Too big to fail is not an economic problem

We hear a lot about regulating the banking system and getting away from the “Too Big to Fail” problem. In this excellent op-ed Chris Berg tells it how it is:

… no matter what the Murray Inquiry recommends – no matter what policy the Government or Reserve Bank or Australian Prudential Regulatory Authority imposes today – the decision of which firms to bail out and which to let fall will be made by the policymakers of the future, according to their own whims, and mindful of political, not economic, considerations.

Simply put, there are no ways to credibly constrain future governments from deeming an institution too big to fail.

Too big to fail is a political issue not an economic issue. Economically there is no institution too big or too important to fail. Rather in the heat of a crisis – and there will always be a crisis – politicians will make a decision to deploy taxpayer funds to various purposes to “alleviate” the extent of the crisis. One such purpose will be to bail out financial institutions.

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46 Responses to Too big to fail is not an economic problem

  1. Empire

    The clusterfuck never ends.

  2. Bertie_Wooster

    Good read.

    Very tired of the continuous leftist assertions that the IPA is in it for crony capitalism and entrenched interests.

    Will be interesting to see whether the dries can hold off the wets in the Coalition cabinet. Some key tests passed at the start of their term, but will be more intense as we approach the 2016 election.

    Does it not seem likely that key employers might go cap in hand to the gov’t if the economic circs aren’t great and the Coalition is struggling in the polls? Buying votes is cheap when its someone else’s money.

  3. Mayan

    The market, indeed our society in general, needs the possibility of failure for its operation.

  4. Bruce of Newcastle

    The problem with the ‘too big to fail’ meme is the statists are using it to justify “bailing in“.

    Bailing in is what the ECB did to the Cypriot banks that needed fixing. “Bailing in” is also called “stealing” . The depositors were raped by the authorities in what was pure theft, so that taxpayers did not have to stump up for banks and German voters didn’t have to go to a referendum where they would vote no to a bailout of Spain Italy Portugal Greece Cyprus with near unanimity.

    So now the Financial System Inquiry here in Oz is also talking about bailing in.

    Buy a big mattress, Cats.

  5. There’s no such thing as ‘too big to fail.’
    The US government should have let the financial institutions fail in the GFC, particularl Lehman. The scaremongering about the financial system locking up was nothing but fearful speculation and catastrophic thinking.

    If a tree falls in the forest, little trees sprout up where it fell.

  6. What happened in Cyprus was criminal.

  7. I think you got time inconsistency reasoning wrong here.

    Is there any credible way in which governments can credibly promise not to bail out the banks?

  8. “Too big to fail” policy is just a version of crony capitalism.

  9. Is there any credible way in which governments can credibly promise not to bail out the banks?

    Why would they promise not to do it?
    There are heaps of things that governments wisely choose not to talk about or speculate on. This can be one of them. Just don’t talk about bank bailouts. And ideally, don’t do them either.

  10. Buy a big mattress, Cats.

    I only have a queen, but it’s called “Elizabeth”. All i need is a Sir Francis Drake to pinch all that stolen gold off the ECB.

  11. Chris M

    Let’s not forget that only six years ago Westpac obtained an emergency loan from the US Federal Reserve. The banks are leveraged to the max & need to be let go if they get into trouble, it will be entirely of their own doing.

  12. Demosthenes

    Is there any credible way in which governments can credibly promise not to bail out the banks?

    A sobering question. For Australia, I guess not. A future parliament can overturn any legislative prohibition on bank bail outs, so it would require entrenchment in the constitution.

  13. Bruce of Newcastle

    Chris – The paradoxical result of Basel III is they now hold much more “capital”.

    For most banks that “capital” is government bonds. Oz even had to issue bonds and get a note from the teacher because under Costello we didn’t have nearly enough for the big 4 to use for Tier 1. Of course there’s no shortage of government bonds in the EU, the place is drowning in government debt, so all their banks have loaded up to the gills.

    The problem, especially in the EU is not actually the banks, its the governments. When one gets shaky their bonds get sold off in the markets and the rules require the banks to mark them to market. Suddenly they have “less” capital, have to raise more to get back to Basel III just when the punters have fled. They can’t roll over their loans and they go insolvent.

    And if one goes insolvent they all go insolvent because the Basel III rules added so much padding that now the weak don’t get culled. They all get culled and you do too because the governments stuck their hands in the banks pockets and that hand cannot now be removed.

    Between marking to market, continuous disclosure and Basel III, its a nightmare. On the other hand that is why our banks are currently yielding more than twice term deposit rates even before share price appreciation. That is a blessed return to capitalism: risk is again being rewarded, just not in bank interest. You have to actually invest to get it, like I the old days.

  14. Peewhit

    As I remember the Reserve bank has always guaranteed the banks and saved the depositors. The only thing saving this from moral hazard is that after saving them they sold them and the shareholders lost their money, and of course the new owner sacked any staff they considered culpable. It has happened in the past.

  15. Bruce of Newcastle

    As I remember the Reserve bank has always guaranteed the banks and saved the depositors.

    The problem is the EU invented bailing-in to get it out of a political problem (ie their self inflicted Cyprus banking system failure) and the idea is now more-or-less accepted.

