Too Big to Fail and Other Stupid Ideas

Two things are bugging me: the government has yet to articulate its vision for the future US Banking landscape, and “too big to fail” remains among the biggest threats to the US economy. Last Friday, Georgian Bank was the 95th bank to fail in the US so far in 2009. The expected hit to the FDIC was $892 million.

The Federal Reserve has kept short-term interest rates near zero for some time and promises to keep them there for some time longer. Lowering interest rates alone hasn’t been enough to combat the critical condition of the US economy; the Fed has also been practicing “quantitative easing.” That’s where they push liquidity into banks. And as most are aware, the Fed has come up with dozens of creative programs like buying mortgages or swapping illiquid securities or lots of other nifty maneuvers. They’ve done a commendable, though not flawless, job of keeping the US Economy out of the morgue.

But, as the government has patched and puttied and battened us down with odd sheets of plywood, a new structure is taking shape. A new financial architecture is forming, and there are no blueprints. We’d better like whatever it is we end up with because it is a behemoth beyond imagining. Will Dr. Bernankenstein be content with whatever form this reanimated monetary flesh may take? And wouldn’t it make sense to have a future vision with pre-considered goals and consequences which current policy could pursue? Could the better course be as simple as having a proactive rather than a reactive plan, and shouldn’t effective leadership require having a plan?

Jamie Dimon, CEO and Chairman of JP Morgan suggested last week that the US needs a policy against the “too big to fail” summary conclusion for banks. We have enormous respect for Mr.. Dimon, but jeez, Mr.. Dimon, are you kidding? Why don’t you also suggest adopting a policy against major hurricanes and raging wildfires? Because we’ve just endured a torturous period during which we’ve all learned that “too big to fail” is precisely what we had and precisely what we continue to have.

First Bear Stearns and second and most important Lehman Brothers demonstrated the mutually dependent, mutually parasitic relationships among all major and most minor financial institutions. Bear Stearns needed the Federal Reserve’s help to stay alive when all the other banks it traded with – that were counter-parties on lots of short-term financial instruments – became worried about Bear and didn’t want to trade with them anymore. But, bad news for the other guys too because the rules say that if Bear Stearns holds a note that no one wants to buy from them, and Bear has to mark that asset at whatever low price it will take to unload it, all the other institutions that hold that same note have to mark it at that same low price on their balance sheets. If too many things that they hold get marked lower, their balance sheets starts to look weaker, and pretty soon no one wants to do business with them either.

The inter-relatedness of banks, and the countless tentacles of the bigger banks, one to another, was both tinder and accelerant as our financial blaze grew and grew. While it seems that the destructive path has been assuaged, the root cause is not only still present, but as consolidations have increased, the risk for future collapse has grown. So… let’s have a policy against it? Having a plan would be preferable.

Both of these topics are related. That “too big to fail” has grown through big banks becoming bigger is a perfect example of a potentially fatal consequence of not developing a long term strategy or vision.

Transparency, compartmentalization, and accountability must be a part of the new American Banking System. Like it or not, our banking system is morphing daily. The new super-sized banks look more risky than the old ones that speeded our descent into this troubled labyrinth.

Hang in there.