Too Big To Fail

Sometimes, albeit rarely, politicians get it right. Such was the case yesterday, when Senator Bernard Sanders, Vermont independent, stated:“If an organization is too big to fail, it is too big to exist.”

Some background: In trying to prevent a financial meltdown, the previous Secretary of the Treasury, Henry Paulson, encouraged and in fact forced certain mergers to occur: JP Morgan took over Bear Sterns and later Washington Mutual, Wells took over Wachovia, and Bank of America took over Merrill Lynch. After absorbing these dwindling businesses, each of the previously strong firms needed to take down significant funds from the government to stay afloat. The government had determined that these financial behemoths, as well as AIG and others, were "too big to fail," i.e. the repurcussions to the economy were too great to allow one of them to default on their many obligations.

The argument previously for allowing combinations of large financial institutions had been that competition among financial institutions had become global, and to compete globally you needed to be big and have the ability to deliver every product. So banks merged, merged, merged until they could deliver all these products and underwrite huge sums. But as they became more competitive globally, they spread the risk of their failure throughout the world. Now, if Citibank fails, it affects not just the US but also Europe, Asia, and Latin America in a meaningful way.

Further, until the early 1990s the businesses of banks and investment banks were quite separate. With the fall of Glass Steagle, a depression era law requiring those businesses to remain apart, the lines distinguishing the two businesses fell away. Banks became investment banks, investment banks became banks. The consequences, as we know now, were disastrous.

The answer is simple - these firms are too big, they need to be broken up. Just as there are limits on the market share of broadcast companies and cable tv companies, there needs to be limits on banks. Also, the lines of business need to again be separated. This is the only way that the failure of a single institution or a single market will have less impact on the economy and financial markets as a whole.

So score one point for Senator Sanders. It may be a long time before another politician gets one right again!