Too big to fail

What are the pros of the “Too Big to Fail” banks? Besides needing to bail them out, are there other cons? What is the metric for “Too Big to Fail”? Is increasing the reserve requirement enough to prevent them requiring bailouts? When Sanders calls for them to be broken up, what are the details?


No pros.

The big con is the big con. They can do whatever they want and they’ll get bailed out if they fail because they own the government.

Are the anti-trust laws that were invoked against the Bell System still on the books? If they are, I would look there for advice.

Too big to fail is too big to exist.

What does antitrust legislation have to do with too big to fail? We’re not talking about 1 big bank that is shutting out the other banks.

One key to breaking up the big banks would be reinstating Glass-Steagall. This would separate out investment banking and various speculative banking activities from “main street” banking like checking accounts and mortgages. Glass-Steagall, which was passed in 1933, was repealed in 1999. There is some controversy over what the impact would be, but it would definitely lead to breakups of the big banks, which all now combine investment and commercial banking.

There are obviously some pluses to being very large diversified banks.

Generally larger companies are significantly less likely to fail. They are usually far more diverse with limited risk to any individual sector of the economy and with income coming from many different sources. They’re also going to be more geographically diverse.

Think about the difference between the current oil and gas downturn versus the one in the 1980s. In the 1980s when banking in Texas was dominated by smaller regional banks, the downturn in oil prices helped cause the failure of hundreds of banks. Today’s lenders to the oil and gas industry are far larger with a much lower percentage of their book of business tied to oil and gas loans (not to mention all sorts of other loans like real estate that are in the same geographic market and will also suffer a downturn). This downturn will cause some minor problems for banks, but that’s about it.

If the banks are too big to fail, they should be subject to additional regulation (not less). Like government, if something goes wrong, there is a person responsible who is also accountable, and that person can lose their job, or worse. For these big banks, if they screw-up, the leaders of those banks should not get to keep their jobs and continue fleecing customers - they should be arrested, face jail time, and essentially strung-up by their proverbial balls. As it is today, few, if any, banksters received any penalties at all for screwing-up at the start of the great recession, and I suspect a lot of them are still in the business (under the guide that no laws were broken). Real people need have their feet held to the fire and face severe penalties for banking hijinx-gone-wrong; that will discourage future bankers from thinking going down that path will be A-OK.

OK, we’ve heard from some people who want blood, and I am certainly willing to believe that a lot of campaign money goes into making sure that the law continues to be what the donors want, more or less, but can we have more discussion along the lines of what SpoilerVirgin and Longhorn Dave offered, and fewer calls for revenge?

Glass Steagall had nothing to do with the financial crisis and its reinstatement would have no effect. None of the too big to fail companies would have fallen under Glass Steagall. AIG was bailed out because it was too big to fail and it is an insurance company and not under Glass Steagall. Wachovia, Washington Mutual, and Bank of America all failed because of bad mortgage loans, which is main street banking. Bear Stearns and Lehman Brothers did not have commercial banks and would not have been affected. Fannie Mae and Freddie Mac also would have been unaffected.

Yup, nailed it.

Some people seem to have a hard time understanding that the credit crisis can’t be boiled down to Bush deregulation led to Wall Street crookedness.

The OP did not ask what caused the financial crisis, he asked what would be involved in breaking up the big banks. Glass-Steagall is a key piece of what would be involved, and specifically the answer to what are the details of Sanders’ call for them to be broken up. There is no question that many of the big banks would be considerably smaller if they had to divest of their commercial or investment banking interests.

The pros of big banks are the same pros of any big firm. Better services, improved employee specialization, lower fixed costs.

Huge banks can put an ATM on every corner. They can have someone working in business loans who’s super knowledgeable about a particular sector of the economy, which makes them better able to offer competitive loans to specific businesses. They can spread the cost of their computer system over 10 million customers, instead of over 10,000.

Those pros don’t go away when the business gets large enough to cause systemic problems. But of course they are balanced by the potential problems.

Well, I’m not so sure how much banks like Goldman Sachs or Morgan Stanley would be affected by reinstating Glass Steagall. Seems most people would consider them too big to fail group but they’re pretty much just investment banks without much in the way of commercial banking or insurance. They would seem to fit in just fine in a Glass Steagall world.

Reinstituting Glass Steagall wouldn’t do anything to prevent a financial crisis like 2008/2009. The solution is to require more capital.

A major objection to “too big to fail” corporations is that the taxpayers need to bail them out. The Third National Bank of Topeka can be forced into bankruptcy with little risk of escalation; not so with JPMorgan Chase & Co. or American International Group. This allows those companies to make bets of the form “Heads we win; Tails the taxpayer loses.”

There is already a big problem that corporate executives are more interested in their next quarterly bonus than in long-term company profits. On top of that, stockholders and bondholders are happy to assume irresponsible risk if the government will step forth to assume losses. The 2008 financial meltdown cost trillions of dollars altogether, but the Wall St. speculaters who brought ruin on us all are still driving their Maseratis and Lamborghinis.

