Stephen G. Cecchetti and Kermit L. Schoenholtz write,
From our perspective, by raising the odds of an effective resolution, FIBA (as a complement to Dodd-Frank) boosts the credibility of the U.S. regime. Over time, foreign regulators also may be reassured that the Chapter 14 mechanism is similar to the FDIC’s SPOE strategy, which they have welcomed. In both cases, the regime’s credibility depends on the presence of living wills and adequate loss-absorbing capital.
Pointer from Mark Thoma.
No, I don’t expect you to be able to follow what they are saying, even if you read the whole post. What it boils down to, and this is a mainstream view, is that with the right tools in place, the next time a big bank gets into trouble, the regulators will be able to “resolve” it without a bailout.
In effect, they are saying that we do not need to break up big banks now, and in fact that would be a bad idea. But when a crisis comes along, then, by golly, that will be a marvelous time to break up the big banks. The way I see it, “resolution” is nearly synonymous with breakup.
Again, this is a mainstream view. But to me, it could hardly be more absurd. In the middle of a crisis, the appeal of an untried approach for breaking up big banks is going to be nil. If you cannot break them up now, when there is no crisis, you will never break them up. Bailouts are an absolute given.
Again, I still have not good evidence of why we need to break up the Big Banks. Here the complaint a lot but the evidence shows they are growing bigger.
1) In reality, it was the medium size banks or investment banks that were the worst offenders. not the largest one. In the case of the largest ones, only Citi really was that borderline survived if you assume BofA was sort shotgun to take Meryll Lynch.
2) Haven’t most long time businesses consolidated a lot the last 30 years. Grocery stores or airlines. The economy has naturally moved this direction with most long time businesses.
3) Historically the US has been the developed world oddball with a heavy local banking presence.
4) In terms of the S&L crisis there was bailouts and lots of failure of small institutions. In fact the government probably wrote a bigger check on that crisis than the 2008 Housing Crisis despite being significantly smaller.
5) Again, I don’t see any evidence that the large banks and financial institution assumed they were going to bailout in 2006 before the crisis reality was becoming clearer. They wrote the loans because they were making more money and they exited the market when they saw the reality.
6) In terms of Financial Crisis, it appears the government best actions is draw a distinct line of winners and losers and have the appropriate bailout. Bank Panics are the biggest threat to capitalism period. (Notice the popularity of socialism has increased anyway.) And TARP drew a line, S&L crisis drew a line, and so did the Banking Holiday in 1933. In these cases there is some form of bailout and ugliness of having to quickly define winners versus losers so most people learn to trust the system.
What about my arguments?
And others, like that big banks fund d3ficits.
Growing bigger is not evidence that they should be bigger when their implicit bailout options increase their margins.
I am not saying the size of Big Banks is necessarily good either but there might be reasons for it. But I don’t think the size of Amazon, Wal-Mart or Krogers is good but there is little break them up at this point. (especially from conservatives & libertarians) And the argument of Bailout seems a little empty as the S&L bailout was mostly small institutions and led to a lot of consolidation of banks in the 1990s.
And how do we know the bailouts is the reason for investor trust? I suspect the largest banks have other businesses to protect against a failure in other loans, At this point probably the second most dangerous loans are probably car loans but a car loan crisis does not cause a full scale crisis or even close to bailouts for the large institutions.
Since we are always going to have bailouts, could we create some derivative called bailout protection options that could be purchased from the Treasury? Adverse selection may be an issue.
Actually if we accept that bailouts are inevitable it might make sense to require banks to purchase bailout insurance which ideally would be priced based on the riskiness of their assets. Not sure who would do the pricing though.
We’d be back to square one because they would underestimate risk.
Maybe just price to the size of their portfolio relative to capital.