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The
"Too Big to Fail" Lie (As Applied to US Banks)
By
Steve Saville The
Speculative Investor
February
23, 2010
Below is an excerpt from a
commentary originally posted at www.speculative-investor.com
on 28th January, 2010.
"They
are too big to fail" was the reason given for using trillions
of dollars in money and guarantees to 'bail out' several large US
banks during 2008-2009. Their failure, it was argued, would all but
bring the entire economy to a standstill; such were the size and
scope of their operations. Providing the banks whatever financial
support they needed to remain in business was therefore touted as
serving the "public interest". However, the "too big
to fail" argument was a giant, multi-faceted lie.
One part of the lie was that rescuing the banks would ensure the
continued flow of credit to private individuals and businesses. It
is now blatantly obvious that this was not true because bank lending
has been in decline ever since the bailouts. Although, perhaps we
are being unkind and it should be put down as a basic
misunderstanding stemming from the popularity of fallacious
Keynesian economic theories.
The crux of the lending issue was/is that the pool of real savings
became severely depleted during the inflation-fueled boom of
2003-2007. It should therefore be no surprise that the private
economy has since been desperately trying to replenish its savings,
and, as a consequence, that there has been less desire and less
ability to create new debt. Once the real issue is understood it
becomes clear that the banks were never likely to quickly return to
their old lending habits and that it would be bad for the economy if
they did.
A second part of the lie was that depositors were at risk, when it
was actually just the bond- and equity-holders of the banks that
were at risk. The bailouts were essentially carried out to prevent
the owners of bank bonds from taking losses on their bad investments
under a policy that could be aptly named "no bank-bondholder
left behind".
A third part of the lie was more a misdirection than a lie, because
the ultimate source of the funds for the bailouts was deliberately
kept vague. There was always the implication that the government was
funding the bailouts, but the government doesn't have or generate
any real savings and can therefore never fund anything. The harsh
reality is that the bailouts involved a massive transfer of wealth
from the rest of the economy to the banks' bondholders in the first
instance, and later to the banks' managers and traders.
Understanding how government bailouts of failed businesses are
funded reveals the overarching lie that a bank or any other business
could ever be "too big to fail". The truth is that one
business or economic sector can only ever be given artificial
support at the expense of other parts of the economy, so the bigger
the business the LESS sense it will make, from an economy-wide
perspective, to bail it out. Moreover, when a business fails it
doesn't just disappear in a puff of smoke; rather, the parts of the
business that are economically viable get sold off and resources get
freed-up to be used elsewhere. In the cases of the big banks, the
underlying banking businesses were healthy and would have continued
to operate under different ownership if the banks had been permitted
to go bust.
Unfortunately, the "too big to fail" lie is still going
strong. From the government's perspective, the theory that the
financial crisis had a lot to do with the sizes of banks* is just
too good to let go. This is because it not only provides
justification for the huge wealth transfer of 2008-2009 and diverts
blame from the government and the Fed; it also creates an
opportunity for the regulators to be seen as saviours rather than
culprits.
President Obama's current proposal** to limit the size and scope of
the banks is the latest in a long line of attempts to portray
regulators as saviours, but we wonder if the public is starting to
'wise up'. The proposal came in the immediate aftermath of the
Massachusetts election shock and has clearly been designed to
redirect the anger of the voting public from big government to big
banks, but could the voters finally be twigging to the reality that
what's needed, more than anything, is a smaller government? Maybe,
although a less optimistic appraisal would be that the average voter
still sees no problem with government-enforced wealth distribution
as long as he/she is a direct beneficiary of the distribution. In
any case, a devout believer in central planning will perceive every
problem as a justification to expand the role of government, even
when it is patently obvious that government caused the problem. And
few are more devout than Mr. Obama.
With regard to the so-called "too big to fail" banks, the
correct solution is very simple and requires nothing except the
application of basic property rights. The solution is to take away
the legal privilege to counterfeit money that the banks currently
enjoy, thus putting the banks on a level playing field with everyone
else. Not surprisingly, this solution is not up for consideration.
*The
immense size that some banks have been able to attain is a symptom,
not a cause. It is a symptom of an inherently unstable monetary
system -- a system that allows money to be created out of nothing by
the private banks and the central bank.
**According to a White House press release last
week: "...the proposal would: 1. Limit the Scope -- The
president and his economic team will work with Congress to ensure
that no bank or financial institution that contains a bank will own,
invest in or sponsor a hedge fund or a private equity fund, or
proprietary trading operations unrelated to serving customers for
its own profit. 2. Limit the Size -- The president also announced a
new proposal to limit the consolidation of our financial sector. The
presidentís proposal will place broader limits on the excessive
growth of the market share of liabilities at the largest financial
firms, to supplement existing caps on the market share of
deposits."
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