closer than 100 yards back in early March. Perhaps just footsteps away. Had Citi been allowed to become the next Lehman (and it would have without the massive government intervention that took place) there likely would have been no turning back and no real remedy and we’d have absolutely been in an economic environment as bad if not worse than the GD.

  26. Love your challenge, so, here are my picks:

    Arthur Laffer:

    An American economist that served on Ronald Reagan’s economic policy board. (Or, would that be most economists from the Hoover Institute, Stanford University…)

    Joseph R Mason:

    http://www.roubini.com/financemarkets-monitor/258017/tbtf_is_not_about_size_its_about_information

    The central argument being: “the root cause is asymmetric information – where a shock to asset values leads investors to exit the market, absent information on the distribution of the shock.”
    >
    Four respondents: http://economy.nationaljournal.com/2009/10/tbtf-what-should-be-done-about.php
    >
    Martin Bailey (Brookings): It kind of reads like Mr. Berneke: “It is not a good idea to try and limit the size of US banks or other financial institutions, which are in many cases smaller than foreign owned banks. Size limits would encourage the industry to move offshore and would probably encourage institutions to make their portfolios more risky—if they have to cut out some of their assets they will cut out the ones making lower returns….. These problems were not specifically problems of size, but of poor management and regulatory practices and these must be changed going forward.”
    >
    Charles Calomiris: Defining economies of scale as “First and foremost, financial institutions need to be large to operate with global scope because their clients are large and global.” In other words, TBTF becomes a relative term? (NPR’s embedded link doesn’t clarify Dr. Calomiris’ point): http://adjix.com/pfn3 )
    >
    Robert Litan: Recognizing TBTF, however; “I am less confidence in our collective ability to define that threshold purposes for actually breaking up existing enterprises.”
    >
    Alan Meltzer: Of like mind above but: “I proposed that the Congress should limit too big to fail, leaving the choice of size to the bank”
    >
    Niall Ferguson : (a free-market polemicist)
    >
    http://www.telegraph.co.uk/finance/financetopics/financialcrisis/6263315/Theres-no-such-thing-as-too-big-to-fail-in-a-free-market.html

    ”It has often been said since the crisis began that an institution that is “too big to fail” (TBTF) is too big to exist. I agree. The question is how we can best get rid of the TBTFs without increasing the power of government in the economy still further.”

    And for us political junkies: http://dyn.politico.com/printstory.cfm?uuid=FB85B31A-18FE-70B2-A880750ED059F8A3 :

    ”For all its talk about “fat cats” in the banking industry, the Obama administration has not embraced reviving Glass-Steagall. Nor have leading lawmakers writing the main bills in Congress. Most experts scoff at the idea that the 1999 repeal — known as Graham-Leach-Bliley — had anything to do with the financial crisis, and the big banks wasted no time in warning Senate Banking Committee members that the Cantwell-McCain bill was misguided and bad for the economy.”

  27. The unanimity of economists comes as no surprise – TBTF provides a convenient narrative that explains the crisis as an incentive problem (moral hazard) which is caused (contemporaneously) by both _too much_ and _too little_ government. It is a doppleganger, conveniently appearing to each person in the manner that is most appealing. Though both the left and the right blame TBTF, the two factions mean radically different things when they use the term. The right claims the problem was too much government, the left that it was too little.

    TBTF is also a very pleasant way for economists to hold onto a particular paradigm, and to deny the culpability of other actors and other factors in this crisis. Those politicians who recognize that fixing TBTF will not alone prevent future crises are wise; those who recognize this and yet fail to fix TBTF anyway are cowards. Many politicians are wise cowards, which is how they stay in office. Many economists are sour iconoclasts who claim bravery by throwing rotten tomatoes from a safe distance, but dare not challenge their profession’s conventions.

    I respect SJ and Baseline for entering the fray aggressively and early – and at great risk to personal reputations – but the fact that professional economists have reached unanimity of belief (if indeed they have) means absolutely nothing.

