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>small institutions must submit to the rigors of the free market. >market discipline has worked to keep smaller institutions on the straight and narrow, it has

>small institutions must submit to the rigors of the free market. >market discipline has worked to keep smaller institutions on the straight and narrow, it has been ineffective with megabanks >market participants have proved [in]effective in monitoring risks at these [huge banks]. >They know they will be protected by a taxpayer rescue should a large institution teeter. How is this not obvious to everyone involved?

josephlord 14y ago
Smaller banks survived this crisis with relatively few failures but that has not always been the case (e.g. Savings and Loans crisis). However the fact that they can fail is critical and a sufficient reason to break them up even if it won't make them better. Banks that are too big to fail are too big to be allowed to exist. Government protection only for the commercial/retail part is an obvious but insufficient requirement.
- ataggart 14y ago
  It's not clear to me how "bigness" matters. The article makes clear that small banks were exposed to disciplining market forces, but for large banks such forces were obviated by government protection. Worrying about size seems to miss the point.
  - svachalek 14y ago
    "Obviated by government protection" BECAUSE of their size. Thus the slogan "too BIG to fail". When big banks make money by taking crazy risks, they earned every penny and how DARE we try to tax or regulate them. When they lose money by taking risks, we need to bail them out for the good of the free world and how DARE we ask to be paid back. Small banks do not have this attitude.
    - betakappaphido 14y ago
      Aka the privatization of profit with the socialization of loss. It's absurdity. Unless you're the profiteer.
  - josephlord 14y ago
    How much collateral damage will there be if they fail? This is the reason the banks got bailed out, they are big and complicated so can't be unpicked and wound up. If they were smaller the collateral damage is smaller and wind up manageable. There are real reasons for not letting big banks fail so we need to avoid them getting that big and complicated so they can be allowed to fail.
  - skywalk 14y ago
    "Bigness" matters because only a few of the large banks are primary dealers [1] - they directly play a role in US treasury auctions. All the other investment banks that aren't primary dealers only play a part in the secondary market. Part of this relationship is also the agreement that large banks are always making markets [2] and providing liquidity for highly-traded Fixed Income products - without someone to make the markets, no one would be able to trade. A large part of the global finance system is based on the ability to easily buy or sell these products, from the huge institutional clients like Fidelity, to the individual investor using their Schwab account (albeit even that is done through a much larger entity to access the market). The move towards computerization in the financial industry over the past 30 years has directly impacted the bottom line of these large banks (via smaller bid/ask spreads [3]), but has also directly lead to increased liquidity due to trading volume. [1] http://en.wikipedia.org/wiki/Primary_dealer http://en.wikipedia.org/wiki/Primary_dealer [2] http://en.wikipedia.org/wiki/Market_maker http://en.wikipedia.org/wiki/Market_maker [3] http://en.wikipedia.org/wiki/Bid-offer_spread http://en.wikipedia.org/wiki/Bid-offer_spread
- eru 14y ago
  Why have government protection at all?
deleted 14y ago
[deleted]
cynicalkane 14y ago
They are obvious and breaking up the banks is a popular topic of speculation in the finance industry. What's a mystery is why it is taking so long for mainstream econ and op-ed writers to catch on. Paul Krugman, for example, proposed that big banks like Citibank provide value by having a huge service network, and therefore he's skeptical of breaking up banks. Which is true--Citibank's size is the primary (and probably only) reason I'm a Citibank customer. But the unstated assumption that there must necessarily a 1:1 ratio of Too-Big-To-Fail bunches of assets to bank service networks is baffling to me. There seems to be a TBTF blind spot in the sphere of wide-area economic and financial knowledge; that is just one example. The solution is always "more regulation", or occasionally, "better regulation" with the implication that everything is the government's fault.
- anigbrowl 14y ago
  What's a mystery is why it is taking so long for mainstream econ and op-ed writers to catch on. I think they're quite familiar with the idea and have caught onto it long ago; they just don't want to be misrepresented as advocating a government takeover of the finance industry or as communists or whatever. It's not so much that they favor large institutions, as they're trying be moderate and consider both sides of the argument. By contrast, read the editorial pages or the comment sections of the Wall Street Journal, in which Obama is regularly characterized as a Marxist ideologue and worse, and any sort of regulation or disciplinary action against the financial services sector is characterized a shakedown, at best. If the government actually proposed carving up the banks there would be (even more) howls for his impeachment. Much as only Nixon could go to China, a reset of the financial sector could only come from some prominent Republican, and a fiscally hawkish one at that.
