A Bankruptcy Lawyer’s Blog

Review: Too Big to Fail: The Hazards of Bank Bailouts

The Lowest Price we could find is $32.95 $20.69

The potential failure of a large bank presents vexing questions for policymakers. It poses significant risks to other financial institutions, to the financial system as a whole, and possibly to the economic and social order. Because of such fears, policymakers in many countriesdeveloped and less developed, democratic and autocraticrespond by protecting bank creditors from all or some of the losses they otherwise would face. Failing banks are labeled “too big to fail” (or TBTF). This important new book examines the issues surrounding TBTF, explaining why it is a problem and discussing ways of dealing with it more effectively.

Gary H. Stern and Ron J. Feldman, officers with the Federal Reserve, warn that not enough has been done to reduce creditors expectations of TBTF protection. Many of the existing pledges and policies meant to convince creditors that they will bear market losses when large banks fail are not credible, resulting in significant net costs to the economy. The authors recommend that policymakers enact a series of reforms to reduce expectations of bailouts when large banks fail.

Review:

Stern and Feldman(SF) do a good job in demonstrating the complete idiocy of deregulating and privatizing the commercial banking industry ,specifically, and the financial sector ,in general ,starting with the Carter administration in 1979 and continuing through all Democratic and Republican administrations through 2008,at a time when the size of the average firm in the industry was getting larger and larger.

SF are absolutely correct that the 1991 Federal Deposit Insurance Corporation Improvement Act(FDICIA)did not improve bank regulation substantially and make the too big to fail problem less severe.Ben Bernanke’s(coordinated with the financial actions of the other 7 major central banks) 1 trillion dollar bailout ,starting in late August,2007 and continuing through May,2008,of Wall Street and the commercial banking system is just the latest additional piece of evidence that the problem of banker speculation,which has been recognized for thousands of years,is fundamental.
I have subtracted one star because the authors appear to have no idea that Adam Smith went over this problem in detail on pp.290-340 of The Wealth of Nations(1776,Modern Library (Cannan)edition).Smith’s discussion is a modern,updated analysis of the standard Catholic(Medieval Church)position concerning banking,loans,the rate of interest,usury laws,and speculation.Smith shows clearly that the banks prefer to make loans available to projectors(Keynes’s stock and financial market speculators and rentiers) because of the apparent high short run rate of return on such loans.The long run consequences,which impose immense negative externality and spillover impacts on people worldwide , are ignored.Nothing has changed since Smith wrote his masterpiece over 230 years ago.Securitization is a code word for speculation.The last 30 years has seen a continuing parade of junk bonds,phony income and balance sheet accounting claims,dot com bombs,and securities backed by bonds backed by mortgages that were backed up by nothing but claims made by rating agencies and underwriters.