Wednesday, March 31, 2010
Too Big To Fail: Our Reality?
What do we mean "too big to fail" ? The phrase gets thrown around a lot and is the title of a book about the financial crisis that enveloped this country and the world in 2008. But, what does it mean? I am going to try to explain this idea of too big to fail and we will see if I succeed or fail.
Basically, we know that there are now just a few major banks in the United States. We don't have to name them as there are only a few of them since for many years now, banks have been merging in order to dominate their markets. The problem of a commercial bank failing became more complicated when the major banks acquired brokerage, and in particularly, investment banking divisions. These bank holding companies, that traded and took positions (traders bought and positioned millions of dollars in securities) in what came to be known as toxic securities (assets) needed cash. Other trading partners wanted those under pressure to come up with more collateral on repurchase agreements, and as confidence in each bank evaporated trading came to a halt. The Federal Reserve Bank became the only source for cash as funds with cash were reluctant to invest in commercial banks and investment banks that could possible fail.
A panic is not a pretty sight. And, when shit hits the fan, no one in the room is an expert. Even those men at the top of the Federal Government, Treasury and the Fed, did not have a clear idea what it would take to restore confidence in the system. The one thing they did know was that unlimited amounts of cash was the only thing that would keep the financial system from having a complete meltdown. The Federal Reserve Bank opened their window to not only commercial banks, but invited Goldman Sachs and Morgan Stanley, who needed cash, to come to the window. At this point, these two investment banking firms became bank holding companies for the purpose of borrowing cash from the Fed.
What we need to do now and what is politically feasible or two different things. Basically, we need to go back to when banks could not get into the investment banking and insurance business. A simple bank operation that gets into trouble can be dealt with, but when banks are permitted to enter into or acquire investment banking capabilities and insurance businesses, the situation becomes so complicated that if one fails, they all come under unbelievable pressure. Glass Steagall, that prohibited banks from entering the brokerage or investment banking business, kept a serious financial panic from rising to the level that it did in 2008. Whether those in Congress can see their way to realize this simple fact remains to be seen. The odds of going back to a simpler time are mostly likely not in the cards. As long as major banks know that they can gamble with other people's money and then get bailed out by the Federal Government, too big to fail will continue to be our reality for years to come.