- azernik 14y ago
  An example of how large collections of assets and large service networks don't have to have a 1:1 correspondence: I'm a member of a two-branch credit union, but I get to use a fairly extensive service network through the Credit Union Service Center system, where a large number of small institutions share the customer-service side of their operations. In the SF bay area, I get full service from any of the several dozen branches of Patelco and USE, plus several smaller CUs.
MichaelApproved 14y ago
"They know they will be protected by a taxpayer rescue should a large institution teeter." This should be mitigated by the fact that shareholders will lose value, even in the event of a taxpayer rescue. Meaning, a bailout isn't a good insurance policy for a shareholder because they lose anyway. But that fear of a bailout doesn't seem to limit the risk appetite as I'd expect. I think it's because regulation and control hasn't made this type of risk transparent to the shareholder. The shareholder isn't calling for these types of regulations because of fear the regulation would be overbearing and hurt profitability. Often, over regulation is a shortsighted concern that allows a company to take on more risk than an investor would typically allow for (at existing valuations).
- refurb 14y ago
  Didn't the shareholders lose out during the past crisis? Just look at the beating the stocks of the major banks took.
- richardw 14y ago
  Shareholders have very little power over the big banks. The bank managers and traders have perfected demonstrating the principal-agent problem (link below). For example, huge bonuses being paid out even as the banks were being torn apart around them. Managers and traders kept arguing that they need to retain "talent", to the detriment of the supposed owners of the business. http://en.wikipedia.org/wiki/Principal%E2%80%93agent_problem http://en.wikipedia.org/wiki/Principal%E2%80%93agent_problem More simply: Taxpayers are suckers Lenders are suckers Shareholders are suckers Managers and traders, not suckers.
rayiner 14y ago
Because it's a narrative with no basis in fact? The smaller banks were the ones hardest hit by the popping of the financial bubble. GS/MS/JPM didn't need the bailout, Lehman and Bear Stearns failed in a free market manner, and Merrill Lynch was bought out. It was the smaller banks that really needed the bailout money.
- glesica 14y ago
  Merrill Lynch hardly failed in a free market manner. It was bought out based on guarantees from the taxpayers IIRC. GS also got help from the SEC in the form of a temporary ban on shorting. I'm not saying you're wrong, just that you've over-simplified the situation... there really aren't any free markets when it comes to finance.
- SilasX 14y ago
  Really? So it was the credit unions that were decimated by the crisis? Or did you just mean the "smaller of the giants"?
- RockyMcNuts 14y ago
  1) that's factually incorrect, 2 of the top five Wall Street firms failed (Lehman and Bear Stearns). 2) the other 3 (Goldman, Morgan Stanley, Merrill Lynch) would have failed after Lehman, the entire financial system had to be backstopped by the government. (If you look beyond pure securities firms, the largest insurance company (AIG) failed as well as the largest bank (Citibank - it effectively got nationalized and shareholders were wiped out, look at a stock price chart (http://finance.yahoo.com/q/bc?s=C&t=my&l=off&z=l&q=l&c= http://finance.yahoo.com/q/bc?s=C&t=my&l=off&z=l...) The lesson learned is that the financial system can't survive a failure like Lehman without a government backstop. So, pick your poison, either 1) permanent government backstop and some regulation to go with, it, ie don't let bankers run leveraged hedge funds on the public dime, take all the profits in good times and stick taxpayers with the bill when it goes south. Or 2) smaller banks that can fail without taking the whole system down.
  - rayiner 14y ago
    Most people in the financial sector do not think Goldman, MS, or JPM would have failed without the bailout. Lehman and Bear Stearns did fail, but their failure was largely handled within the banking system itself (a lot of Lehman being bought by Barclays and Bear Stearns being absorbed by JPM). It's the smaller banks that struggled the most and continue to do so: http://articles.latimes.com/2012/jul/06/business/la-fi-banks-tarp-20120706 http://articles.latimes.com/2012/jul/06/business/la-fi-banks...
mattmcknight 14y ago
Systemic risk to an investment class such as mortgages, means that most banks would be subject to the same ill effects, and smaller less diversified banks will fail. There were 157 bank failures in 2010...zero in 2006. http://www.fdic.gov/bank/historical/bank/2010/index.html http://www.fdic.gov/bank/historical/bank/2010/index.html However, just limit the amount of Federal Deposit Insurance that can be issued to one entity, if we can't figure out what they're doing.

