Too Big to Fail - Even Greenspan Is Speaking Out

In speaking to the Council of Foreign Relations, Greenspan said what I have heard many other credible financial experts say, namely that financial institutions which are ‘too big to fail’ (TBTF) are simply too big.

Is this Alan Greenspan talking? I am astonished that the man we have called bubble-blower in chief is willing to repudiate the notion of too big to fail. I applaud him.

Here is how Bloomberg quotes Greenspan:

“If they’re too big to fail, they’re too big,” Greenspan said today. “In 1911 we broke up Standard Oil — so what happened? The individual parts became more valuable than the whole. Maybe that’s what we need to do.”

At one point, no bank was considered too big to fail, Greenspan said. That changed after the Treasury Department under then-Secretary Hank Paulson effectively nationalized Fannie Mae (FNM) and Freddie Mac (FRE), and the Treasury and Fed bailed out Bear Stearns Cos. and American International Group Inc (AIG).

“It’s going to be very difficult to repair their credibility on that because when push came to shove, they didn’t stand up,” Greenspan said.

Greenspan’s comments put him on the record as more desirous of change than the Obama Administration. The Wall Street Journal accurately characterizes the Obama Administration's big regulatory proposal on TBTF institutions thusly:

The Obama-Summers-Geithner solution — in case you haven’t studied the administration’s white paper — in Summers’ words:

Raise capital requirements

Eliminate a system where financial institutions can choose who regulates them

Impose rigorous standards and supervision to protect the economy and investors

Establish resolution authority to ensure that no financial institution is too big to fail

Create a unified, independent agency to protect the American consumer from fraud and abuse and ensure that people get the clear information they need about loans and other financial products.

This is a good start and I certainly like their thinking on establishing a resolution procedure for TBTF institutions. But, of course, nothing in the Obama-Summers-Geithner solution advocates the break-up of TBTF institutions. Perhaps this is because the Bush and Obama Administrations have redefined what it means to be too big to fail.

Bill Black, who has some experience in these matters, took on this issue in a recent post on the University of Missouri-KC economics blog. He says:

The Obama administration is continuing the Bush administration policy of refusing to comply with the Prompt Corrective Action (PCA) law (see here and here). Both administrations twisted a deeply flawed doctrine – “too big to fail” – into a policy enshrining crony capitalism.

Historically, “too big to fail” was a misnomer – large, insolvent banks and S&Ls were placed in receivership and their “risk capital” (shareholders and subordinated debtholders) received nothing. That treatment is fair, minimizes the costs to the taxpayers, and minimizes “moral hazard.” “Too big to fail” meant only that they were not placed in liquidating receiverships (akin to a Chapter 7 “liquidating” bankruptcy). In this crisis, however, regulators have twisted the term into immunity. Massive insolvent banks are not placed in receivership, their senior managers are left in place, and the taxpayers secretly subsidize their risk capital. This policy is indefensible. It is also unlawful. It violates the Prompt Corrective Action law. If it is continued it will cause future crises and recurrent scandals.

I hope this solution sounds familiar because it is precisely the resolution process I advocate in my post “More on greed, regulation, Lehman and the financial industry." The point is the one Greenspan makes, namely that:

Failure is an integral part, a necessary part of a market system… If you start focusing on those who should be shrinking, it undermines growing standards of living and can even bring them down.

Let’s see what we get from Obama on this issue now that even Alan Greenspan has decided to speak out.

Comments

[Michael Clark:]

Now after all this time, Alan understands. It must have been that snake bite. Where was he during testimony in the 90's when he said the bigger the better, the less regulation the better everything will be...?

Oct 18 03:44 AM

[a. palmer jr.:]

I think Greenspan needs a vacation...how about a hunting trip with Dick Cheney?

Oct 18 09:57 AM

[chinooking:]

greenspan is a fed bank CRIMINAL ,so is paulson ,so is cox,and little george was such a puppet

Oct 18 12:37 PM

[DCBill:]

What credibility does this man possess?

He aided and abetted some of these TBTG institutions getting that way helping to hatchet Glass-Steagall!!

