Fighting "too big to fail" is kind of simplistic

[Kurt_and_Hunter]

Sorry to be the nuance police, but there are two parts to "Too big to fail".... Big and Fail.

The general thinking is that some institutions are so large that they cannot be allowed to fail so we should prevent institutions from being that big and thus will not be forced to bail them out in the next crash.

This suggests that we could allow smaller institutions to fail.

We can allow smaller institutions to fail today because most of the financial sector is concentrated in a big companies. We bail out Citi because Citi is 10% of US banking, or whatever the number is. Break Citi into ten pieces and they still represent 10% of the industry and would all have to be bailed out if they were mini-Citis.

A crash creates a situation where some things need to be bailed out because the effect on all of society of them failing is too great. That is unavoidable. The result of that would be that in the next crash we would have to bail out 50 medium sized banks instead of five huge banks.

Bailouts are not optional in an economic collapse.

The only way to prevent bailouts is to prevent economic collapses.

If one believes that keeping financial institutions smaller will help prevent crashes then that's cool. But it is a separate argument.

Republicans are arguing that the solution to TBTF is toughness... just don't bail anyone out.

In an economic collapse that toughness would doom us to a depression. (Leaders were very tough after the crash of 1929... see where that got us.)

So what is needed is regulation likely to prevent collapses and financial institutions should be shrunk only insofar as that shrinkage makes collapses less likely, not as a predicate to mishandling the next crisis.

(That is the essence of the Republican promise... a threat to mishandle the next collapse on the theory that by ensuring such a collapse would be truly ruinous it will magically prevent it.)

[Jim Sagle]

1. 'Break Citi into ten pieces and they still represent 10% of the industry'

and would all have to be bailed out if they were mini-Citis.

Actually they WOULDN'T have to be bailed out, and any argument/assertion to the contrary is not nuance but corporatist hogwash.

But hey, you knew that.

[Zynx]

3. If fairly large institutions start failing, there is the risk of a run on the system.

A $100 billion bank going down will still cause some panic, I assure you.

[Jim Sagle]

8. Your assurance means squat.

All the REAL experts say otherwise.

And btw, there's a couple bank failures every week.

[Kurt_and_Hunter]

7. Ten banks that are all insolvent due to x percentage of bad paper...

act roughly the same as one bank with the combined assets of those ten banks. The total number of depositors insured by the FDIC is the same. The total number and size of obligations to other entities is the same.

If the failure of the one bank would be unendurable (if) then the failure of the ten would be unendurable.

I am sympathetic to arguments that concentration creates its own problems, but simple size-limits would not be a cure-all.

(Most institutions in the S&L crisis were, by modern standards, laughably small but there were so many of them that they were bailed out.)

[Zynx]

2. Be careful when you throw around the term "economic collapse".

That would imply that a crisis in what economists like to call "the real economy" triggered the financial crisis. However, real economic output was not exactly overstretched going into 2007. Real GDP was actually below potential with relatively weak growth rates. In 2001, we actually had an economy that had outstripped its potential output. In the case of 2007-2008, the recession was triggered due to institutional fragilities in the financial system that were sorely tested, brought on by the collapse of the real estate bubble. That had a large effect on "real" economic output, as we still see even after the beginnings of the recovery.

I would prefer the term "financial collapse", because economists prefer to make this distinction. Obviously, the two systems are not separate and real economic output is entirely reliant on the financial system operating. Hence, the need for the bailouts and hence why we need proactive measures to prevent situations where the financial system is on the verge of imploding, as you have said.

[Kurt_and_Hunter]

4. Fair enough

[Zynx]

9. It's semantics, not really substantive, but economists are sticklers for these sorts of term

differences.

[alcibiades_mystery]

5. Quite right

The question is on the relationship between so-called "bigness" and systemic risk. Would 100 smaller banks produce the same level of systemic risk? That's a question without an answer from most of the "too big to fail" chanters. The truth is that precious few people even understand how finance works and what role it plays in the economy - even when they lose their job because their employer can't secure commercial paper for daily operations or some such.

I'd say the other chanted item that needs to go by the wayside is the supposed distinction between finance capital and the so-called "real economy." There is no distinction in practice. There is no Wall Street-Main Street split anymore, supposing there ever was one in modern capitalist societies. It is a silly little conceit.

[RaleighNCDUer]

6. It is actually NOT a seperate argument. It is the very core of the argument.

When you have one institution controlling such a large segment of the financial industry, what you have is one institutional bureaucracy controlling that industry. That means a very few people are making decisions that affect a great number of people and a great amount of money.

If that institution is broken into ten smaller units, there will be ten CEOs, ten bureaucracies, ten management teams making those decisions, and they won't ALL make the same decisions. In fact, some, seeing how others are playing it, will deliberately buck the trend to capture niche markets which would automatically lessen any collapse. Others will see the pyramid schemes for what they are and be hesitant to get caught in them. And yet others will understand that the potential for criminal fraud is too great and hold back on that account.

As a result you have greater balance, thus less chance of ANY of them failing. And if they do fail, there will be the others available to help weather the storm.

Not to mention, if an institution is 'too big to fail', that can be an unspoken cushion for risk, knowing that if the scheme goes wrong they will NOT go belly up because the government can't allow them to fail. This increases the chance of indulging in risky or criminal behavior. A smaller institution, knowing that the only help they are going to get is a regulator coming by to sell off their assets, will be less likely to attempt such risky behavior.