At the height of the crisis, almost all the major investment banks were insolvent; regulators should have insisted that they raise more capital but the regulators were completely dominated by Wall Street figures who didn’t want stock wealth diluted. This was an utter travesty. Hundreds of billions in taxpayer dollars were lost, along with the opportunity to teach “moral hazard” to the Wall St. gamblers.

Raising the reserve requirement for customer deposits would have little effect. The crisis wasn’t caused directly by commercial loans, but by shenanigans like rating-agency corruption and speculation in derivatives with no legitimate hedging purpose.

Note that financial derivatives in play have a nominal value measured in quadrillions of dollars – yes that’s Quadrillion with a Q. It was huge bets on derivatives that brought down AIG(*) and the problem is getting worse after the crisis with the gamblers learning there is no hazard lesson to be learned. IIUC, Dodd-Frank legislation was deliberately stripped of regulations on derivatives trading.

(* - Many of these bets were not “Heads the AIG stockholders win, tails taxpayer loses” but rather “Heads the AIG salesmen win with billion-dollar bonuses!” It turns out the upper management of the world’s largest insurance company were unaware of of the most basic principle of insurance: fair-weather profits should be held in reserve for a rainy day.)

It is common for a small group of companies – even without explicit cooperation – to operate as a cartel, maximizing total cartel profit. With many well-funded companies, true competition is more likely.

I don’t have a huge problem with what you said overall, but this is not really all that correct of an answer. It really depends on what you count. At the end of the day, the U.S. made money on many of the bailout programs, like TARP. Obviously they took a risk, so they could have lost. Also, there were several indirect bailouts, many of which would have a cost. For example, do you think the extreme zero interest rate policy made or lost money for the taxpayer; it depends on your perspective. How about the massive expansion in the Fed balance sheet. Do you count the billions in fines or not. My point is that you can read one reputable source and they’ll tell you it was a cost of trillions and another that is also reputable that says it was a profit of hundreds of billions.

I tend to believe that at the end of the day, the direct cost wasn’t much, but the real cost was the terrible precedent it set.

Not raising the reserve requirement on deposits but raising the capital requirement for the institutions. Require them to have higher equity ratios.

A lot of the rating agency stuff is overblown. Much of the problem with the rating agencies was that they were over relied upon. Some of the risks really were extremely difficult to assess. Having said that there absolutely were a lot of conflicts of interest and reform was necessary.

What really matters is the net exposure. If you have bets going both directions then you wouldn’t lose it all.

Well, nobody expects the derivatives to be cashed in for the whole quadrillion-plus! :eek: But it was derivatives underwriting that brought down the behemoth AIG, so the risks are substantial.

What seemed particularly egregious to me (I don’t know if it was illegal) were banks that underwrote large loans, then bet against those loans in the derivative market. In at least one case, as a condition for getting a loan, a bank made a borrower promise to default on a different debt, with the bank then making a big profit betting against that debt in the derivatives market.

As you suggest, calculating the net loss to taxpayers for the bailouts is difficult. IIRC, FRB entities still have 100’s of billions of dollars of troubled assets on their books – these are not included in the TARP “totals.”

That seems like the textbook definition of hedging to me. What do you have against it?

If you own a bond and bet against it you’re hedging your bet. When you bet against bonds you don’t own you’re gambling.

I’m not opposed to gambling per se, but these were big bets which put the financial system at risk for no public benefit. In some cases the bets led to a financial collapse and it was the taxpayers, not the bankrupt counterparty, that needed to make parties whole to keep the economy stable.

TL;DR: The biggest recession since the 1930’s was caused by wild Wall St. gambling with no public benefit.

Well, in some cases that would be more of a synthetic type of hedge. I mean, there’s not a market in existence to hedge for every type of risk. Sometimes you need to hedge using something that is just similar to the risk that you have. You open yourself up to basis risk, but you could still be trying to do a legitimate hedge.

What if the bond you own that you want to hedge has no market to hedge because it is small and illiquid. Maybe you pick something that is in the same industry that you think has many of the same risks. You think they are correlated enough that it works as an imperfect hedge.

To use a real life example that I’ve done myself, think about hedging commodity exposure. I produce and sell oil in the Louisiana market, and I want to hedge my exposure. My problem is the only liquid tradeable oil markets are West Texas Intermediate oil or Brent North Sea oil. I might hedge using one of those thinking that they would move in tandem with the Louisiana oil price. That would have been a problem though if I did that in 2009 for 2010 production because although historically they had always traded within a couple of dollars of each other a storage glut developed affecting the West Texas Intermediate oil and it soon began trading at as much as a $27 deduct. All I wanted to do was basic risk management hedging, but I had to hedge using a different commodity and then they ended up not being as tied as I had expected. The same type of things can happen in all sorts of markets.

Sometimes it’s not corruption, manipulation, short-term thinking, incompetence, or whatever other negative thing you want to say. Sometimes it’s just bad luck and something totally unexpected occurs.