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Too Big to Fail but Not Too Big to Save

The systemic problem underlying this crisis has been succinctly described as the ” too big to fail, but not too big to save” banking system we have been lumbered with. Willem Buiter, not one to shirk a challenge, has a go at what governments should do. I like the idea of stripping the Limited Liability cover from shareholders the best.

The too big to fail problem has been central to the degeneration and corruption of the financial system in the north Atlantic region over the past two decades. The ‘too large to fail’ category is sometimes extended to become the ‘too big to fail’, ‘too interconnected to fail’, ‘too complex to fail’ and ‘too international’ to fail problem, but the real issue is size.  The real issue is size.  Even if a financial business is highly interconnected, that is, if its total exposure to the rest of the world and the exposure of the rest of the world to the financial entity are complex and far-reaching, it can still be allowed to fail if the total amounts involved are small.  A complex but small business is no threat to systemic stability; neither is a highly international but small business.  Size is the core of the problem; the other dimensions (interconnectedness, complexity and international linkages) only matter (and indeed worsen the instability problem) if the institution in question is big.  So how do we prevent banks and other financial businesses from becoming too large to fail?  Link to article

Simon Johnson from the Baseline Scenario has his own take on this too and wonders what further nightmare we are storing up by ducking the issue.

The second view, of course, is rather more skeptical regarding whether we are really out of crisis in any meaningful sense.  In this view, the underlying cause of the crisis is much simpler – the economic supersizing of finance in the United States and elsewhere, as manifest particularly in the rise of big banks to positions of extraordinary political and cultural power.

If the size, nature, and clout of finance is the problem, then the official view is nothing close to a solution.  At best, pumping resources into the financial sector delays the day of reckoning and likely increases its costs.  More likely, the Mother of All Bailouts is storing up serious problems for the near-term future.

We’ll double our national debt (as a percent of GDP), and for what?  To further entrench a rent-seeking set of firms that the government determined are “too big to fail,” but will not now take any steps to break up or otherwise limit their size.  Link to article

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