Too big to fail? / by Simmon Li

While I didn't really like "too-big-to-fail", I think the Euro debt crisis is a clear illustration of what happens when the government (and therefore tax payer) underwrites the risk of the financial industry. Regardless of the consequences, I think we ought to consider a sensible way to dismantle "too-big-to-fail". I don't advocate letting all these institutions fail at once, but the solution needs to yield a new way of doing things, and not simply reinforce the system. I'm aware of our growing fiscal/deficit problems here in North America, and this is where my concern stems from. It's an interesting system where politicians (G20 Seoul, for example) all agree that there are systemic risks, and draft a list of international "too-big-to-fail" institutions to address these risks. That strikes me as the wrong way to go about solving this problem. Perhaps I have no idea what I'm talking about (likely the case), but as I said to a friend, I think the solution needs to pave the way for reform and regulatory oversight. The dismantling of financial oversight, domestically for the United States, has been terrible for the world. Iceland's national bank went under around a year ago, Greece 6 months ago, and the story on the horizon is Ireland. Next up, Portugal, Italy, France, and some other European states. I believe it's only a matter of time before the problem snowballs into one with much more gravity than the current situation. As I mention, I don't think we're immune to the problem here in the Western hemisphere. Canada's debt as % of GDP is pretty high (if I recall, it's around 76%), and growing. The US isn't as saturated, but the rate of acceleration is higher by 2 fold (~35% vs ours at ~17%). Battered already by the weak global economy, this debt problem will only make things worse. The problem of too-big-to-fail stems from the fact that governments and other institutions underwrite the risks, which means debt increases should these failures happen. Instead of too-big-to-fail, I think the label "risk-free" is a better way of characterizing what is actually happening. Essentially, once a too-big-to-fail fails, the government steps in and starts to manage it. So, we have increased government size, increased debt, and we reinforce the idea that as a manager of this institution, you can run risks that may be just slightly unreasonable because the government has you covered. In an interesting twist, a lot of banks actually don't want to be assigned the G20 "too-big-to-fail" label, because they will be required to have more liquidity, keep more cash on hand, while also being subjected to tighter oversight. I've said that I don't like the label, I think the increased oversight and monitoring are paramount. If the G20 Seoul list and accompanying policy recommendations are implemented well (and that's another can of worms), I believe that it will be much better than not having such oversight. At the end of the day, I'm an advocate for more oversight and sensible regulation so that we are prevented from even stepping into this "too-big-to-fail" territory.

Now, as someone who knows very little about all the macroeconomic issues and theory involved in this crisis, it just seems to me like the extension and continuation of the systemic risks by way of too-big-to-fail only leads to degenerative cycle: ~6 months down the road another bailout is needed for another institution. Call me populist, but the fact that many financial institutions made record-breaking profits in the past two years speaks to the apparent failure of this bail-out business. If it's supposed to save economies, it clearly hasn't. It's saved certain segments of the economy, but the "real" economy is still suffering (see the US). As far as I'm concerned, the EU debt problem is a glimpse into the future, and it's one that's worth taking a look at. As far as the original bailouts are concerned, I think they did do some good in that they helped to prevent a further slip down the slope. More importantly, I think they were important to exposing the systemic risk and failure in the system. I think it can be forgiven because it was the first time we've encountered something of this scope and magnitude. While history likes to ascribe the end of the Great Depression to the New Deal (I think it helped to stop the plunge), it was really World War II that ended it. In defence of bailouts though, the Marshal Plan worked wonderfully to get Europe and Japan back on track. So I think bailouts *can* work, but as with everything in government and politics, it's the implementation that matters, not how much money we throw away. In any case, it seems to me that the solutions proposed so far seem to focus on specific parts of systemic risk without considering the whole construction. The effectiveness of the bailout can be discussed, but by creating bailouts you end up causing problems elsewhere (debt, in this case). These two are inextricably linked, and I fear that if we keep going down this garden path, we will soon find ourselves lost and unable to get out. Canada remained relatively stable in 2008 due to stringent regulation and oversight which, interestingly enough, is missing in the US: coincidence? It's certainly something to think about. While Canada may have escaped fairly unscathed, I think we have to remain cautious about the EU debt situation.

In any case, anarchy isn't the answer. We can't be  having many of these institutions fail at once, it would be silly. On the other hand, extending olive branch after olive branch on taxpayer dime is also silly and unsustainable. We need to expose the system to checks and balances to make sure that we don't reach a "too-big-to-fail" point.