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Home Publications Blogs Beat the Press Too Big to Fail and the Economic Crisis

Too Big to Fail and the Economic Crisis

Saturday, 07 December 2013 09:03

Neil Irwin seems to miss the major issues on too big to fail in his discussion of Treasury Secretary Jack Lew's remarks proclaiming too big to fail (TBTF) to be sort of over. The most obvious issue is simply whether the markets believe TBTF is over.

This is a question of whether they think Jack Lew or his successors will simply wave good bye if J.P. Morgan, Goldman Sachs, or one of the other megabanks goes under. If they don't believe that the government will just let one of these banks sink then they will still be willing to lend money to them at a below market rate since they are counting on the government to back up their loans.

This below market interest rate amounts to a massive subsidy to the top executives and shareholders of these banks. Bloomberg news estimated the size of this subsidy at $83 billion a year, more than the cost of the food stamp program. Insofar as Lew's efforts to create doubts about a government rescue are successful, the size of this subsidy would shrink toward zero. However as long as the markets do not take him seriously (my bet is they don't), the big banks will still be getting a massive subsidy.

This is one of the reasons why President Obama's recent comments on inequality were seriously misplaced. He said the government cannot stand on the sidelines as the distribution of income becomes much more unequal. Of course government is not standing on the sidelines; it is actively working to increase inequality through measures like the TBTF subsidy.

The other point that Irwin gets wrong is implying that the economic crisis in some way hinged on getting the TBTF issue right. The economy's current weakness is attributable to a lack of a source of demand to replace the demand generated by the housing bubble. Investment and consumption are both at normal levels relative to the size of the economy; there is no evidence that the residue of the financial crisis is holding them back. 

The issue going forward will be whether we have people at the Fed and other regulatory agencies who take bubbles seriously. We clearly did not in the past and since no one faced any career consequences as a result of this gargantuan failure, there is not much reason to believe that lessons have been learned. 

Comments (7)Add Comment
written by skeptonomist, December 07, 2013 8:55
The lack of government backup did not prevent the collapse of 1929, or the panic of 1907 or any others before that. Banking was much more dispersed then, although big NY banks usually played a major role in overexpansion. Bankers and financiers do not need TBTF to overexpand, nor will threat of bankruptcy or even criminal prosecution deter them from pushing leverage to the point where the entire system is threatened. This is just what finance does if not strictly regulated. There is no more reason to think that the Fed could prevent a crash or reverse the subsequent recession than it did in 1929. It was created to prevent a repeat of 1907 and it failed utterly.

Banks are not getting any smaller, and there is little reason to think that Dodd-Frank as actually implemented will impose really significant regulation. Lew himself came in through the revolving door and there is certainly no reason to think that he would be hard on banks in the event of a collapse. Maybe things will be different in the next collapse - a bailout may not fly politically - but there is no reason to think that Lew and the Fed have things under control or could control things by discretionary action. We've heard this story before.
written by skeptonomist, December 07, 2013 9:09
Regulations are certainly meaningless if not enforced by those in charge, and banking, SEC and other regulations have been and continue to be poorly enforced. Obama may make speeches about inequality (as he did in 2008) but I have seen no change in his practice of appointing people from finance industries to positions of governance over those industries. He would have appointed Summers over Yellen if Democratic Senators had not rebelled.
There is no more "too big to fail"
written by Bill H, December 07, 2013 9:17
Not because the banks are not to big; they are bigger than ever. Because we now belive that lessons have been learned, financial instruments have been tamed, and banks can no longer fail. Hahahahahahaha.
New Social Compact: Since People are Corporations, Give People TBTF Rights
written by Last Mover, December 07, 2013 9:44

Why not? If corporations are persons then persons are corporations.

Besides, it's the corporate welfare queens who constantly beat the sock puppet media message that everyone should pull their weight ... as they regularly privatize gains and socialize losses in every way imaginable.

Level the playing field. If corporations have TBTF rights then everyone should have them.