    Including our current Financial System Inquiry, as I linked above. The idea of stealing all the rich peoples’ dosh is irresistible. The $250k per person per bank deposit-insured sum is still valid but everything above that is fair game now.

    Most people won’t have that problem (I don’t), but every ASX company will. Pure socialist economics wrapped up and hidden in a palatable package. Property rights are out the window.

  16. Bruce of Newcastle

    I will point out the hierarchy does still stand: shares, creditors, depositors. The problem in Cyprus and Iceland was that after the first two were wiped out there was still a gigantic hole. In both Iceland and Cyprus the authorities decided to steal the depositors money to fill it, with no recompense, no equity, no IOU’s. Just theft.

    That is why putting money in a bank is not as safe as you think.

    OK, those were fairly unusual circumstances, and we have $250k deposit guarantee, but that can be voided by a government in an instant by fiat. The only thing standing in the way is the electoral pain it would cause them. But above $250k the voters don’t care since its not them. Just our market economy, jobs and justice.

  17. Ripper

    Bailing in is what the ECB did to the Cypriot banks that needed fixing. “Bailing in” is also called “stealing” . The depositors were raped by the authorities in what was pure theft,

    The only difference to ZIRP policies is that the Cypriot case was more blatant.

  18. Tim

    Nothing wrong with “bailing in” if (a) the shareholders are wiped out and the depositors recapitalise the bank with their deposits in exchange for the new shares, and (b) this is the explicitly known solution that will be adopted in a bank crisis before the depositors use the bank. In this case, it destroys much of the moral hazard while retaining the “too big to fail institution” without too much disruption.

    Maybe add in a few show trials for senior bank management letting it happen in the first place, and it is all smooth sailing.

  19. Andrew

    Disregard everything above “Tim” – the rest of the thread is complete rubbish.

  20. Squirrel

    It’s not so much about too big too fail – we’re at, or approaching, the point of too big to bailout. In the case of a very serious crunch, the Australian Government may not be able to raise sufficient funds, which is presumably why “bail in” is now being talked about.

    Weaning the big four off foreign funds, and thus gradually easing the property bubble (which, of course, is not a bubble, no such thing, nothing to see here….) would help to reduce the risks, but would be unpopular with too many people, so most unlikely to happen.

  21. Craig Mc

    Chris M, I remember all the banks were forced to take emergency loans, otherwise everyone would know which banks were in trouble, and run on them.

  22. 2dogs

    Is there any credible way in which governments can credibly promise not to bail out the banks?

    Trust banking. Balances can be kept off the balance sheet of the institution. Failure of the institution merely results in a new trustee being appointed. Losses in the trust are borne by the depositors.

  23. JohnA

    Too big to fail also applied to AII in the GFC. AII took over or re-insured everybody and wound up being the sole carrier of risk in mainland USA, IIRC.

    So we need a 20-pillars policy, because the accumulation of risk is eventually going to negate the entire raison d’etre of insurance.

    Likewise with the banks, because the RBA backing means that the accumulation of risk ultimately arrives at the RBA, and the government (read taxpayers).

    The only reason we have RBA backing of the banks is because they are fundamentally trading while insolvent, due to the non-essential practice of fractional reserve deposit management. They cannot meet all of their liabilities in the normal course of trade.

    There, I have finally said it!

  24. Johnno

    Indeed. There is one solution though. A Referendum. A Constitutional amendment that would make it illegal to bail out a bank.

  25. Aristogeiton

    Johnno
    #1392149, posted on July 23, 2014 at 8:09 am
    Indeed. There is one solution though. A Referendum. A Constitutional amendment that would make it illegal to bail out a bank.

    Lol. Draft such a provision. I’ll wait…

  26. Alfonso

    Bwaaa….the Aust banks know they are living in a world where the taxpayer will always bail the four pillars.
    They will gear any way they choose, so stop wasting your breath.

  27. John Comnenus

    A couple of unspoken things that are too big to fail that never get addressed:

    Government and the Public Service.

    Government is on a never ending debt fuelled growth path. Abbott has done little to arrest this unhealthy development. Rudd and Gillard put that growth on non performance enhancing steroids. And the public service repeatedly fails all the time. Yet the solution of the Left to these entities is always more growth for Government and the Public Service regardless of their failures. The only economies of scale a bigger Public Service achieves is in the increasing scale of its failure. Think pink batts, school halls and a multitude of Green schemes.

  28. manalive

    Was the Farrow Group too big to fail? The Cain government said it was – it was “systemically significant”, to use our contemporary econocrat buzzword …

    No it was “systemically politically significant” being centred in electorally volatile Geelong.
    The shambolic Cain Government was trying to save itself by using taxpayers’ (or motorists’) money to protect greedy capitalist Labor voters who thought that an 18% term deposit return was risk-free.

  29. John Comnenus

    Government is never considered too big to fail, regardless of its consistent failures. Government always has the option to force the tax payer to bail it out. Why else would you measure the Government’s debt as a percentage of GDP? This measure clearly suggests that Government can use up to 100% of GDP to bail itself out when it’s failures become massive. Government thinks the limiting factor on their capacity to fail and be bailed out is all the wealth in the economy.