  28. How big the bank is really isn’t the problem. The problem is political power, and really big corporate interests wield nearly all political power.

    Too Big To Fail (TBTF) is more appropriately called Too Politically Powerful To Be Allowed To Exist In A Republic Or Democracy (TPPTBATEINR/D), but it is much easier to just call it TBTF for the sake of economy.

  29. So Rue, please explain the following:

    1. How can catastrophe have been averted if the bad bets/assets still exist?

    2. What happens when the sovereign lifeline gets taken away?

    3. If it is NEVER taken away, who pays for it? And given the enormous tax burden it will require, how can this lead to economic growth?

    A better use of Public Money would have been to PAY OFF ALL THE DEBT – yes, all of it – as it would have eliminated the troubled assets, kept the CDS bomb from exploding, kept the banks solvent, and put huge amounts of money into the pockets of citizens to stimulate the economy all for approximately the same amount of money.

    Here’s Steve Keens presentation about this (slide #10 on his .ppt, the green plot).
    http://www.debtdeflation.com/blogs/2009/08/15/video-of-whitlam-institute-talk/

  30. Too bad you didn’t link the quote, because I think I saw the same quote somewhere else yesterday but I can’t remember where because I blew it off as insignificant boilerplate.

    Why? Well, if this conveys the content:

    He claims “all serious economists agree” that Too Big To Fail banks are a huge problem that must be addressed with some urgency.

    then who doesn’t claim to agree with that in principle, where it’s given in such non-specific, non-prescriptive terms? Geithner says he agrees with that in principle.

    But the world’s full of people who claim to agree about the existence of a problem but who would in fact reject any actual measure which would help solve the problem.

    In this case the real measures are clear: impose rigorous size restrictions, reinstate Glass-Steagal, ban all speculative derivatives, restore rational and equitable marginal tax rates.

    Simple, fair, resilient measures.

    So the measure of “economists”, or of anyone else, who really wants to deal with the problem is who supports any or all of those things specifically.

  31. Hi
    I am not an economist, so writing this from a lay person’s perspective, but in my view the problem seems to be not so much the existence of “too big to fail” organisation, but lack of strategy for dealing with these organisation when they fail. Nearly everything I read regulatory reform is focused on regulation trying to prevent institutions becoming “too big to
    fail”, instead I think we should be focusing on what to do when an institution is deemed “too big to fail” when a failure occurs. Ultimately you only know a firm is “too big to fail” when failure is imminent. I think the focus is to come up with clear guildlines to what happens when an organisation fails and is deemed “too big to fail”. For example if say Insto 1 falls and failure will cause systemic risk, the govt takes over Insto 1′s counterparty risk, BUT all shareholders and hybrid holders should be wiped out. Sub debt holders get 30% Face Value and senior get 50%. The problems lies in everyone not willing to deal with failure rather than existance of these banks.

  32. Simon, et al,

    Just an oldy which shares my opine,

    “An ounce of prevention is worth a pound of cure.”

    PDR

  33. They have to “take a payoff” or else they can’t raise
    enough funds to run a winning campaign. Which suggests
    that public financing of our elections is the way to
    go. Fat chance, huh?

  34. Yes to tackle the “too big to fail” and not getting rid of the bank-growth-hormones that bring us the “too big to fail” does not make any sense, and could in fact make things much worse. What in this respect is needed the most though is the announcement of a plan to eliminate the capital requirements for banks discrimination on risks and which has completely tilted the regulatory structure in favor of the big.

  35. re: He claims “all serious economists agree” that Too Big To Fail banks are a huge problem that must be addressed with some urgency.

    If so, then “all serious economists” are waking up about to an “urgent” situation at least 16 months too late.

  36. Not when the ounce of prevention is the wrong ounce of prevention. The bank regulators naively thought that if they structured the capital requirements for banks to be based on perceived risk they would prevent a crisis… and, of course, as some of us held while there was still time to rectify, just the opposite happened. More than getting rid of the too big to fail we need to get rid of those too arrogant to regulate.