josephlord 14y ago

Smaller banks survived this crisis with relatively few failures but that has not always been the case (e.g. Savings and Loans crisis). However the fact that they can fail is critical and a sufficient reason to break them up even if it won't make them better. Banks that are too big to fail are too big to be allowed to exist. Government protection only for the commercial/retail part is an obvious but insufficient requirement.

ataggart 14y ago
It's not clear to me how "bigness" matters. The article makes clear that small banks were exposed to disciplining market forces, but for large banks such forces were obviated by government protection. Worrying about size seems to miss the point.
- svachalek 14y ago
  "Obviated by government protection" BECAUSE of their size. Thus the slogan "too BIG to fail". When big banks make money by taking crazy risks, they earned every penny and how DARE we try to tax or regulate them. When they lose money by taking risks, we need to bail them out for the good of the free world and how DARE we ask to be paid back. Small banks do not have this attitude.
  - betakappaphido 14y ago
    Aka the privatization of profit with the socialization of loss. It's absurdity. Unless you're the profiteer.
- josephlord 14y ago
  How much collateral damage will there be if they fail? This is the reason the banks got bailed out, they are big and complicated so can't be unpicked and wound up. If they were smaller the collateral damage is smaller and wind up manageable. There are real reasons for not letting big banks fail so we need to avoid them getting that big and complicated so they can be allowed to fail.
- skywalk 14y ago
  "Bigness" matters because only a few of the large banks are primary dealers [1] - they directly play a role in US treasury auctions. All the other investment banks that aren't primary dealers only play a part in the secondary market. Part of this relationship is also the agreement that large banks are always making markets [2] and providing liquidity for highly-traded Fixed Income products - without someone to make the markets, no one would be able to trade. A large part of the global finance system is based on the ability to easily buy or sell these products, from the huge institutional clients like Fidelity, to the individual investor using their Schwab account (albeit even that is done through a much larger entity to access the market). The move towards computerization in the financial industry over the past 30 years has directly impacted the bottom line of these large banks (via smaller bid/ask spreads [3]), but has also directly lead to increased liquidity due to trading volume. [1] http://en.wikipedia.org/wiki/Primary_dealer http://en.wikipedia.org/wiki/Primary_dealer [2] http://en.wikipedia.org/wiki/Market_maker http://en.wikipedia.org/wiki/Market_maker [3] http://en.wikipedia.org/wiki/Bid-offer_spread http://en.wikipedia.org/wiki/Bid-offer_spread
eru 14y ago
Why have government protection at all?

deleted 14y ago

[deleted]

cynicalkane 14y ago

They are obvious and breaking up the banks is a popular topic of speculation in the finance industry. What's a mystery is why it is taking so long for mainstream econ and op-ed writers to catch on. Paul Krugman, for example, proposed that big banks like Citibank provide value by having a huge service network, and therefore he's skeptical of breaking up banks. Which is true--Citibank's size is the primary (and probably only) reason I'm a Citibank customer. But the unstated assumption that there must necessarily a 1:1 ratio of Too-Big-To-Fail bunches of assets to bank service networks is baffling to me. There seems to be a TBTF blind spot in the sphere of wide-area economic and financial knowledge; that is just one example. The solution is always "more regulation", or occasionally, "better regulation" with the implication that everything is the government's fault.

anigbrowl 14y ago
What's a mystery is why it is taking so long for mainstream econ and op-ed writers to catch on. I think they're quite familiar with the idea and have caught onto it long ago; they just don't want to be misrepresented as advocating a government takeover of the finance industry or as communists or whatever. It's not so much that they favor large institutions, as they're trying be moderate and consider both sides of the argument. By contrast, read the editorial pages or the comment sections of the Wall Street Journal, in which Obama is regularly characterized as a Marxist ideologue and worse, and any sort of regulation or disciplinary action against the financial services sector is characterized a shakedown, at best. If the government actually proposed carving up the banks there would be (even more) howls for his impeachment. Much as only Nixon could go to China, a reset of the financial sector could only come from some prominent Republican, and a fiscally hawkish one at that.
azernik 14y ago
An example of how large collections of assets and large service networks don't have to have a 1:1 correspondence: I'm a member of a two-branch credit union, but I get to use a fairly extensive service network through the Credit Union Service Center system, where a large number of small institutions share the customer-service side of their operations. In the SF bay area, I get full service from any of the several dozen branches of Patelco and USE, plus several smaller CUs.