No more unemployment. No more subsistence wages. No more bankruptcy. No more foreclosures. No more lack of health care. No more pandering for food, clothing and shelter.

America can't allow its people to fail. The risk is too high. If Americans fail it manifests as systemic risk to bring down the entire economy. Even the big banks would be affected despite their TBTF rights, with fewer, poorer customers who set off a death spiral in the financial industry.

Enact universal TBTF rights now. Make a person-to-person visit to a corporation today and shake his or her hand in thanks for permission granted to you, to join the human race to which corporations already belong.
ignoring bubbles is a big whopper of a mistake....
written by pete, December 07, 2013 10:13
In the run up to the crash, financial institutions were doing fine, in the post Glass-Steagle world. Many had relatively low interest rates, and did fail, even some "too' big ones like Wachovia, WAMU, Countrywide, Merril Lynch, Bear Stearns, Lehman, Fannie and Freddie. Some of these had there debt completely covered in the bail out, but the equity vanished. Thus stockholders do no necessarily benefit from bailouts at all. My AIG has a -95% return marked to market, even though it was "bailed out". Ha ha . If Citi or JPM "fail" it is likely that the bondholders will not suffer, but the stockholders will. Jamie Dimon will lose quite a chunk of change if JPM fails.
Thks for thoughtful critique of Neil Irwin assessment of TBTF
written by jaaaaayceeeee, December 07, 2013 11:39

and presumably Jacob Lew's. I forget how long it will take before our economy is producing livelihoods again, so long as no politician or news media is willing to say that a lack of demand is our problem -- it's so many more years, that I hate to remember.

In other words, Neil Irwin is being too coy when he says it's only a possibility that we may still be in a situation of God help us all.
The $83 billion is only the tip of iceberg; you have to add the other free insurance to this number..
written by Perplexed, December 07, 2013 7:02
"This is a question of whether they think Jack Lew or his successors will simply wave good bye if J.P. Morgan, Goldman Sachs, or one of the other megabanks goes under."

The $83 billion subsidy only covers the risk reduction to investors; the "insurance" provided by other potential victims of these institutions is provide free of charge. No one covers the costs that the failure of one of these companies imposes on other victims. The fallout from the mismanagement of one these mega-banks cascades across of millions of other economic actors, none of whom would be protected by these "reforms." Even if "Lew or his successors will simply wave good bye," (lets take a vote on what anyone with a clue really believes the probability of that actually happening is), the "uninsured" losses to others would be enormous. What would the losses be to other asset holder? To other companies in the economy as demand collapses? To the government as the safety net expenses skyrocket? And, as usual, the largest losses will be suffered by the unemployed who will lose their entire incomes with the safety net covering little but a tiny portion of their losses, and no coverage for the rest of it. These are the people taking on the TBTF risk, with $0 in compensation for the insurance they provide. We wouldn't even allow a contractor to repair a bridge without providing adequate proof of insurance to cover any damage they might do to public assets or to individuals they might cause injury to, yet we provide this coverage for free to banks and then listen to them tell us they should be allowed to concentrate this risk into any form that best benefits them?

Its past time for a "free market" solution. Insist they provide proof of insurance for ALL of the damage they might cause by their high leverage and increased size & possible impact, and then let them grow to whatever size they can buy insurance for. Why is the public's responsibility to manage the risks of these "private" businesses and provide free insurance to them in the event they get it wrong? If the public is taking on and managing the risks, the public should be owning the stock and making the decisions. If the public is bearing the risk, they should be compensated, at the "market rate."

"We the People" have turned into "We the Fools," and, as bankers well know, Fools and their money are easily separated. Nationalize the TBTF's and let Elizabeth Warren oversea the break-up. If we had done that to begin with, we wouldn't still be dealing with it now.

What exactly does the public get out of 1 mega-bank that it wouldn't get out of 100, or 1,000 banks of a manageable size and manageable risk concentration? Cheaper banking? Who's kidding who?

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.