  37. That would be the so-called “Stand-up Economists.” They create a demand floor by enforcing a two-drink minimum ;-)

  38. One of the arguments at the time was that the financial arrangements were so complicated that no one other than the people that created them could understand them well enough to wind them down. There may be an element of truth to that assertion, evidenced by the fact that so many Lehman traders are still at their desks over a year after its failure. However, that rationale really doesn’t apply to the CEOs and other officers who never really understood the products.

  39. A Glimmer of Hope?

    Senator Dodd ,who will not seek reelection, said:

    “There are other things we can do to break them [big banks]up, but I’m not sure that’s the right answer,” Dodd said in a Dec. 16 interview.

  40. While we write in baseline, the Basel Committee just released a Consultative Document titled “Strengthening the resilience of the banking sector” which evidences that the regulators refuse to assume their responsibilities or to accept that their regulatory paradigm is utterly faulted, and keeps on digging us ever deeper and deeper in the hole.
    http://www.bis.org/publ/bcbs164.pdf

    In it you will, among so much confusion observe the following:

    “The Committee is introducing a global minimum liquidity standard for internationally active banks”

    And so this category of “internationally active banks” will have a different set of regulations that will presumably send to the market the message that these banks are especially safe and so these banks will most certainly need to pay less for deposits and equity, and so these banks will now enter an almost formal category of “too super big to fail globally”. How on earth is the world supposed to check or even be able to understand what is happening so as to make sure that no hanky panky is going on between the super-big and the regulators?

    “the Committee is supporting the efforts of the Committee on Payments and Settlement Systems to establish strong standards for central counterparties and exchanges. Banks’ collateral and mark-to-market exposures to central counterparties meeting these strict criteria will qualify for a zero percent risk weight”

    And so now, out of the blue, the regulators are creating a new theoretical risk-free zone, that we know will be exploited to the tilt… until it breaks. I perfectly agree with the existence of “strong standards for central counterparties and exchanges” but to subsidize them by allowing them a “zero percent risk weight” means that their risk is not even going to appear on the books turning it into one more forgotten and ignored risk… just like the sovereign debt with zero percent risk weighted exposure currently represent.

    And the beat goes on!

  41. “1. How can catastrophe have been averted if the bad bets/assets still exist?”

    It’s been delayed more than averted. Or rather, extended. So instead of another Great Depression, we end up with 1990′s Japan.

    “2. What happens when the sovereign lifeline gets taken away?”

    It won’t be taken away all at once, just gradually reduced over time.

    “3. If it is NEVER taken away, who pays for it? And given the enormous tax burden it will require, how can this lead to economic growth?”

    It need not “require” an enormous tax burden. Remember, tax receipts are endogenous to the system and depend heavily on economic growth. To the extent that government policy prevents a complete collapse of the economy, tax receipts will be higher than had the government just stood by and done nothing.

  42. Japan was a creditor. We lack the resources to fund it unless foreigners buy the debt.
    But look:
    http://www.zerohedge.com/sites/default/files/images/user5/imageroot/volcker/UST%20holdings%20intl.jpg
    they are selling US debt…

  43. David Plouffe, obo President Obama, wants to hear from voters through their brief online survey (“….we want to hear your reflections on our work together in 2009 and how you want OFA to move forward in the new year”): http://adjix.com/pjn3

    How interested are you in each of the following issues?

    Creating jobs and strengthening the economy: *
    1 Very Interested 2 3 4 5 Less Interested

    Ensuring every American has quality, affordable health care: *
    1 Very Interested 2 3 4 5 Less Interested

    Promoting clean energy and green jobs: *
    1 Very Interested 2 3 4 5 Less Interested

    Reforming our financial regulatory system: *
    1 Very Interested 2 3 4 5 Less Interested

    Providing a high-quality education for every American child: *
    1 Very Interested 2 3 4 5 Less Interested

    Reforming our immigration system: *
    1 Very Interested 2 3 4 5 Less Interested

    OPTIONAL: What other issues are you interested in working on?:

    I was hoping my $50 to Obama’s 2008 political campaign would garner enough access and influence that I wouldn’t have to worry about a dysfunctional Congress and their lobbying partners.