MichaelApproved 14y ago

"They know they will be protected by a taxpayer rescue should a large institution teeter." This should be mitigated by the fact that shareholders will lose value, even in the event of a taxpayer rescue. Meaning, a bailout isn't a good insurance policy for a shareholder because they lose anyway. But that fear of a bailout doesn't seem to limit the risk appetite as I'd expect. I think it's because regulation and control hasn't made this type of risk transparent to the shareholder. The shareholder isn't calling for these types of regulations because of fear the regulation would be overbearing and hurt profitability. Often, over regulation is a shortsighted concern that allows a company to take on more risk than an investor would typically allow for (at existing valuations).

refurb 14y ago
Didn't the shareholders lose out during the past crisis? Just look at the beating the stocks of the major banks took.
richardw 14y ago
Shareholders have very little power over the big banks. The bank managers and traders have perfected demonstrating the principal-agent problem (link below). For example, huge bonuses being paid out even as the banks were being torn apart around them. Managers and traders kept arguing that they need to retain "talent", to the detriment of the supposed owners of the business. http://en.wikipedia.org/wiki/Principal%E2%80%93agent_problem http://en.wikipedia.org/wiki/Principal%E2%80%93agent_problem More simply: Taxpayers are suckers Lenders are suckers Shareholders are suckers Managers and traders, not suckers.

rayiner 14y ago

Because it's a narrative with no basis in fact? The smaller banks were the ones hardest hit by the popping of the financial bubble. GS/MS/JPM didn't need the bailout, Lehman and Bear Stearns failed in a free market manner, and Merrill Lynch was bought out. It was the smaller banks that really needed the bailout money.

glesica 14y ago
Merrill Lynch hardly failed in a free market manner. It was bought out based on guarantees from the taxpayers IIRC. GS also got help from the SEC in the form of a temporary ban on shorting. I'm not saying you're wrong, just that you've over-simplified the situation... there really aren't any free markets when it comes to finance.
SilasX 14y ago
Really? So it was the credit unions that were decimated by the crisis? Or did you just mean the "smaller of the giants"?
RockyMcNuts 14y ago
1) that's factually incorrect, 2 of the top five Wall Street firms failed (Lehman and Bear Stearns). 2) the other 3 (Goldman, Morgan Stanley, Merrill Lynch) would have failed after Lehman, the entire financial system had to be backstopped by the government. (If you look beyond pure securities firms, the largest insurance company (AIG) failed as well as the largest bank (Citibank - it effectively got nationalized and shareholders were wiped out, look at a stock price chart (http://finance.yahoo.com/q/bc?s=C&t=my&l=off&z=l&q=l&c= http://finance.yahoo.com/q/bc?s=C&t=my&l=off&z=l...) The lesson learned is that the financial system can't survive a failure like Lehman without a government backstop. So, pick your poison, either 1) permanent government backstop and some regulation to go with, it, ie don't let bankers run leveraged hedge funds on the public dime, take all the profits in good times and stick taxpayers with the bill when it goes south. Or 2) smaller banks that can fail without taking the whole system down.
- rayiner 14y ago
  Most people in the financial sector do not think Goldman, MS, or JPM would have failed without the bailout. Lehman and Bear Stearns did fail, but their failure was largely handled within the banking system itself (a lot of Lehman being bought by Barclays and Bear Stearns being absorbed by JPM). It's the smaller banks that struggled the most and continue to do so: http://articles.latimes.com/2012/jul/06/business/la-fi-banks-tarp-20120706 http://articles.latimes.com/2012/jul/06/business/la-fi-banks...

mattmcknight 14y ago

Systemic risk to an investment class such as mortgages, means that most banks would be subject to the same ill effects, and smaller less diversified banks will fail. There were 157 bank failures in 2010...zero in 2006. http://www.fdic.gov/bank/historical/bank/2010/index.html http://www.fdic.gov/bank/historical/bank/2010/index.html However, just limit the amount of Federal Deposit Insurance that can be issued to one entity, if we can't figure out what they're doing.