Too Big to Fail: A Worsening Problem?

One of the themes stressed by the BarCap research is that the funding problems of weak banks are likely to see stronger, better-funded, European banks growing bigger at their expense, thus exacerbating the Too Big to Fail problem.

This isn’t a theoretical issue. Former IMF Chief Economist Simon Johnson has been flagging for some time that the crisis has seen the biggest six banks in the US substantially increase their overall share of bank assets. Johnson’s recent AEA presentation is well worth reading. It paints a depressing picture in which the rescue of the financial sector has boosted and emboldened the leading banks and, with a timid and perhaps compromised US Treasury unwilling to act, Johnson seems to be predicting an even larger crisis down the road.

It’s hard to know how much to agree with this diagnosis. Johnson is hardly the only person discussing this as a serious issue. For instance, Mervyn King has spoken in very strong terms about this issue, for instance in this speech which has many choice quotes including:

Anyone who proposed giving government guarantees to retail depositors and other creditors, and then suggested that such funding could be used to finance highly risky and speculative activities, would be thought rather unworldly. But that is where we now are.

Andy Haldane’s “doom loop” speech is further evidence of how seriously the Bank of England takes this issue.

In the US, while the Treasury has clearly whiffed so far on this issue, influential voices such as Paul Volker and St. Louis Fed President Thomas Hoenig have also emphasised the importance of dealing with TBTF. Even more officially, the Basle Committee is apparently now looking in to special treatment of global banks that are deemed to big to fail. So perhaps there are reasons to think that, um, this time might be different.

Still, with leading international banks making money again and huge bonuses back, it’s hard not to get the sinking feeling that the bankers will be able to water down proposals for tighter regulation and that we could heading down the same path yet again.