  44. Yes, Per. Despite the fact that VAR has been exposed as a complete fraud, we are going to continue to use it. On top of that, we are going to continue to let regulated institutions determine how to calculate it, and we’re even going to give them permission to leave entire asset classes out of the calculation! All of which might be palatable (barely) if it were coupled with some sort of international resolution authority, but such authority is not proposed (unless I am missing it).

  45. Wouldn’t the traditional role of community banks fall in this case to localized credit unions formed by citizens sick of being fleeced? This seems like the perfect niche for them, and we (as in the fleeced citizens) can do it without the help of the government or the consent of the TBTFs.

  46. Bravo, Blago! Too bad economists can’t think of or respond to your insight on the big vs. small banks pseudo-problem.

  47. Instead of paying off all the bad debt, weren’t a number of people, Martin Wolf and others, calling for the ‘slaying of zombie banks’? Meaning, that they be put through bankruptcy workouts. But this didn’t happen, probably for political reasons, and all the derivatives are still on the books of financial institutions, like Bofa, Citi and the rest. My understanding is that these bad debts which weren’t cleared or retired, are what’s choking off new lending by these large banks. So we really do have a Japan, 1990s situation.
    BUT…it is so important to maintain aggregate demand through a new stimulus, and extending indefinitely federal UI. As people have noted, this crisis is not over in any way.

    P.S. Why aren’t the unions in the streets, where is the Social-Democratic “left”?

  48. Heard you this morning on BBC Radio 4 (snow left me on avery packed train, but that’s another story).

    Could you use the Iceland example to highlight the folly of having banks with assets worth more than a government can support?

    Also, keep up the good work!

  49. RueTheDay,

    I didn’t know that about last March and Citibank. I thought the most dangerous time was about a year ago, right before the inauguration. So, thanks for the info!
    Your post gives me hope that through all the polite and not-so-polite chatter on blogs, newspapers, etc. that it’s understood by most people, especially in government, that we are not out of this by any measure, and that the situation is still very scary.

  50. Oh SOMEBODY understands them. They understand there’s enough PERSONAL gain that the damage to the rest of us is written off as an externality, particularly now that it’s been made clear that the US government will backstop any screw ups they make with $Infinity.

  51. Senator Dodd is right to have doubts. As I’ve tried to point out before, too-big-to-fail is a pseudo-problem and the entire discussion is a very dangerous distraction from the real issues, which are in my opinion:

    -the immediate restoration of Glass-Stegall
    -the banning of financial instruments that absolutely no one understands, CDOs, CDSs, etc.
    -the absolute necessity of maintaining aggregate demand through indefinite extension of federal UI programs and a new stimulus.

    Robert Skidelsky is very good on all of this.

  52. There’s an interesting article in The New Yorker, yes, the New Yorker about the Chicago school.
    One particularly amusing moment is the author’s conversation with Eugene Fama who says that we’re experiencing an economic crisis not a financial crisis, therefore he sees no reason to revise or change his theories.
    As I read this, I heard(in my imagination) Nassem Talib cursing furiously under his breath.

  53. Too-big-to-fail financial institutions have been enabled by regulation that fosters oligopolies rather than competition. This can be illustrated by tracking growth of financial regulations in the Federal Register with the growth of the top 25 financial institutions’ capital requirement. The oligarchs know all too well that, in a regulated industry scale is the prime determinant of commercial engagement. Furthermore, it is not so much that regulators suffer from cupidity or culpability as their deterministic training ill-equips them to address indeterminate (mark-to-model) financial instruments in terms other than scale.

