Bernanke on "Too Big To Fail"

Bernanke gave a speech on Saturday.

I will spend some time today discussing the efforts the Federal Reserve and other policymakers are making to put an end to the too-big-to-fail problem and thus help foster effective competition in financial services.

Among the most serious and most insidious barriers to competition in financial services is the too-big-to-fail problem.

The costs to all of us of having firms deemed too big to fail were stunningly evident during the days in which the financial system teetered near collapse. But the existence of too-big-to-fail firms also imposes heavy costs on our financial system even in more placid times. Perhaps most important, if a firm is publicly perceived as too big, or interconnected, or systemically critical for the authorities to permit its failure, its creditors and counterparties have less incentive to evaluate the quality of the firm’s business model, its management, and its risk-taking behavior.

Well, at least he understands the problem. Right now, today, every liability of Goldman Sachs, Morgan Stanley, JP Morgan, Bank of America, and Citigroup is 100% guaranteed by the U.S. taxpayer. The events of the past two years have left no doubt about this.

The solution, of course, is self-evident: Break up the big banks. You cannot be too big to fail if you are not too big.

But then, I don’t have a Ph.D. from Princeton.

Some proposals have been made to limit the scope and activities of financial institutions, and I think a number of those ideas are worth careful consideration. … But even if such proposals are implemented, our technologically sophisticated and globalized economy will still need large, complex, and blah blah blah blah

Bernanke goes on to describe the Fed’s three-pronged “solution” to the TBTF problem.

First, increased supervision and regulation, taking account of “potential risks to the financial system as a whole, and not just those to individual firms”. (Never mind that history shows these banks will always — always — find ways to evade regulation. Heck, that is what half of all financial “innovations” are all about.)

Second, programs to “increase the resilience of the financial system itself”, like improving “the clearing and settlement of credit default swaps”. (Right. As if Goldman Sachs would never get a bail-out if only their CDS contracts traded on an exchange…)

Third, “resolution authority”. This is the most laughable of all. We already have a resolution authority; it is called the FDIC and the Prompt Corrective Action law. It has never been used on any firm of significant size, nothing like it ever will be, and everyone knows this.

In my humble opinion, Professor Johnson makes a much stronger case than Professor Bernanke.

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