  30. .

    Government failure exists. Usually bank bailouts are government failure.

  31. .

    This may please some viewers:

    http://www.ldp.org.au/index.php/policies/1280-money-and-banks

    The Liberal Democrats believe that inflation is taxation by stealth, that the Reserve Bank should be more accountable, and that banks should be free to fail…

  32. Aristogeiton

    Ivory tower latte libertarian cultural Marxism, Dot. Disgraceful.

  33. John Comnenus

    Dot,

    i agree, My point is that no one ever argues that Government’s should not be too big to fail, nor do they ever decry us bailing it out.

  34. Aristogeiton

    John Comnenus
    #1392208, posted on July 23, 2014 at 9:44 am
    Dot,

    i agree, My point is that no one ever argues that Government’s should not be too big to fail, nor do they ever decry us bailing it out.

    If the Federal Government shut down forever tomorrow, would anyone give a fuck? The States would raise taxation and pitch in for the Defence Force. The Federal Government doesn’t actually provide any useful service, apart from defence.

  35. People would ‘give a fuck’ in that it would be very disruptive in the short term. But you’re right, life would go on. Australia was doing okay before federation and would survive a de-federation.

  36. .

    A far less big deal I wonder about every so often is if we ever really needed to build Canberra.

    The High Court sits anywhere, we had telephony back before Federation, the Parliament could rotate where it sat and the States could furnish the PM and GG with a house in every city.

    Laws of national reach but not necessarily under Federal power such as banking laws could be agreed to by an internal treaty, as could criminal law and so on (which is less troublesome as a law particular to a state etc).

  37. Aristogeiton

    .
    #1392235, posted on July 23, 2014 at 10:30 am
    A far less big deal I wonder about every so often is if we ever really needed to build Canberra.

    The place is a blight and an eyesore.

  38. John Comnenus

    Ari,

    The point I am making is that there is an assumption that government is too big to fail and that they can always force us taxpayers to bail them out.

    No bank will ever need a bail out the size of the bail out we are all going to provide the Government through increased taxes and funding wholly due to the fiscal failures of the Rudd – Gillard years. The operating assumption of Government is that the bail out fund they can access to cover their failures is 100% of GDP.

    As for Canberra, it isn’t a blight and is a pleasant place to live. It is a brain sore because it is full of rent seeking Left wing people. But I agree that it’s construction was unecessary.

  39. Pyrmonter

    @ Jim Rose – the credible policy is to prevent bank growth. The implication of TBTF is that too many banks are too large, that is, reach diminishing returns to scale. A costed scale-responsive charge for the benefit of the guarantee could eliminate this in much the same way as credit markets would do so if there were no guarantee.

  40. Pyrmonter

    as regards Farrow – the state was the prudential regulator.

    Under the then (pre-Ipp reform) law as regards liability – where any significant contribution to loss led to liability for the entire loss – the government may have been advised it had a fair chance of ultimate exposure for failing to act in a way depositors expected it to. Similar proceedings were pursued, at length, against a rather more adroit regulator (Three Rivers Council v Bank of England) in respect of the BCCI collapse; those proceedings failed, but were not so far from success.

  41. Demosthenes

    The place is a blight and an eyesore.

    It’s an objectively beautiful city. Its majority employer is a blight, sure, but the place is nice.

  42. M Ryutin

    Canberra must be the most boring large city in the country.
    That aside, on Too Big To Fail, this from the Dallas Reserve a few years ago is a very worthwhile read and puts it all into context.
    http://dallasfed.org/assets/documents/fed/annual/2011/ar11.pdf
    Or Google “Choosing the Road to Prosperity” by Harvey Rosenblum to get to the key piece.

    In the USA, turning TBTF into “Even Bigger” was a huge mistake.

  43. .Dr.Sir Fred Lenin

    Any politician suggesting “bailing in” ,should be subject to Mandatory Term of Natural Life at Hard Labour,with no prospect of parole It is pure robbery with the threat of violence,most politicians seem to be Scum these days.

  44. JohnA

    Alfonso #1392155, posted on July 23, 2014 at 8:23 am

    Bwaaa….the Aust banks know they are living in a world where the taxpayer will always bail the four pillars.
    They will gear any way they choose, so stop wasting your breath.

    What it needs is political will. The mechanism is already there.

    Rachet up the liquid asset reserve ratio until it reaches 100% of liabilities due in the next reporting period. The problem with fractional reserve banking is the fractional part.

  45. Combine_Dave

    If a bank goes bust why wouldn’t you lose your hard earned (in that bank)?

  46. Andrew

    Rachet up the liquid asset reserve ratio until it reaches 100% of liabilities due in the next reporting period. The problem with fractional reserve banking is the fractional part.

    Can someone who understands banking better than I do explain, when we abolish the hated fractional reserve and require 100% of deposits to be held in the liquid assets reserve:
    a) Where loans will come from, and
    b) Why a bank would bother taking deposits at all (let alone paying interest on them), since they would have to be stored in the vault in case 100% of depositors exited today?

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