  54. Orthogonal Vision

    Wouldn’t it be more interesting to see who is regarded as a “not serious” economist? It would seem that Bernanke falls into that class.

    Can the serious economists weight in please?

  55. You are absolutely right… though I feel that calling them naïve and gullible focuses better on their “deterministic training ills”

  56. Any economist, like me, who believes himself truly serious is all but that!

  57. I believe Simon has written that after the Asian crisis the financiers also argued that they were the only ones that could fix the mess. The mess this time may be more complicated in scale/scope, but in the latter’s case the finaciers/bankers were removed and things turned out ok. Also, AIG brought in new people to unwind positions. It would seem to me that only portions of the banks would need change.

  58. There are a couple of bios (do a Google search)…but they did little to alleviate the mystery.

  59. Community banks in the 1970s were commercial banks that were members of the FED. They could borrow money to support the local community that they served. Also, the FED could better control inflation by setting interest rates to clientele where it could make a difference. The present FED rates affect the stock market and the gambling banks. In local cultures there is no positive effect at all, only negative affects of giant banks that act as an illicit middle man to the local needs.

  60. You may have an interesting point here, Redleg. Many of the comments approach the issue purely from a business standpoint. I have been in “regional” or “super-regional” banking for over 30 years and have seen bank consolidation happen over that time. Although there have been and still are many fine community banks I have also seen many of them run by local big-wig shysters or incompetents who simply wielded power in a community and either lost the depositors money or were able to control business and extract profit. Instead of their power ending at the county or city line, it now goes from sea to shining sea. We need a certain level of “granularity” or decentralization in banking. Banks must be big enough to achieve certain economies of scale and strong core competencies yet there need to be enough to compete with each other, spread risk and not be too big to fail or hold the country hostage.

  61. Petter Karal

    Good job, but do really all of these people disagree with the proposition “that Too Big Too Fail banks are a huge problem that must be addressed with some urgency”?

    Of all those examples, the only one that explicitly goes against that proposition is Mason. I have no idea about whether or not he fulfills Simon’s criterion of “serious economist”, but he is “Louisiana Bankers Association Chair of Banking”. That makes his opposition to TBTF less surprising, at least.

  62. It is simple porfolio therory! The us financial system now has all of it’s eggs in one basket and Timmy and Ben are holding it. To them it looks like breakfast for a year. To everyone else, it’ an accident waiting to happen. The government just wants keep it’s puppets on a string. Big government means more power to those in charge. The people of america see this and will vote the politicians out.

  63. In reply to Hung, bravo to you for your argument. This is worthy of more analysis and for policy study and recommendation by Congress on their deliberations of TBTF.

  64. A too big to fail policy would be just fine with me, if only we make this small stipulation — that I be officially declared too big to fail. I think that both in terms of ego and, well, shall we say, personal magnitude, I am eminently qualified for the Too Big to Fail label, far more so than lesser men who do not carry nearly as much weight in the community as I do.

    In other news, I would be perfectly willing to rejoin the Church — but only if they make me Pope. Under any other circumstance, the Doctrine of Papal Infallibility becomes too irksome and insufferable.

  65. Let us recall the immortal words of Warren Buffet when he was asked for his opinion on portfolio theory:

    “Demented”.

  66. As someone who is not only no economist, but also somewhat poorly educated, I agree completely. To eliminate that “moral hazard” thingy the shareholders should have been broken as they are in a bankrupcy, also, all the high-ranking officers should have been fired as a matter of principle. The problem was lack of will to punish.

  67. Just curious – what are the “serious economists” who defend TBTF saying about why enormous financial institutions too large to fail need to remain too big (and thus perpetually dependent on the fed for a handout to rescue “the economy” from their failures)?

    Don’t really understand how “too big to fail” can be defended in any way. The idea that we need to prop up the financial sector whenever they screw up is not a practice we should be continuing.

  68. very good point.

