Friday, 22 January 2010

Not too big to fail

It had to come. The backlash against the banks was long overdue after the mayhem of the financial crisis of last year. It took the Massachusetts election result, where Ted Kennedy’s seat was won by a Republican (yes the liberal bastion of the US actually voted Republican) to trigger it.

This blogger is a staunch and unabashed votary of free trade, capitalism and the efficiency of markets. This post, which might seem to back a populist move is actually championing the cause of capitalism, although it might appear at first sight to be arguing against it.

The fundamental problem of the financial crisis was the too big to fail theory. The institutions in trouble were too big to be allowed to go bust. Therefore, however crazy their actions were, they had to be bailed out , primarily by the US government, for the consequences of not doing so would have been worse.

This must not be allowed to be repeated. Nobody should be allowed to become so big that irrespective of whatever they do, they cannot go bust. That goes against the basic tenet of capitalism – sure, capitalism rewards success handsomely, but it equally punishes failures and kills those that deserve to be killed.

For some time there were competing pulls and pressures within the US government on what to do on this issue. Of course the banks clambered over themselves to preach the gospel of capitalism, as the times have started to turn good. No regulation, should allow innovation, scale brings efficiency, should not penalise a company for success, etc etc.

With the Senate filibuster majority now gone, thanks to Massachusetts, the kids gloves have come off. President Obama has proposed two significant measures – restrictions on proprietary trading by the banks and limits on the size and concentration of financial institutions. This post is not to discuss the technicalities of these – no doubt they would be opposed as the wrong way to go about it and there would be fierce lobbying. But directionally they are right. It is now time for the world (read US) to act and make sure there is no institution that becomes too big to fail. Good luck to the banks when they win ; we won’t grudge them their success and good riddance to them when they lose; we won’t shed any tears either.

Tim Geithner the Treasury Secretary put it well . “Just because things seem populist doesn’t mean they’re not the right thing to do”, he said.

As an aside, I think the Massachusetts result is actually a boon for Obama politically , although the Democrats lost. Even in the acrimonious health care debate, which is now prone to Republican filibuster in the Senate. By losing the battle, he may have improved his chances of winning the war.

Maybe, just maybe, they will succeed in abolishing the concept of too big to fail (doubtful, but its not a crime to hope). If that does happen, the world owes a thank you to the people of Massachusetts.


gils said...


Sandhya Sriram said...

i am posting this at 11.23 PM IST on 22nd Jan, Deepa's post is already dated 23rd.

Your audience spread across time zone, thoughts zone and topic zone with no limits on any direction. that is the magic of your charisma :-)

Obama's moves have been thus far reasonably sensible. this one sounds sensible @ one end. but it has to be handled in a mature fashion. maybe an economy like US can still give it a try.

Deepa said...

//By losing the battle, he may have improved his chances of winning the war.//

So you mean, if his proposals are shot down, he would have ultimately proved who the villian is!

I was going on a tangent before this! :P

Ramesh said...

@gils - Thalaivar has to be first always !

@Sandhya - Oh Sandhya you should be asleep by then ....

I think its going to happen. There is already presedence - when AT&T became too big in the 70s, they broke it up. Some way or the other, it has to happen with banks. Because next time, they would have grown so big that even governments can't bail them out - we would have a major civil war if a crisis like that happened - imagine if the entire savings of a large section of the population went up in smoke and you literally had only the cash in your pocket as wealth.

Ramesh said...

@Deepa - Not so much that way. A major policy change like health care has to have some degree of bipartisanship to succeed in what has become a very polarised America. When the Democarts were ramrodding their bill, the opposition to it has been vitriolic and growing amongst half the population. Now that the super majority has gone, the Republicans too have to find some compromise - if they simply scuttle the bill; the anger of the other half of the population will turn on them viciously. Healthcare reform can only succeed if at least a few members from the other side vote for it. Now Obama will reach out more to the other side and they can't simply reject everything. Hence I think the greater the chance for the "war" to be won.

gils said...

firstu vanthu edathapudichi vachitu odipoiten..jus nw read the post...losing war to win battle!! politicsla ithu possiblea?? however great his reforms maybe..if they are not winning him seats in only shows that he is not successful in selling his idea to people or explaining to them about what he is trying to do...which will ultimately lead to his ouster and some crackpot populist guy might come in power...
and chaos reigns!! :D:D

Ravi Rajagopalan said...

The great thing about American public life is that the politics of interests always trumps over the politics of identity. This is why I believe even a truncated Health Care bill will be a landmark. But for that to happen, Obama must stop being Lincoln and go back to his Chicago machine roots, and become LBJ - the racist, segregationist, serially unfaithful, faithless friend, crude and foulmouthed man, who passed the Civil Rights Act and the Voting Rights Act.

VA said...

True, "too big to fail" applies perfectly to financial institutions, banks or companies with relatively longer working capital cycles, for the implications have been well witnessed by us in last 20 months or so.

The measures proposed by Obama should definitely address the underlying causes. On a second thought, isn't limiting the size and concentration of banks too drastic a measure as not everyone runs a hollow business? I am not sure of the alternatives available to Obama at the moment though (You would definitely be knowing a lot about this). Companies/ banks/ FIs with strong fundamentals are more often able to weather such financial storms.

Ramesh said...

@gils - because the American system of govt is very different, I think Obama actually agains. He is directly elected ; so if the Senate blocks his proposals, he actually stands to gain from the public.

@Dada - Without doubt the helthcare bill will be a landmark. It actually amazes me of how vitriolic the opposition to it is. On this Americans are truly backward compared to the rest of the world.

@VA - No it isn't too drastic I think. Even a well run company now, could become a basket case in course of time. The world cannot affod a too big to fail situation even if too big is well run and looks good now.

VA said...

Yes, very true!

J said...

//I think the Massachusetts result is actually a boon for Obama politically//

I so hope you are right. I dont understand how Americans are so divided on something as fundamental as health care. Unfortunately, I guess the timing is also not the best.

Exkalibur666 said...

Isn't Reliance in our own back yard going forward in the same direction...being too big to much is Reliance's weight in the SENSEX..

Ramesh said...

@Exkalibur - Yes Reliance has become very big, but I don't think size is such a problem in any other industry other than banking. If Reliance falls many people will get hurt, but everything won't come to a standstill. If even a mid sized bank falls, the chain effect is such that everybody gets killed. Hence I think the too big to fail concept has to be attacked vigorously in the banking sector alone.

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