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If They're Too Big to Fail...

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If They're Too Big to Fail...

then why are they still in business?

It was January of 2008—long before Bear Stearns, Fannie and Freddie, AIG and credit default swaps became regular topics at American dinner tables—when David Henry, a reporter for BusinessWeek, posed the following: “It’s the question bank regulators dread: Should they bail out a crucial bank if it collapses?

“With economic and market conditions sliding precipitously, risk is rising fast that at least one major institution could implode, endangering the financial system with it.”

He went on to predict: “... if the casualty is any one of about a dozen U.S. commercial banks or a handful of other prominent financial players, regulators would probably feel compelled to fashion some kind of bailout to keep the damage from spreading to the broader financial system.”

Almost three trillion dollars later the American taxpayer knows all too well that there are many businesses the government deems to be too big to fail. What the American taxpayer does not know, and what the government seems to be ignoring, is whether or not it’s in our best interest to fix the symptom of big business run amuck without fixing the underlying cause—institutions so large that their failure threatens the failure of not just the U.S. economy, but the economy throughout the world.

Simon Johnson, a former chief economist for the International Monetary Fund, warns that current bailout efforts are not enough for the American economy to recover; in a special report for The Atlantic, ("The Quiet Coup" - read it here) he likens the U.S. to a “banana republic” and says the IMF experience has shown, “the biggest obstacle to recovery is almost invariably the politics of countries in crisis.

“Typically, these countries are in a desperate economic situation for one simple reason—the powerful elites within them overreached in good times and took too many risks.”

He points out that policies associated with the current problem—”lightweight regulation, cheap money, the unwritten Chinese-American economic alliance, the promotion of homeownership—(all) had something in common. Even though some are traditionally associated with Democrats and some with Republicans, they all benefited the financial sector.”

And he says that in order to truly fix the problem we must temporarily nationalize banks, clean them up, and then force them to become smaller entities. “This is the best way to limit the power of individual institutions in a sector that is essential to the economy as a whole.”

Matthew Goldstein of BusinessWeek concurs. “What’s needed now more than anything, is a plan to ensure that no financial institution is ever again ‘too big to fail,’” he writes.

Even former Secretary of Labor Robert Reich is sharing the call: “Pardon me for asking,” he writes in his blog, “but if a company is too big to fail, maybe—just maybe—it’s too big, period.”

Not to mention whether we’re even competent to judge when that’s the case. Take the AIG bailout, for instance, triggered out of concern for the failure of their counterparties—like Goldman Sachs. AIG got bailout funds and Goldman got $12.9 billion of those dollars. Yet Goldman’s Chief Financial Officer, David VInar, now says Goldman was never in danger of failure if AIG had gone under.

Businesses who received dollars in the initial bailout package are still refusing to tell Congress where those dollars went, and still have not communicated just how much money they’ve lost. As Johnson writes, “At the root of the banks’ problems are the large losses they have undoubtedly taken on their securities and loan portfolios. But they don’t want to recognize the full extent of their losses, because that would likely expose them as insolvent. So they talk down the problem, and ask for handouts that aren’t enough to make them healthy (again, they can’t reveal the size of the handouts that would be necessary for that), but are enough to keep them upright a little longer.”

The current $2.8 trillion in bailout dollars throws a frightening shadow over any long-term health for the American economy. That amount is “like having a second U.S. budget dedicated solely to saving the U.S. financial system, and that truly is surreal,” said Finance Committee chairman Sen. Max Baucus (D) of Montana.

And for Johnson, that former IMF official, the current refusal to consider whether it’s in our best interest to allow businesses to become too big to fail does not give him much faith in America’s future.

“...the U.S., of course, is the world’s most powerful nation, rich beyond measure, and blessed with the exorbitant privilege of paying its foreign debts in its own currency, which it can print. As a result, it could very well stumble along for years—as Japan did during its lost decade—never summoning the courage to do what it needs to do, and never really recovering. A clean break with the past—involving the takeover and cleanup of major banks—hardly looks like a sure thing right now.

“In my view, the U.S. faces two plausible scenarios. The first involves complicated bank-by-bank deals and a continual drumbeat of (repeated) bailouts, like the ones we saw in February with Citigroup and AIG. The administration will try to muddle through, and confusion will reign.

“The second scenario begins more bleakly, and might end that way too. But it does provide at least some hope that we’ll be shaken out of our torpor. It goes like this: the global economy continues to deteriorate, the banking system in east-central Europe collapses, and—because eastern Europe’s banks are mostly owned by western European banks—justifiable fears of government insolvency spread throughout the Continent. Creditors take further hits and confidence falls further. The Asian economies that export manufactured goods are devastated, and the commodity producers in Latin America and Africa are not much better off. A dramatic worsening of the global environment forces the U.S. economy, already staggering, down onto both knees. The baseline growth rates used in the administration’s current budget are increasingly seen as unrealistic, and the rosy “stress scenario” that the U.S. Treasury is currently using to evaluate banks’ balance sheets becomes a source of great embarrassment.

“Under this kind of pressure, and faced with the prospect of a national and global collapse, minds may become more concentrated.”

There is, of course, a third possibility that Johnson doesn’t consider—that the American public itself limits an institution’s ability to become too big to fail by ceasing to support that institution with its dollars. No one is forcing us to deposit money with bank beheamoths like the five biggest—Bank of America, Wells Fargo, Citibank, JP Morgan Chase and HSBC Bank USA—who have been called “Dead Men Walking” even after $145 billion between them in bailouts, due to their holdings in credit default swaps, “a ticking time bomb,” according to a company that grades banks on their degree of loss risk.

The “Buy Local” movement may be more important than you think, especially when it comes to where you deposit your money.

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Landon Otis

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money, banks, bailout, too big to fail, Simon Johnson

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