    I have been saying that this is a political problem with financial/ economic consequences for over a year now.

    I believe that the solution is simple: ALL political donations, whether by an individual or group, must be held to equal campaign contribution limits. One person can contribute no more than $x, then one PAC can also contribute no more than $x. Do that and the political problem (TBTF) is mitigated.

  69. That ounce was probably called “Glass-Steagall”.

    While I’m aware that correlation doesn’t necessarily mean cause, how many financial crises were there while this law was in effect? One (S&L)?

    I’m convinced that separating commercial and investment banks was the ounce of prevention, and should be reinstated ASAP, preferably without a grace period. Let’s get the inevitable deleveraging over with already.

  70. That’s when a sovereign nation does not let the Ultra-TBTF banks do business in that nation. They can go to Iceland and screw them over again. Does anyone know how to say “sorry about that” in Icelandic?

  71. And its pretty clear that the Government (big or small) isn’t in charge.

  72. I have not read one single opinion over the years holding that holds that we are benefitted from having banks that are “too big to fail” and so to interpret the post as a discussion of that is pure silliness.

    The real question is… how to address the problem… and in this respect I am convinced that we first need to eliminate the reasons why some banks became too big to fail… and then take care of the problem that will arise when some of these “too big to fail” lose their footing. Just to go out, like a raging bull in a china shop, driven mostly by ingrained hate of bank oligarchs, in a delicate moment like this, is plainly irresponsible… as it was plainly irresponsible not to speak out in time… unless of course, though known as an expert, one did not really know much about the issue.

  73. Glass – Stegal WAS too big to fail legislation. S.J. has it right about readoping a law from 75 years ago. It was good law but now we need to update to mordern time. Include CDO et all…

  74. In my opinion, too-big-to-fail is a pseudo-problem. Canada has very large banks that are doing reasonably well and have required no bailouts(as far as I know). Why? Because they stayed away from financial instruments that no one understands.
    What do you mean by determinate and non-determinant? The point for me, is that ALL the models are useless. This is not a technical problem that can be fixed by even more phony maths. Derivatives are not just useless, but very dangerous as Warren Buffet, Taleb and others have repeatedly said over the years.

  75. I find it more constructive to think that regulators are “randomness colorblind.” Their lack of governance perspecuity leads to their errors of omission and commission. Arguing about “nits” based on my experience, but most definately agree in principle.

  76. Agree that 2B2F is a vapor target. Canada also had no version of Glass Steagall or Depression Era bank failures.

    Determinate vs. indeterminate is another way to say risk vs. uncertainty. I argue that where there is complexity there is uncertainty.

    Risk is measurable (i.e., insurance company actuaries), whereas uncertainty is NOT measurable.

    Randomness consists of predictability (USTBs), probability (posiutive cash flow instruments), and uncertainty (negative cash flow instruments). Much has been developed through physical sciences complex adaptive systems (See Dr. Stuart Kauffman UVM).

    My view is consistent with Knight and Roubini, Taleb recognizes the metric but questions, most regulatory agencies live in an exclusively dertrministic world.

    It is hard to have a meaningful discussion with dissimilar underlying randomness conditions. As the world moves toward 3-D models (GPS) regulators are stuck in a binary 2-D mode.

  77. Redleg is right. TBTF is really Too Politically Powerful To Be Allowed To Exist In A Republic Or Democracy (TPPTBATEINR/D.

    Campaign finance reform is obviously the only answer to this problem, but surely there are better solutions than getting THE GOVERNMENT involved in campaign financing. Here’s three that would fix it:

    1) Make PAC’s illegal
    2) Make bundling illegal
    3) Make the upper limit that an organization can contribute the same as the upper limit that a human being can contribute.

    And my personal favorite::

    4) The only people who are allowed to contribute to a campaign are people who are registered to vote for that candidate. If you aren’t eligible to vote for them, you aren’t eligible to donate to their campaign.

    I personally would put the upper limit on campaign contributions at about $100 per candidate.

