The Failure Of Too Big To Fail

Long-time readers know that I've said multiple times in both the Global No-Confidence Vote series of posts and in general posts dealing with the financial crisis that the largest single problem the Obama administration has right now economically is the lack of political will to break up the banks that are "Too Big To Fail".

Without breaking up these banks, anything the Obama administration does to try to fix the economy will be for naught, because eventually we will be right back in this situation again. The Gramm-Leach-Bliley Act legalized the Megabank and broke down the protections between bank, investment house, and insurance company, allowing behemoths like today's Citibank, Wells Fargo, Bank of America, AIG, and Goldman Sachs to exist. Any company with counter-party obligations large enough to bring down an entire country's economy is a danger. With these companies, it became obligations large enough and inter-connected enough to bring down the global economy. They cannot be allowed to continue to exist, or we will continue to face the specter of systemic risk destroying everything.

But now, there's a glimmer of hope, anyway. The Obama administration may indeed be finally ready to take on "Too Big To Fail".

Under the administration's proposal, companies such as Citi, Goldman Sachs and others in a broad top tier engaged in complex transactions would face stricter scrutiny and have to hold more assets and more cash as cushions against a downturn.

They also would have to anticipate their own demise, drafting detailed descriptions of how they could be dismantled quickly without causing damaging repercussions. Think of it as planning their own funerals — and burials.

Obama's plan, in short, aims to make it far less appealing to be so big. That was the middle ground the administration sought, a step short of an outright ban on systemically risky companies.

"Without banning them we're providing some pretty heavy penalties for entering" the top group of institutions that could pose a risk to the entire financial system, said Diana Farrell, deputy director of the White House's National Economic Council.

"The regulator might say to a large institution, 'Make sure there is very good reason to allow yourself to get that big, or that interconnected, or that complex because the penalties will wipe out any advantages, such as lower cost of capital, you might have.'"

Some companies, such as Citi and Goldman Sachs, might bite the bullet and take on the added burden; in global capital markets some firms need to be large.

Others might choose to reduce their financial footprint.

"It's a very sophisticated and very effective way to force institutions to deconsolidate," said Karen Shaw Petrou, managing partner at Federal Financial Analytics, a consulting firm that advises financial institutions.

If this is true, if the Obama administration really is going to make the regulatory environment on the TBTF megabanks so costly and onerous that they shrink themselves, or else have to submit to not being allowed to leverage as much (and making less profit) as well has having a safe "self-destruction" plan in place, then this just may accomplish what is needed.

Making it preferable to be a smaller bank instead of a larger one is certainly the way to go, but only if the regulations are strictly enforced.

Me, I see a whole lot of loopholes in this coming large enough that will allow you to drive, well, a megabank through.

We'll see. But it least it's a start.