He's too addicted to the limelight; AG just should ride quietly into the sunset, enjoy his retirement, and keep his mouth shut.


On Oct 18 12:37 PM chinooking wrote:

> greenspan is a fed bank CRIMINAL ,so is paulson ,so is cox,and little
> george was such a puppet

Oct 18 05:09 PM

[BRUCE E. W.:]

I question as to whether FRE/FNM are in the same category as Lehman/ Citi / Goldman / JP Morgan etc. since they are not intermediaries of the e-financials that have essentially printed their own electonic currencies in fanciful paper that ultimately diluted the economy and eluded legitimate accountability. The mortgages that are threatened and the government backed support of their security are not the same as the securities invented and then further insured as gambling stakes by AIG. I may be wrong, but the mortgage industry involves the only bottom/up restructuring that is actually based on real lives and peoples fundamental investments in necessities of life (housing) and surviving a crisis that was made from the top down. If I recall correctly even Adam Smith noted under political economy that the first obligation of government was to provide assurance for their subbsistence and survival. While I wholeheartedly agree with you that the market should be allowed to play out with the oversized financial service sector (decentralizing will permit a vertical diversification and restore competitive health); I can't see how breaking the mortgages into vulnerable equity/assets for vulture capital will do anything more than intensify the crony capitalism and narrow elitism that is consigning our economy into regionally captured markets with no competitive diversity. At the bottom level, these mortgages are all privitized interests of the real demographic foundation of our society. It is a delusion to presume that busting the core agency that is protecting them from profiteering and privately centralized equity (acquisitions) would be a healthy primer for a free, open, and public market future inb America.

Oct 18 05:40 PM

[wakeup call:]

Has everyone forgotten that Citi was deemed too big to fail in the 90s after it suffered hugh real estate losses and Walid was allows to invest in a significant share to bail it out.

Oct 19 07:33 AM

[Fund Insider:]

Jeez, leave Greenspan alone. No economist has all the answers.
We all enjoyed the huge market run up, in the values of our stocks and homes, which would not have happened without his low regulation, free market policies. Huge run ups have always been followed by huge declines. Reduced regulation is always followed by over-regulation. Human DNA requires that we ride a roller coaster, never happy unless we are on the way up, but coasters get all their energy from the free fall ! If you don't like the roller coaster ride, put your money under the mattress in your rented home.

PS I worked mostly for small financial services firms, but had a 2 year stint with Citibank before it became Citigroup. Citi had many resources that other smaller firms didn't have and was able to achieve many great things unthinkable by smaller firms. That said, small firms have an agility that can never be matched by large firms. The free market needs both companies that can move mountains and small firms that can quickly get around the mountains and move the economy forward. There is no inherent good or evil in bigness and size of businesses should NOT be regulated in any way. Many firms grow too big, and if the government doesn't step in the free market does so anyway. Most large firms buy and sell subsidiaries as they continually evaluate what fits in with their strategy. If they allow themselves to grow
fat and lazy, let them go bankrupt and the pieces will be sold off
as they should have been to start with.

Gov involvement in "too big" should only be limited to cases where a firm uses illegal monopolistic tactics so as to eliminate any fair competition from those smaller but valuable competitors that breed innovation and options for customers. Anti-trust should be the only reason govt breaks up a large firm, not some perception that we have too much risk, ridiculous. Had the US let evolution take it's course in the 1970s, Chrysler would be long gone and GM would probably be far healthier today due to lack of competition from it's own government, not elimination of competition. They still had to contend with Ford and many others, I just don't advocate unfair competition from the government for non-utility type services, any more than we should allow unfair competition from a monopoly.
After all, the US gov is the ultimate monopoly and should ban itself from bailing out/buying firms just on the basis of it's own anti-trust laws !

Oct 19 10:36 AM

[Warm_Paw:]

Goldman Sachs runs the United States of America.
Obama's just this token black guy puppet.
I think Obama's coming to realize that.
When the REAL power says SHIT! he comes slidin'

Oct 19 11:28 AM