  78. Mr. Boyko,

    Yes, I’m trying to tell you that you cannot use the ideas of risk, probability and uncertainty that are found in physical models and apply them to financial “processes”. You are making a category mistake.
    The physical processes of Nature and price movements in financial markets exist in entirely different domains, there is no connection between them.
    Although, I see that lately you haven’t mentioned that you think financial “risk” is quantifiable, which is nice to see. Or do you still believe that?

  79. “The physical processes of Nature and price movements in financial markets exist in entirely different domains, there is no connection between them.”

    You are right on, Ed. The categories are precisely why a proper book-keeping is double entry. One entry measures the value in trade. Simultaneously a second entry expresses rights to ownership. The rights to ownership category have a capital potential whose gain [loss] is decided by the outcome of future physical trades that can be measured. The rest is guess work.

  80. Dan Palanza,

    Thanks!
    Hmmm…I studied bookeeping a few years ago, but don’t really understand what you’re referring to, although I hadn’t thought of linking “physical” reality to entries on a ledger, but that is intriguing way to think of it.
    Anyway, I’m only repeating more or less what Taleb, Keynes, Skidelsky and others say, which is it’s completely mistaken to think that the application of mechanics, either statics or dynamics, either 2-D or 3-D, to economics or finance is anything other than a nonsense.

    Cheers

  81. That is exactly what I said

    “Risk is measurable (i.e., insurance company actuaries), whereas uncertainty is NOT measurable.”

  82. A better example:
    http://blip.tv/file/2814691/
    Keen explains his bailout model at about the 20 minute mark. Different talk, same .ppt.

  83. “Hmmm…I studied bookeeping a few years ago, but don’t really understand what you’re referring to, although I hadn’t thought of linking “physical” reality to entries on a ledger, but that is intriguing way to think of it.”

    Ed, my arguments are not taking up present book-keeping practices because the discipline is falling short of the mark. I’m focusing the Industrial Quality Book-keeping of 50 years ago. That is technology that we cannot survive without in a computerized world. Book-keeping’s job is to record an accurate, reusable history. When book-keeping fails to distinguish the physical measure of facts from its composition of history that reports those measured facts the system becomes too easy to cheat.

    Modeling of the oceans, the environment, and the trading of goods and services need the proper real-time modeling that only Industrial Book-keeping of 50 years ago can deliver. Science needs this technology to gain the political traction our culture needs if we are to get ourselves beyond the mess that commingling the physical and intellectual data has gotten us into.

    Note: in 30 years of research I have yet to meet an accountant, an economist, or a CFO who understands this important modeling issue as it occurs in a proper double-entry book-keeping system.

  84. “Risk is measurable”

    Stephen, the issue is between a physically measured value versus a probable conjecture of value. You may recall that Einstein, in the study of quantum phenomenon was not pleased with a probability solution to the solution of particle|wave relationships. He felt that science could do better. We are now in a state of affairs where science must do better, or we are not going to have a nation or a planet. We all know that things are going wrong.

    The difference between a measure and the expression of a conjecture is important. They are both essential to a complete science, but they must be understood so that they are not commingled. There number systems are fundamentally different.

  85. Mr. Palanza:

    I agree with the need to differentiate between between risk and uncertainty. That is why “We’re All Screwed” argues against One-size-fits-all regulatory metrics that are primarily deterministic in approach.

    Economic dislocation are becoming larger and more frequent.

    Capital market governance is primarily a function pricing and related practices. FASB 157 is a constructive step toward pricing differentiation. The practice side needs to be similarly adjusted.

  86. Keen’s ppt presentation is constructive. In “We’re All Screwed” I use Schumpeter for the “boom” portion of the model and Minsky for the bust portion of the model. Barbera and Mishkin have good references on Minsky.

