I hate when politicians try to make “too big to fail” about whiny consumers who couldn’t get a loan to finish a deck that overlooks their backyard. The concept raised its head again during a Senate sub-committee hearing on J.P. Morgan Chase’s loss of some six or more billion dollars, a loss resulting from some bone-headed position they took on a trade.
What politicians should be saying is that neither a bank, no matter how large, or a consumer, no matter the size of the proposed deck, should get a bailout. Taking away the punch bowl would result in both banks and consumers practicing more discipline over their own banking practices.
For banks, a major part of that discipline may be reducing the number of connections they have with other banks. While regulators and commentators have determined that the size of a bank, whether measured by customer base, amount of deposits, or market capitalization lies at the root of the problem with banks, I see the cause of the bank problems having to do with where they invest their funds and who invests with them. Banks saw their assets take a hit when the value of the securities they held in other financial institutions started to take a hit. When the bankers of bankers realized that their capital and the expected returns on them might evaporate, they made calls that became less likely to be answered. If Citibank didn’t own assets backed by loans made by Countrywide or any other institution where consumers could not keep up with payments, we more than likely would be having another conversation. Were there a regulation prohibiting this type of connectivity, banks may not have found themselves in this type of mess. Maybe banks should have had their investments and lending restricted to non-financial entities, thus investing in real drivers of the economy instead of just investing in paper junk held by their financial entity cousins.
But therein lies a dilemma. Should government, even based on an argument of protecting the economy, regulate a bank’s entry into a market relationship with another bank? I don’t think it should. What government can do is cut off the spigot. The government should reintroduce the notion of risk into the market by taking away the punch bowl. Congress should pass and the President sign into law legislation that terminates the discount window and federal funds overnight loans between banks.
Also, the federal government needs to get out of the deposit insurance business. Put the onus on the consumer to do its due diligence to identify banks with practices that put the capital “F” into fiduciary.
I would expect the “government as Sky Daddy” advocates will scream and shout that consumers need protection from abusers of the public’s trust, but the best reassurances that a consumer can have is that of information. If government has any role, it should be that of information clearing house. Government can do what it really does best which is become a depository of market information accessible by banks and consumers alike. Consumers with unbiased, low cost market information may be able to make better decisions about where to put their deposits and make their investments.