Monday, July 6, 2009

Too big to fail

A large part of the rational for the massive government bail out is that the companies are “too big to fail”. I, as a layman, take that phrase to mean that the particular company is so interwoven with its industry that letting it fail would hurt the entire industry. I also take it to mean that the damage to that particular industry would damage the entire economy.

The politicians listened to the industry experts and began dismantling the Glass-Steagall Act of 1933 with changes the Depository Institutions Deregulation and Monetary Control Act of 1980 and by the Gramm-Leach-Bliley Act.

Some, but by no means all, of these changes were key to the financial melt down in the US economy. A few financial experts warned against those changes which allowed the merging of banks into such big conglomerates. A lot of us laymen worried about those same changes and warned whoever would listen (not many people) that these changes were risky.

One of the big reasons sighted was to allow the aggregation of capital to finance bigger projects than the smaller institution could finance. The truth be told, it never was about figuring out how to finance the projects, it was always about those specific companies being able to finance the entire project by themselves, instead of forming a limited corporation to finance that single project.

We’ve known how to create a corporation to finance big projects for several hundred years. The problem, of course, is that the profits are shared by all the partners not retained by a single entity.

We recognized in 1933 that some financial transactions should be firewalled from other transactions. We also knew that we needed to regulate the size of any single institution to keep them from getting "too big to fail". We changed those regulations, not to make the public safer, not to make the business more efficient for the public, we change the regs to make selected institutions more profitable. Not to keep them alive, but to enhance profit.

One thing you learn in business that politicians don’t seem to learn is that if it’s not working, stop doing it!

The changes to the banking regulations that apparently helped create this firestorm need to be changed back, and as quickly as possible to the ones that gave us a stable economy for almost 60 years. We need to demand that those over-bloated banks get back to a size where no single institution can ever be “too big to fail” again.

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