  87. James K. Galbraith responds to Paul Krugman in “Who where these economists, anyway?” “These economists” refers to the ones Krugman cites without naming names. Galbraith fills in the gaps with five different “heterodox” groups.

    http://www.nea.org/assets/docs/HE/TA09EconomistGalbraith.pdf

  88. I noticed on the IMF blog that splitting investment banks into 10 parts (which BTW assumes that their credit portfolios are uncorrelated, as in: uncorrelated defaults;) is not really under IMF’s consideration, unless it is covered by this “robust resolution regime” euphemism:

    “Finally, a robust resolution regime is required for large, complex financial institutions that operate in multiple jurisdictions.”

    But still, even your Glass-Steagall 2.0 would be less harmful for investor utility than Tobin-taxing ‘speculative’ transactions (50% of which are in fact liquidity-providing), because such taxes not only increase bid/ask spreads but also paradoxically (by draining liquidity) *increase* volatility, thus deteriorating both elements of investor’s utility: return and risk.

    See the aforementioned blog article ‘Don’t Forget Financial Sector Reform’ posted on the IMF website by John Lipsky
    [ http://blog-imfdirect.imf.org/2010/01/07/financial-sector-reform/ ]

  89. Below what I posted there and that “awaits moderation”

    The principal pillar of the current financial regulations that of discriminating the capital requirements of banks based on perceived default risks is utterly wrong.

    Not only did it cause an excessive demand for AAAs and which, naturally, given the shortage of real AAAs, was met with the fabrication of false AAAs, but it also provides additional benefits to those who having reached the top of credibility, the AAAs, least needed it. To benefit the AAA rated with low capital requirements amounts by definition, to the mother of all pro-cyclical regulations.

    The largest source for misallocation of funds, namely the fact that the borrowing by AAA rated governments are still benefitted with a zero capital requirement, shows clearly that the faulty group-thinking that led to the current crisis keeps on going as strong as ever.

    Also the exponential increase in the importance of the credit rating agencies is causing the whole system to end up as dumb followers of a human very fallible GPS system, that has already once failed, “subprime mortgages”, and that is bound to fail over and over again, every time more explosively.

    Nothing of the above is even mentioned in what the author calls the “broad agreement on the key principles of financial sector reform.”

    To have a Financial Stability Board, a veritable clone of the Basel Committee thinking, to be the sounding board for financial regulatory reform is almost laughable, were the implications not so tragic.

    The regulators are obviously trapped in their current paradigm and, if they cannot get out of it, they have to be thrown out of it.

    The minimum think we need is that they clearly specify the objectives for the financial sector as just not defaulting sounds as ambitious as not having you kid to fall once while learning to walk.
    Our banks should be the best instrument for the society to take the right and best risks… not the experts in avoiding them.

    Our banks are not there only to avoid default risks or to be a safe-mattress for the depositors our banks are there to help society to move forward to grow and to generate sustainable jobs.

    To see how there are now calls for tightening up the capital requirements of banks only to have bureaucrats make the credit allocation decisions is almost criminal behavior.

    There is nothing wrong with having the public purse to pick up the cost of a bank crisis, if the banks had been doing their best in helping society… but it is a horror story having to foot that cost when a crisis like this has resulted from banks assisting a real estate property boom that brought so little.

    Per Kurowski

    I am a former Executive Director of the World Bank, 2002-2004 and I have been arguing against the Basel Committee bank regulation paradigm for more than a decade.
    http://www.subprimeregulations.blogspot.com/
    http://financefordevelopment.blogspot.com/

  90. Folks, It’s been a real joy to eavesdrop on this intelligent, dignified and clearly concerned discussion you ladies and gentlemen (yes, I’m delighted to see some ladies joining in; there should be more of you) have been conducting on an almost intractable but monstrous problem. (None of the vitriol one often sees on some of the purely opinionated blogs.) As one who has been privileged to work in the economic field without actually having completed all of the formal prerequisites, I am impressed. This is the sort of discussion that should be occurring on a large number of very difficult challenges people face the world over. Thanks.