Dear Friends,
It seems to me, the too big to fail dilemma gets worse, every time our legislators have a go at it. The Elite’s regulations always result in pernicious incentives that, instead of preventing banks from becoming too big to fail, actually create the conditions where banks must become too big to fail, else they cannot compete. The new regulation bears such an associated cost that it makes small banks uncompetitive, not due to market forces, but to regulatory causes. Of course, the Elite only take, they never give, their solutions are always more regulation, as we have opined in the past, so their solution must add to the problem, no matter how well crafted their regulation is. This increases the chance for great disturbance to our financial system. The same system your 401K is invested in, as well as your checking account, your savings account and any other account you have of M2 or M3 money. This makes the too big to fail problem your problem too.
Too big to fail is a result of old bank regulations, passed in an earnest effort to solve issues that became apparent after the 1929 banking crisis. As with all regulation, it created more problems than it solved, requiring more regulation. Banks actually create money, just like they had a printing press in their basements, but to create money, they need to have deposits and make loans. Obviously, creating money is a strong incentive to bankers to get deposits like, checking accounts, savings accounts, money markets etc… All a bank’s insured deposits are guaranteed by the Federal government through the Federal bank, (The Fed).
Banks are required, by regulation, to have a certain amount of the money deposited in their bank available as M1 money. The theory is, in normal times, a bank will never see 10% of it’s deposits withdrawn in a day. The problem is… our economy is a complex system. In complex systems, rare events graph in long tails instead of bell curves. Very unlikely occurrences are not only possible in complex systems but are certain. Because of this, there are times when more money is demanded than the bank can produce, if that happens the bank is in bankruptcy and must close it’s doors. It becomes the property of the Fed, it’s assets sold, and it’s debts paid. The Fed then insures every depositor’s first 200K of money if the assets don’t meet the debts.
When a bank becomes too big to fail it means that if it were to fail and go bankrupt the entire economic system would be put in jeopardy. The daily debts and outlays of a tottering, too big to fail, institution would be disrupted if it were to fail. Checks would bounce even though sufficient funds were available, paychecks couldn’t be cashed, large money changers could be shut down for a period of time like PayPal, inter bank payments would be disrupted, and the Fed would be handed a steaming pile to deal with. This could lead to a cascade of possible bank failures as the debts one bank owed another were disrupted by failures causing more failures. Banks that survived the first round would stop lending and hoard assets to stay alive. The entire monetary system could collapse if this were to happen… and it almost did! The 2008 banking disaster could very well have led to the very cascade of bank failures I have explained.
Therefore, a bank that is too big to fail will be bailed out, no matter how far off the rails it goes. This gives their debt issuance the implicit backing from the US Government, further exacerbating the problem. Because a smaller bank doesn’t have the implicit backing of the government and so must pay a higher rate on it’s debt! Plus a higher regulatory cost to nominal deposits makes it a virtual commandment for all banks to get… too big to fail! If you think about it for even a moment, even a fool would realize, we need to get a handle on the too big to fail dilemma.
The answer is as simple as it is hard for the Elite to swallow. Remove as much banking regulation as possible. Leave only standardizations eliminating regulations. This would level the playing field for the smaller banks and credit unions. Then, determine an upper level of bank holdings, that would make a bank become a systemic risk. Reduce that by 10% and set this as the upper limit for protected managers. Banks would be allowed to grow beyond this limit, but if they failed for any reason, the board of directors, the president, the CEO, the CFO and all the vice presidents would go to jail, even past bank officers up to the time the bank passed the limit. They would serve not less than 4 years and no more than 10 years. Make the law as simple as possible with no wiggle room for an especially weaselly CEO to worm through. Make them personally liable for the bank’s solvency if it grows past this point… and it won’t.
The self interest of every member of a bank’s board of directors will make absolutely sure, every bank in which he or she is a member of the board, will remain well under the limit. No bank president will allow his or her bank to grow beyond the limit, and top quality candidates for vice presidents, will be non existent. This would solve the too big to fail problem simply and efficiently. Our economy would be allowed to grow at an expanded rate due to less regulation, money would be more available to small businesses and entrepreneurs because small banks usually lend to these important economic actors, and a major systemic problem will have been addressed, once and for all.
Sincerely,
John Pepin
