Thursday, December 23, 2010

Red Herring- Too Big To Fail

Some have argued that a failure of the 2010 Congress was its  failure to break up the big six "too-big-to-fail" banks.

The issue isn't "too big to fail."  That is a red herring in the analysis of our banking system problems..

The issue is the repeal of Glass-Steagall and the "rescue" of the commercial banks of the 1990's by allowing them to merge with investment banks.

In the 30s, we broke them up into 2 industries (1) low risk, low return commercial banks, to handle "the people's money/savings" - money we need and can't put at risk;  and (2) high risk high reward investment firms to handle investment money - money folks and companies are willing to put at risk and can afford to loose.

From the 70s through the 1990s, the incursion of other, unregulated industries into the profitable lines of the commercial banks made them relatively unprofitable, return-on-investment-wise.

Traditionally, central banks (like the Federal Reserve) have promoted commercial bank system efficiency and confidence by standing as the "lender of last resort."  Not "too big to fail" but "too important to fail."  (That role  had never been invoked through at least the 1980's, but the possibility served to promote the commercial banking system.)

When commercial banks became relatively unprofitable in the 90's, their "rescue" by allowing them to merge with high risk banks, while extending the role of "lender of last resort" to the investments banks was madly short-sighted.

Don't be distracted by the idea of "too big to fail." 

Recognize that we need (1) profitable but safe commercial banks (which also provide the incredibly important global payments systems and import/export finacing) and (2) separate high risk high reward investment banks for those who have some money they can afford to put at risk.

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