More Too Big to Fail

Simon and Charles Calomiris were quoted on NPR this morning on the topic of the day — too big to fail.

I thought one of Calomiris’s examples was interesting. He cited Mexico, where banking was dominated by six families that wouldn’t lend to potential competitors. After the Mexican financial crisis and the entry of foreign banks, now it is easier for companies to raise money. It seems to me that story could be used by either side.

By James Kwak

10 thoughts on “More Too Big to Fail

  1. Does anyone know how much money American Enterprise Institute pays Calomiris to speak out for the “efficiency” of big banks?? Maybe we could forgive him if we knew. Apparently HE feels he has not sold his soul……….

  2. Has anyone done a benefit:cost evaluation for mega banks since deregulation (ca. 1985)?

    The bailout cost is something like $20 trillion. If the ratio >1 then Calomiris is right. Then again, if it is >1, or even >.75 I suspect we’ll see pigs on the wing…

  3. The bailout’s COST is not $20 trillion (140% of annual output). That might be the sum of the SIZE of all programs, but a dollar spent on extending unemployment benefits (stimulus) or a $1 guarantee of a Wells Fargo bond are not money that is lost the same way that losses on Maiden Lane or permanently lost capital are.

    So what is the cost?

    I think you have to integrate the output gap over the duration of the recession (as yet unknown), and add the PV of the interest on the added debt, or something like that. Perhaps to be fair we should add back some of the benefits of the bubble that preceded the bust.

    IMF and Rogoff+Reinhart have done studies on the costs of bailouts…

  4. Backstops should qualify as a cost, or at least the administrative costs associated with the backstop.

    The bigger problem (I think) is quantifying the benefit.

    Personally, I think any institution that might approach TBTF should be broken up simply based on political power. But I think that this depression is a symptom of a political/ideological disease.

  5. I’ve listened to and read Mr. Calomiris’s stuff. His argument depends on the listener not knowing anything about the “plumbing” of financial markets. Large financial institutions do not provide lower-cost risk-management services via derivatives hedging. Nor, as trading counterparts, do they need all that heft to operate efficiently in global markets. Every hedge fund that succeeds in the rough-and-tumble global markets — without an explicit guarantee against failure by a host government that’s been compromised by the indigenous banking industry — demonstrates the contrary position.

    The plumbing works like this: Every bundle of risk a bank takes on is broken down into component risks, which are hedged by the individual desks tasked with trading in particular markets. So someone looking to off-load, say, interest rate, FX and maybe equities risk, will be crossing bid-ask spreads on all three desks. The traders running the books into which these separate risks will be dumped all have their own P&L and have to know the cost of laying off whatever risk they take on in the OTC derivatives markets. So when they make a price, they’ve already included a liquidity premium and their own P&L in whatever price they provide on the individual piece of risk they’re responsible for. While “brownie” points may be garnered for being a “team player” — e.g., pricing part of the overall hedge at mids instead of on the bid or offer — this doesn’t cover the particular desk’s “nut.” At the end of the year, every trader is comp’d by the P&L of their individual books. You’re only paid if you make money.

    The bottom line: A “customer” is better off going to the market and getting the best bid and best offer on the components of the risk bundle and transacting on that basis. As an aside, this is one reason the banks are fighting the push to get everything on to an exchange: Once the bids and offers are totally transparent, the “value added” of risk management services approaches zero. The really easy money will be gone.

    All of this back-and-forth by the apologists of big-is-best banking is so tedious. The folks making the argument have to demonstrate a tangible benefit where none exists. So they have to cloak their assertions — and they are, at the end of the day, nothing more than assertions — with unsupportable claims about the benefits of economies of scale. It’s as bogus as the claims made by the same apologists that these firms are too important for their fates to be left to the market.

    These apologists are just banal. So meticulous and self-serving. Mundane, trivial and boring. We and they would all do well to re-read Hannah Arendt. Particularly our executive-branch functionaries, who grant these clerks standing.

  6. In support of “free minds and free markets,” I wrote “We’re All Screwed to provide a blueprint for fundamental change to the legacy, one-size-fits-all deterministic governance regime. Trying to have a one-size-fits-all governance, is analogous to writing one driving manual for the US and UK. In “We’re All Screwed,” I describe how to segment the market into predictable, probabilistic, and indeterminate regimes to do the right things for governance effectiveness and how to do things right for governance efficiency.

    The legacy governance system for the US capital market is in disrepair. To achieve real regulatory reform, policymakers have to move beyond form to substantive issues. Unless experimentations to the legacy, one-size-fits-all deterministic regime take place, our capital market will be caught in a recursive loop of errors of commission (boom-bust bubble inefficiencies) and errors of omission (externality market inefficiencies). Such inefficiencies will eventually render our source of economic wealth ineffective.

    If this happens, we’re all screwed.

    Stephen A. Boyko

    Author of “We’re All Screwed: How Toxic Regulation Will Crush the Free Market System” (

    Book Review: Brenda Jubin, Ph.D Thursday, October 8, 2009
    Boyko, We’re All Screwed!

  7. The guarantees are contingent claims — options — written by the Fed and supported by its balance sheet. Any academics reading this might consider a paper using options-based modelling to calculate the value of the puts literally being given to the banks. These undergird the banks’ profitability, transforming their linear exposure (P&L) into a call that guarantees profitability and stops out their losses at or above zero — they still get paid even in years where they’ve blown up their balance sheets and imperil the global economy. Talk about asymmetric.

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