November 14, 2011

The problem with the 'too big to fail' concept

I wrote earlier with respect to the Greek debt crisis that the banks that were described by the phrase 'too big to fail' were not a loose and undefined category but that there is an actual list of 29 banks that governments feel obliged to bail out if they get in trouble. Of these 17 are based in Europe, eight in the US, and four in Asia. Of course, knowing that they are too big to fail only encourages these banks to thumb their noses at the normal rules of the marketplace and take excessive risks with other people's money for their own benefit, which is what has caused all these problems in the first place.

The big US banks are doing extremely well because, after their risky investments imploded, the US government and the Federal Reserve essentially gave them free money to make new risky investments. They then made huge profits but if they had failed then the taxpayers would have been on the hook for the losses once again.

Wall Street firms — either independent companies or the high-flying trading arms of banks — are doing even better. They've made more profit in the first 2 1/2 years of the Obama administration than they did during the entire Bush administration, industry data show. (See data in an Excel file here.)

Behind this turnaround are government policies that saved the financial sector from collapse and then gave banks and other financial firms huge advantages on the path to recovery. For example, the federal government invested hundreds of billions of taxpayer dollars in banks, money that the firms used for risky investments on which they made huge profits.

Neither Bush nor Obama, for instance, compelled banks to increase lending to ordinary businesses or consumers, known as "prime borrowers."

A recent study by two professors at the University of Michigan found that banks, instead of significantly increasing lending after being bailed out, used taxpayer money to invest in risky securities to profit from short-term price movements. The study found that bailed-out banks increased their returns by nearly 10 percent as a result.

No bank should be too big to fail because then they can extort us. If a bank is too big to fail, then it should belong to the people, i.e., be nationalized, because the taxpayers are essentially paying the bills. Otherwise, the US government should do to the big banks what they do to smaller banks when they fail. They are taken over by the appropriate regulatory agency, reorganized, top management replaced, new policies put into place to make sure that the banks are following sound business practices, and then returned to the private sector. Even better would be to break up the big banks into smaller banks.

Instead of that the US government gives free money to the very institutions and people who create these crises. They then make risky investments. If the investments work, they make huge profits that they keep for themselves. If the investments turn sour, taxpayers bail them out. This situation has arisen because of the fact that there is an incestuous relationship between the big financial firms and the US government with top officials moving back and forth between the two. The US Department of the Treasury is essentially a subsidiary of Goldman Sachs.

What we now have is not capitalism but exactly what the oligarchs want: the privatization of profit and the socialization of risk.


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The last sentence reminds what ecologist Garrett Hardin (author of Tragedy of Commons)warned about: PPCC, privatization of profits, commonization of costs.

Posted by amarnath on November 14, 2011 11:21 AM