Thursday, April 15, 2010

Too Big to Fail. Again

Everyone agrees that a big factor in the recent mortgage meltdown was the "too big to fail" syndrome.

Big banks and big corporations are understood to be so big that their failure might cause a systemic failure of the credit system.

That's why we have the Federal Reserve System. To have a lender of last resort. And of course we have a bunch of other institutions each with a pot of money to help out in a jam.

Now come the Democrats in Congress with a $50 billion fund for the FDIC to use in case a big financial firm goes under in the future. According to Michael Barone:

Under the bill, the FDIC would use this "resolution authority" rather than have the firm go into bankruptcy courts, as Lehman Brothers did after it collapsed in September 2008.

But that just restores the situation that got us into trouble. Big banks know that, when push comes to shove, the government will bail them out because the government can't allow the credit system to fail.

Knowing that, they can afford to take big risks.

What is needed is to put the shareholders and bondholders on notice that they will be cleaned out. And it wouldn't hurt to have the major corporate officers personally liable to the full extent of their assets.

The way to cure "too big to fail" is to make sure that people are not just spending "other peoples money" when they are swinging their big dicks around on their highly leveraged deals. They need to worry that they are risking their mansions, their trophy wives, and their kids' educations.

The more that the government provides insurance the more it encourages "moral hazard," that is, the behavior that is insured against.

You'd think that the solons like Sen. Dodd (D-CT) would understand that. Maybe he does. But after all, a tax is a tax, and if the government taxes the big financial institutions for a big tax then they can spend the monies until the FDIC actually needs the money. The point is that money is money.

In reality, when the Feds get in a jam, they sell bonds or they print money. It really doesn't matter if they have $50 billion in a fund or not. At bailout time, the question is: does the market believe the Feds when they say that they stand behind Lehman or Fannie and Freddie. So far, the market has decided to believe the Feds. But in the future, it may not.

The big problem with our political masters is that they are not serious about anything except political power. They really don't care about the economy, about freedom, about people. They care about their power, they care about reelection and they care about people coming to them to ask for favors.

All the rest is narrative.

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