The Fed's Lame Defense of 'Too Big to Fail'

Federal Reserve Governor Daniel Tarullo argues that we should not break up the 'too big to fail' financials or reimpose Glass-Steagall because:

Financial institutions that experienced so many problems -- such as Bear Stearns and Lehman Brothers, which did not have commercial banking operations -- would still have posed a "too big to fail" threat had commercial banks been prohibited from owning investment banks prior to the crisis.

He also said that commercial banks without investment-banking issues have, in the past, had serious difficulties as well. "Some very large institutions have in the past encountered serious difficulties through risky lending alone."

That's like arguing that nuclear power plants shouldn't be regulated as to how close they are to earthquake faults because some plants failed because their concrete containment dome wasn't thick enough.

Giant banks become dangerous to the entire economy if one or more of the following occur:

1. They are too big;
2. They speculate too much, especially if they are speculating with deposits gained through normal depository banking functions (the whole dynamic Glass-Steagall was enacted to stop); or
3. They focus too much of their investments in credit default swaps or other instruments which allow massive looting.

Nuclear plants must be sited away from earthquake faults and their containment domes have to be thick enough. Similarly, all 3 of the giant bank's problems must be addressed. The TBTFs should be broken up (see this and this). Glass-Steagall should be reimposed. And risky investments which encourage looting and which generally destabilize the system should be reined in.

Note: Sure, higher capital and liquidity requirements - as suggested by Tarullo - would be helpful. But unless the real core risks are addressed, they won't be nearly enough.

Comments

[john s. gordon:]

the nuclear electric industry would never have existed except for the federal govt assuming the unlimited financial liability under price-anderson, which gets reauthorized periodically.
in view of the hazard to the citizens of the u.s posed by the TBTF banks & the looting tendency of their high up executives, do we need a price-anderson analog for the bankster industry?
> jack

Nov 10 09:01 AM

[Skeptical09:]

Let's see. The banks responded to pressure from the government to make housing affordable for people who could not afford it and to provide credit to those who could not repay it; the government failed to adequately supervise the process, even with its exisiting authority, which was extensive; wants to blame runaway compensation when the real pressure comes from the necessity to achieve quarterly earnings, etc. ...and then blames the industry for governments failures! Now it wants to assess the industry to pay for mistakes driven by the government. What is wrong with this picture.

Nov 10 09:33 AM

[Davewmart:]

john s gordon:
No other large chemical industry would exist either under the restrictions you suggest.
Do you imagine that the oil companies, for instance, are fully insured if there was a terrorist attack, such as a missile into a gas tanker in port?

The real beneficiary of exemptions has been the coal industry, which routinely emits huge amounts of pollutants to the environment at vast cost to health.
What do you think the cost of coal would be without these waivers?

The nuclear industry has also paid around $25bn into a fund to provide long term storage, which is now never going to be built.

Nov 10 10:43 AM

[fizzicyst:]

You are right on! Tarullo sounds like a lobbyist for the TBTF banks.

Nov 10 12:00 PM

[PizzaMan:]

There's a problem with "Too Big To Fail". We already have the problem.

To further use your analogy, those nuclear power plants have already been built on the fault lines, and they are powering the major cities. What do we do? Just shut them down? Tell it to the residents of the cities you just blacked out.

Some things are easier said than done. I've learned that you get yourself into big trouble when you follow advice that starts off with the phrase "all you got to do is just ..."

So you want to break up the large banks. Fine. Give me a real plan. Don't say "all you got to do is just break up the Too Big To Fail Banks". I'ts not productive to just call for them to be broken up. That's driving down the road looking in the rear view mirror. We've got to power those cities somehow before we can shut down the nuclear power plants. You haven't even suggested the equivalent of powering the cities with coal-fired power plants (built on fault linies).

Nov 11 10:22 AM